Making the change to commonhold

1.1 Commonhold as a tenure

Commonhold was created in the UK by the Commonhold and Leasehold Reform Act 2002.  It is a form of freehold in which an owner owns their own unit and is also a member of the commonhold association ("CA") which owns and runs the common parts in the building or wider development.  The scheme is regulated by the terms of the commonhold community statement, which is in prescribed form here. The CA is a limited liability company with prescribed form articles of association set out here. To date, it has not been a commonly-used form of tenure.  There are various possible reasons for this, including a natural reluctance on the part of developers to move away from the familiarity of the leasehold system, and lenders' concerns about what would happen to a unit's value if the CA were to become insolvent and/or fail to maintain the scheme in good repair and condition.

1.2 The Law Commission's report

In 2020, the Law Commission published its report on commonhold, “Reinvigorating commonhold: the alternative to leasehold ownership”.  Its recommendations sought to tackle the primary issues with the existing commonhold system including: challenges in converting existing leasehold schemes to commonhold; the lack of suitability of the commonhold statutory framework for complex modern developments; concerns around the governance of the CA; and the inability to include shared ownership within the current legislative framework.  Mr Pennycock's announcement did not refer to this report so it is not known as yet whether these recommendations will be translated into a refreshed version of the current commonhold regime.

1.3 The Commonhold Council

The Commonhold Council was set up by the previous government to advise them on the implementation of a reformed commonhold regime and to bring forward solutions to prepare homeowners and the market for the widespread take up of commonhold for new supply of flats.  Any conclusions they reached have not been published, and their appointments have now lapsed.  It is unclear whether the Government's plans will incorporate any of the Council's work.

2.1 Transparency and control

In the commonhold system, the unit owners run and manage their own units and play a part in running the common parts of a scheme through participation in the CA. This means that the owners are able collectively to make their own decisions about repairs and services rather than these being taken on their behalf by a landlord.  It also has the benefit of owners not paying ground rents or other fees to a third-party landlord.

2.2 Areas of concern

However, commonhold is not without issues for residents, even if all the Law Commission's 2020 recommendations were to be implemented.  The main areas of concern for residents are as follows:

2.2.1 Disputes

As any leaseholder with a share of the freehold of their building knows, the idea that co-owners always agree about how and when to carry out repair works is unrealistic.  Owners of different parts of a scheme may have conflicting views about which works to prioritise, and may also have different budgets.  In the current regime, the CA's directors control the expenditure, and although unit owners can appoint and remove the directors, they currently have limited direct say or protection regarding the level of expenditure in the commonhold and, therefore, on how much each unit owner must contribute.  This contrasts with the leasehold system in which there are various protections for leaseholders, such as section 20 Landlord and Tenant Act 1985 which provides that leaseholders paying variable service charges must be consulted before a landlord carries out qualifying works or enters into a long-term agreement for the provision of services.

Also, most decisions within a CA are taken on the basis of a majority vote, and there are no protections for owners who are disadvantaged by any such decisions.  The Law Commission's report makes a number of recommendations regarding minority protection, including giving unit owners a right to apply to the Tribunal to challenge a vote of the commonhold association in certain circumstances.  Separately, the CCS contains a dispute-resolution mechanism, which involves a waterfall approach of arbitration or expert determination, referral to the ombudsman and only then litigation.  However, not all owners will have the time, money or determination to bring such an action – taking legal action against neighbours is notoriously stressful.

There are also concerns about the protections for vulnerable owners.  The Law Commission's report suggests that a CA should be able to apply to court for the sale of a defaulting unit owner’s unit, in order to recover arrears of commonhold contributions from the proceeds of sale, where the owner owes commonhold contributions, plus interest, of at least £1,000 or where any amount of commonhold contributions and/or interest has been outstanding for over one year.  Although they also suggest a protocol and a system of checks and balances, this would need proper consideration to ensure that residents have at least the same level of protection that they currently receive through the leasehold system of forfeiture that the Government wishes to move away from.

2.2.2 Management burden

One of the key features of commonhold is that the CA is a company limited by guarantee whose directors are unit owners, and it is obliged to organise the repair, maintenance and insurance of the property.  This means that the directors of the CA take on the responsibilities and duties of company directors under the Companies Act 2006 (such as acting within their powers; exercising reasonable care, skill and diligence; avoiding conflicts of interest; not accepting benefits from third parties; filing annual reports and accounts); from general law (such as a duty of confidentiality) and from statute (such as health, safety and welfare at work of its employees; and avoiding fraudulent trading). There are also specific statutory obligations that relate to real estate ownership and management (such as fire safety duties under the Building Safety Act 2022 and the rules relating to the management of estate service charge systems contained in the Leasehold and Freehold Reform Act 2024). 

For those residents who do not take on the role of director, there is still an expectation that they will attend regular meetings of the CA, take time to understand the issues and challenges faced by their community and participate in the voting process.  Clearly the extent to which individuals will take part will vary across schemes, but the evidence from the few schemes in England and Wales is that "engagement may not be forthcoming at all or may dwindle over time".^[1]

As mentioned above, the absence of a landlord does not equate to the absence of service charge.  Owners are obliged to make commonhold contributions to the CA and will face sanctions for non-payment.  Once the Leasehold and Freehold Act 2024 is fully implemented, they will have some legal protections against malpractice on the part of the CA but arguably less than if they were leaseholders paying a variable service charge to a landlord.

