Section 5, Right of First Refusal and purchasing the freehold

Section 5 of the Landlord and Tenant Act covers the Right of First Refusal. This means that (in most cases) when a Landlord wants to dispose of the freehold they must offer it to the leaseholders first, before offering it for sale on the open market.

Introduction

The RTM ("Right To Manage") company I'm part of became freeholders in August 2021. We did this under Section 5 of the Landlord and Tenant Act (1987), the so-called 'Right of First Refusal'.

Our situation was unusual in a couple of respects: the existing freehold company was in administration, so the freehold was transferred to us by the administrator, and it was a new freehold title created by splitting up a larger freehold into three parts.

Parts of this article will relate specifically to the situation we encountered, and might therefore be limited in relevance, but I hope there's enough generic Section 5 stuff to be of use to anyone acquiring a freehold under Section 5.

I should point out that the best source of information for leaseholders in relation to Section 5 — and most things to do with leaseholders, RTM companies etc. — is the Leasehold Advisory Service at lease-advice.org. Even the government refers people to this site in some of its official literature.

What is Section 5?

When a freeholder wants to dispose of the freehold, Section 5 describes a law that ensures the tenants (i.e. the leaseholders) are given the opportunity to acquire the freehold before anyone else.

You cannot force a freeholder to sell his interest under Section 5. If you want to do that, you need to use Collective Enfranchisement. But if a freeholder wants to dispose of the freehold interest then it must be offered to the tenants first. It's a criminal offence if a freeholder does not do this (other than in certain limited circumstances).

The freeholder sets the price they are prepared to sell at and you have no right to challenge that price at a property tribunal. You do have certain protections, though. If you do not want the freehold at that price, the freeholder can offer it for sale on the open market, but he must offer the open market the same price he is offering you. If he changes that price, he must first offer it to you, the leaseholders, at the new price before it can go back on the open market.

You have these protections under the law. If the freeholder breaches them it's a criminal offence, which will result in a fine, and you have the right to demand the opportunity to acquire the freehold under Section 5 even if the freehold has been sold to someone else in the interim.

Once you've been given an official offer of the freehold, Section 5 controls the proceedings thereafter. I'll mention more about that process later.

You need a solicitor

If you plan to accept a freehold offer under Section 5, you will need a solicitor. It is certainly possible to proceed without one, but definitely not advisable. I read an awful lot about Section 5 before and during our own freehold acquisition, but I'm just a layman. The subtleties of law can easily catch you out if you do not have reliable legal advice.

However, engaging a solicitor is no excuse for not researching things yourself. If you have a leaseholder with the time an energy to learn about the process it will give you an advantage. The freehold will become your responsibility and you need to know what's going on.

Section 5 costs

You will have to pay whatever price the freeholder is asking for the title, plus your legal costs, disbursements and solicitors' sundries. By default, freeholders have to pay their own legal costs unless they include a clause saying you must pay their costs as part of the offer.

It is hard to estimate what your solicitors costs might be. It depends on how complex things are. It could be anywhere from £3,000 to £12,000, and disbursements and sundries will amount to roughly £350.

Obviously I have no idea what price your freeholder is likely to demand for the title itself. They can set the price as they choose, although if it's too much they are unlikely to sell to either you or on the open market and you'd have to wonder why they're doing it in the first place.

You might get an idea of what a fair price is by using the formulae for enfranchisement on lease-advice.org. If the leaseholders and freeholder cannot agree the price under self-enfranchisement the leaseholders can ask a property tribunal to determine the price and they will generally follow a formula such as the one I linked to. This is not the case with Section 5 — leaseholders have no right to invoke a property tribunal — but following the formula may give you a rough idea of fair value.

Specific aside regarding costs

We had an unusual situation with our freehold. We had a loosely worded covenant in our leases that intimated the freeholder must transfer the freehold to us at no cost. I'm not sure how that would have held up if we'd had to rely on it in court, but it was enough to cause doubt, and the administrators who transferred the freehold to us accepted it.

We therefore paid nothing for the freehold itself, but agreed to pay £5,000 towards the freeholder's costs, and had to find £10,000 for our own legal costs and disbursements.

All-in it cost us roughly £15,000.

