Structuring Residential Leasehold Development Schemes - Part 2

Our first blog in this series of blogs on ways to structure a residential leasehold development scheme focused on a developer retaining both the reversion and the management of the building.

In this second blog, the focus will be on the developer who wishes to retain the reversion but wants to contract out the management and provision of services to a management company.

A developer may want to collect the ground rents reserved under the leases, particularly if they are more than nominal sums, and will therefore retain the freehold interest in the building. However, the developer may not also want to be responsible for the ongoing management obligations and can contract out these obligations to either a tenant’s management company, a professional management company or via an associated company under the control of the developer.

Tenant’s management company

• Under this arrangement, the scheme will be set up as a letting scheme where tenants from a common landlord enter into interlocking restrictive covenants governing the use of their respective premises.
• The landlord will grant the individual leases to the tenants but the entirety of the development will be divided up between each of the leases so no part is left undermined. The tenants will covenant with both the landlord and each other to repair and ensure the flat and also any common parts included within the demise to each tenant.
• The landlord will covenant to grant all the leases in the same form and to enforce the tenant’s covenants in other leases, and each tenant will covenant not to assign its lease except to someone who enters into a deed of covenant with each of the other tenants to perform the tenant obligations in the lease.

This arrangement is suitable for smaller developments as a deed of covenant needs to be entered into each time a tenant sells its property. This will involve the incoming tenant having to covenant with each of the existing tenants and each having to execute the deed which can be problematic if there are a large number of existing tenants.

Professional management company

With this arrangement the developer will have three choices:

• Remain the landlord and employ the management company as its agent;
• Join the management company as a party to the lease with the intention that the developer will either transfer the freehold to the management company, grant the management company a lease of the reversion or grant the management company a lease of the common parts;
• Join the management company as a party to the lease with no intention of granting it a legal interest such as in (ii) above. It should be noted that in this situation the management company will be a ‘floating management company’ where the management company will not enjoy a landlord-tenant relationship with the tenants, making enforceability of covenants problematic for the management company.

The clear advantage of using this arrangement is that the management function will lie with a professional management company that will have experience in managing developments.

There are, however, a number of disadvantages, including the enforceability of the covenants issue mentioned above by and with the floating management company.  In addition, the landlord will remain liable to the tenants under the covenant in the lease to carry out the management company obligations should the management company fail to do so, and if the developer landlord is not satisfied with the performance of the management company and the management company is joined as a party to the lease, it will be difficult to change the management company.

The associated company under the control of the developer

With this arrangement the developer can either:

• Employ the associated company as an agent. Here, the landlord would still be directly accountable to the tenants and the landlord-tenant relationship is preserved;
• Join the associated company as a party to the lease with the intention that the developer will either transfer the freehold to the management company, grant the management company a lease of the reversion or they will have no legal interest at all and will be a floating management company, however, as set out above, it would be advisable to avoid the latter option.

As such, a developer will need to think carefully about the type of management company it wants to contract out to and the type of arrangement which is most suitable for it and also for the tenants.

Our next blog in this series will focus on the situation where a developer wishes to dispose of the freehold interest and the management, both to a tenants’ management company. We will set out what happens when the landlord transfers the freehold or grants a lease of the reversion to the management company, and the advantages and disadvantages of this arrangement.

If you are a developer entering into a leasehold development scheme and would like advice on the best structure to suit your needs, or if you would like us to set up a particular residential leasehold development scheme for you, our Commercial Property team can meet all of your legal needs. You can contact us by calling 0161 941 4000 or by emailing lawyers@myerson.co.uk.