It is also important to acknowledge that property management is a highly skilled job and that, for some, employing a professional property manager will be the best solution.  This will be especially important where the common parts include complex communal facilities and the provision of additional services, such as the delivery of care services in some forms of retirement housing, in relation to which we have co-authored a report which is currently under consideration by Government.  The Law Commission's report stated  that "in all but small blocks, where self-management is a realistic choice, the expectation is that professional managers will be appointed"^[2].  This is very sensible but of course for the owners it means additional costs (paying the agents' fees) and complexity (sourcing, engaging and monitoring the agents' performance).

2.2.3 Conversion to freehold

The current process of converting an existing leasehold site to commonhold is very burdensome, requiring consent from all the leaseholders, mortgage lenders and the freeholder.  The Law Commission has made a number of suggestions for improving this process, but it would still involve a complex legal process and mean leaseholders having to find the funds with which to purchase the freehold (unless they already own a share of the freehold or if the Government provides loans to non-consenting leaseholders to cover their share of purchasing the freehold as per the Commission's recommendation 12).

The Law Commission acknowledges that lenders’ acceptance of commonhold is fundamental to the reinvigoration of commonhold, and has taken on board many of lenders' concerns.  As part of this, the Commission's recommendations include a number of thoughtful measures intended to reduce the likelihood of the CA becoming insolvent or of the common parts falling into disrepair.

However, one of their recommendations involves giving the CA the power to raise emergency finance through borrowing via a floating charge over the common parts.  UK Finance strongly objected to the principle that unit owners, as borrowers, should be able to support the creation by a commonhold association of a charge without the consent of their lenders.  Putting to one side the issue of whether anyone would want to offer finance on the back of this form of security, the Commission decided that rather than require the CA to obtain lender consent, they would require that where there are mortgages secured on the units, the grant of the charge should require the approval of the Tribunal. Any unit owner’s mortgage lender or other secured lender should have an automatic right to be joined in the proceedings to set out any objections to the charge.  This will enable lenders to get involved but the outcome of any such Tribunal hearing will be uncertain and will involve incurring legal costs.

In terms of a lender's position on the conversion of a leasehold property into a commonhold unit, the Commission recommends that Government work with lenders to facilitate the automatic transfer of charges from the leasehold title to the commonhold unit title on conversion.  UK Finance had warned the Commission that such automatic transfer of charges could be problematic because many of the loan agreements with consumers may not mention commonhold at all, which would potentially cause legal difficulties during the lifetime of the mortgage, not least around the enforcement of security where there are arrears.  However, the Commission felt that commonhold will offer lenders better security than a charge over a leasehold interest and that this substitution should not therefore be unpalatable to lenders.

4.1 New-build flats

If the Government does legislate to require new-build flats to be structured as commonholds, there will be an initial learning-curve for developers of owner-occupied residential units.  BTR and PBSA will probably not be affected as their residents are on short-term letting arrangements.  The Law Commission has set out a proposal whereby a developer would register a new development as a commonhold and would retain the right to participate in the CA for as long as, and in proportion to, the number of units which remain in its ownership as it builds out the scheme and sells off each unit.  The developer will also be able to reserve certain rights to make changes to the commonhold to facilitate subsequent development, but for no other purpose.  The Commission's recommendations also include provision for constructing a mixed-use or multi-block schemes in "sections", which would enable the effective management of commercial and residential interests within the commonhold and would ensure that only owners within a particular section are able to vote on (and liable to pay for) services and matters affecting that section.

An obvious point to make is that there would no longer be a role for landlords to remain involved in the management of an owner-occupied residential block after the sale of the final unit, so investors will need to change their investment strategies accordingly.  It remains to be seen whether an exemption or specific commonhold regimewill be made for any sub-sectors such as housing for vulnerable adults or certain models of retirement housing where care is also provided.

4.2 On conversion

The Law Commission's report sets out a number of suggestions for improving the process by which leaseholders could take steps to convert a building into a commonhold scheme.  The Government's decisions about which recommendations to implement will have significant repercussions for investors which currently own residential buildings let on long leases, ranging from how the price they receive for their interest would be calculated, through to whether they would be required to take 999-year leasebacks over the flats owned by leaseholders who did not agree to participate in the conversion process.  It will therefore be imperative to engage in the Government's planned consultation process in the New Year.

Mandating the use of commonhold for new residential flats would be a once-in-a-lifetime change in the UK's legal system. There are a number of areas within commonhold that need consideration in order to properly address the perceived issues with leasehold that the Government wishes to fix and make commonhold the better alternative. We look forward to participating in discussions with all stakeholders as to how best to update and reinvigorate commonhold to protect residents and businesses across the housing market alike. Please get in touch if you would like to discuss the ramifications of this policy for your business.