As I previously mentioned, though, we bought from administrators and it was a completely new title that was extracted from a previous title that covered more plots than our own. The process took two years to complete, which sometimes felt like a lifetime. There were benefits with the way we went, though: as it was new freehold and the administrators knew little about things on the ground here, we had scope for negotiation with the contract and freehold title. This is a luxury most won't have.

The Section 5 process

Once you accept the offer of a freehold there are timings for how things proceed. You need to be aware of those timings because they're governed by law.

The following diagram sketches out the procedure.

Diagram of the steps and timings for Section5's 'Right of First Refusal'.
The Section 5 'Right of First Refusal' process.

You should look at the Leaseholders Advisory Service's article about Section 5 for details, but, briefly, the numbered steps are as follows:

  1. The freeholder makes an offer. They must give you a minimum of two months to tell them whether you will accept or reject the offer. You must make sure you qualify (see the article I linked to above) and make sure you have more than 50% of leaseholders in favour of accepting the offer.
  2. You now have an additional two months (minimum) to tell the freeholder who your nominated person is. This will be the person or entity who will own the freehold once it's transferred. It's usually a company set up by the leaseholders for the purpose of owning the freehold. After four weeks into this period you are committed in the sense that if you now withdraw you must pay the freeholder's costs. They have the same commitment to you at this point.
  3. The freeholder now has one month to send you the transfer contract.
  4. When you receive the contract you then have two months (maximum) to sign and return the contract. If a company is going to own the freehold then the directors need to sign it.
  5. The freeholder then has seven days to exchange the contract.

Note the timings carefully. If either party misses a timing they are deemed to have withdrawn from the process. You and the freeholder can withdraw at any time before exchange, but if either side does so after four weeks into the nomination period then they must refund the other side's costs.

Aside regarding the nominee

The nominee — which may also be referred to as the 'nominated purchaser' or 'nominee person' — is the entity that will ultimately become the freeholder after transfer. This may be an individual where a leasehold house is concerned, but with leasehold blocks of flats it's generally a company.

I suggest you set up a property management company and use that as the nominee. You'll have to act fast to do this if a freehold offer drops on your doorstep without prior notice.

If you are an RTM company the best option is to set up a new company to receive the freehold. This is because an RTM company ceases to be an RTM company when it has the freehold (the right to manage is, strictly speaking, the right to manage in place of the freeholder).

It's not the end of the world if you do transfer the freehold to the RTM company. We had no choice but to that because the clause in our leases we relied on get the freehold for nothing also instructed the freeholder to transfer the title to the RTM. What you have to do in this case is change your RTM's Articles of Association and rename your RTM to something that doesn't have 'RTM' in its name.

After you get the freehold

Once you get the freehold you must issue a Section 3 notice telling all leaseholders there's a new landlord. It is a criminal offence not to do so.

As a priority you should check the insurance situation for the freehold. The freeholder may cancel the buildings insurance after the freehold transfer has completed.

Gotchas and notes

If you're the person organising all this, I urge you (strongly!) to get all the money from participants up front. I made the mistake of not doing that and it's not a mistake I'll make again. I'd suggest you look at all the costs and add a third, then divide that by the number of participants and send each one a bill. It is easier to give excess money back than to try and get it partway through the process when leaseholders' circumstances may have changed.

Watch your solicitor's costs carefully. Solicitors charge by time (often in six minute intervals) and complications can increase costs significantly. Get a written quote up front, but don't rely on it. Solicitors will always have some legalese to cover unexpected work in their quote. By the time you know about it you're likely to be far enough through the process such that it's not cost-effective to withdraw — they'll have you over barrel. Expect to pay more, which I why I suggest adding a third to the estimated costs at the outset.

I might appear to have a bit of a downer on solicitors — and yes, I do sometimes believe them to be agents of Satan — but our solicitor was pretty good. It did cost more than we'd originally been quoted, but, to be fair, it was a two year negotiation and I could see where the extra costs had come from (sort of!).

Is it worth it?

I can't tell you if it's worth it. It depends on what you're being charged for the freehold in the first place. In our case it was worth it. £1,500 per leaseholder is worth it to be forever your own boss, free of ground rent, and to be able to extend leases for nothing.

You will have more responsibility, but, if you're already operating as an RTM, not a huge amount more in day-to-day operations.

I can certainly imagine prices that wouldn't have been acceptable to me personally, but any fair offer is likely to be worth it in the long run.