Rights of First Refusal – What is it and Why is it an Issue?

Part 1 of the Landlord and Tenant Act 1987, as amended by the Housing Act 1996, introduced the concept of the residential tenants' rights of first refusal.

Rights of first refusal is where a landlord is proposing to sell his interest in a building containing flats, the right may exist, and by law, the landlord must first offer it to the qualifying tenants before offering it on the open market.

For the right of first refusal to exist, the premises, the landlord and the tenants must meet certain requirements.

The Premises are defined as the "whole or part of a building" containing at least two flats, but no more than 50% of the premises are to be in non-residential use.  

The property litigation legislation is silent on what is intended as a building, but it is generally understood to mean a separate building, or in some cases, a part of a building which may be divided vertically from another part.

In the absence of a legal definition, you should apply the ordinary meaning of the word as being 'an inclosure of brick or stone covered by a roof'.  

The legislation states that if the proposed transaction involves the disposal of an estate or grant an interest and all conditions are satisfied, the landlord must serve a notice on each qualifying tenant known as the 'offer notice'.

Breach of this obligation by the landlord or his agent is a criminal offence, punishable by a level 5 fine on conviction (£5000). The local authority has the power to prosecute for this offence, but they are not obliged to.

The notice's form depends on the disposal type, so deciding which disposal options to take is important. However, the most common are sales by contract, referred to as section 5A notices.

The landlord will be considered to have complied if notice is served upon at least 90% of the qualifying tenants or all but one if there are less than ten qualifying tenants.

To identify and validly serve the notices on the qualifying leaseholders, it is necessary to review each tenant's lease and title documents. It may be pertinent to serve multiple notices in relation to the same flat.

It has been seen that the first quarter of 2023 is proving financially challenging for many individuals, and the temporary restrictions that were in place during COVID have now gone.

As a result, some predict that there will be an increase in formal insolvency procedures. Therefore, insolvency practitioners must be mindful of the right of first refusal.

There is an exemption where there is a disposal to a receiver or trustee in bankruptcy: the transfer of the estate to the receiver, liquidator or trustee in the first instance is an exempt disposal, as well as a transfer to the mortgagee in exercising a power of sale or leasing.

However, any subsequent disposal by the receiver, liquidator or trustee will not be exempt, and the tenants will need to receive notice of their rights.

The right of first refusal does not prevent corporate restructuring or family arrangements, and there are exemptions that could assist.

However, any complex restructuring must be carefully thought out, with each step assessed to determine whether the right will trigger.

It may be in complex disposals more than one section 5 notice is required. If this is the case, it needs to be planned to minimise delays caused by the statutory procedure.

For residential and mixed-use landlords trying to acquire property in a rapidly moving market, the Act can be problematic.

It is, therefore, important that the right of first refusal is considered initially to manage expectations regarding the outcome and timings.