Real Estate Legal Update - Autumn 2022

A welcome from the editor...

Welcome to the latest edition of the Real Estate Legal Update. This quarter, we look at cases on penalty clauses in sale contracts, what 'reasonable' means when it comes to not unreasonably withholding consent under a restrictive covenant and what factors the Upper Tribunal will take into account when considering whether a restrictive covenant is obsolete. In the Landlord and Tenant round-up, we look at the grounds on which a landlord can oppose the grant of a renewal lease and to what extent the costs of (very expensive and lengthy) litigation can be recovered from tenants through a service charge. In Planning Points, we consider upwards development under permitted development rights and our Tax Tips cover two cases involving unhappy taxpayers who ended up paying out considerably more Stamp Duty Land Tax than they had planned for.

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CASE LAW UPDATE

Contracts - penalty clause: Upton Rocks Healthcare Ltd v Halton Borough Council

Key points:

• The test for whether a contractual clause is a penalty is whether it imposes a detriment on the contract breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary contractual obligation

• The rule against penalties is applied sparingly, as it is effectively an interference with parties' freedom of contract, but it is important that penalties are not exorbitant or unconscionable

HBC sold a development site in Widnes to a buyer (LCL) for £220,000. The sale was conditional on the renewal of an expired planning permission and provided for LCL to make various additional payments by way of overage if triggered by certain events. The sale to LCL completed in 2011. As is usual, the 2011 transfer required LCL to obtain a deed of covenant from any future owner of the land that they would make the necessary payments to HBC, and a restriction was placed on LCL's title to the land meaning it couldn't be registered in the name of a new owner without HBC's consent. In 2012, the parties entered into additional documents relating to the site, including a Deed of Variation of the 2011 transfer, which provided that if LCL hadn't started development on a specified part of the site within 36 months from the date of the 2011 transfer, it would have to pay an additional £240,000 to HBC.LCL then transferred the site to IL for £125,000. IL entered into the required deed of covenant, and again, a restriction was put on the title.In 2015, HBC contacted IL claiming the £240,000 payment on the basis that no development had started within the 36-month period. IL's position was that some development works had been carried out, albeit by LCL. A dispute arose, but was not resolved and in 2019, IL sold the site to URHL for £850,000 for the construction of a health centre. In order to become registered as the owner of the site, and even though the dispute over whether development had commenced remained unresolved, URHL agreed to pay the £240,000 to HBC. It then brought proceedings to recover the payment.One of URHL's arguments was that the requirement to pay the £240,000 amounted to a penalty clause and was therefore unenforceable. The Court accepted that HBC had a legitimate interest (promoting the prompt development of the site) to protect, but found that the clause was 'extravagant, exorbitant and unconscionable' and ordered HBC to reimburse URHL with interest.

Practical implications: We are used to seeing disputes around penalty clauses in the context of deposits payable on exchange of contracts, where historically an obligation to pay a deposit of more than 10% of the purchase price has been deemed to be an unenforceable penalty, so it is interesting to see the concept applied in a different scenario.In this case, the drafting of the development obligations left something to be desired both in terms of what might amount to 'development' and because the requirement was only for development to have commenced, not been completed. However, when agreeing such clauses, it is crucial to ensure the amount or nature of the penalty is in proportion to the legitimate interest it is imposed to protect.

Restrictive covenants - reasonableness: Davies-Gilbert v Goacher & Chester

Key points:

• Qualified restrictive covenants in relation to freehold land restrict an owner's ability to use the land without the consent or licence of the owner of the land that benefits from the covenant
• Applying for consent under such covenants has recently become more complex as the High Court has decided that the principles that apply to public-law decision makers also apply to private individuals

DG owned a large area of land, known as the Gilbert Estate, in the South Downs National Park, East Sussex. Over the years, parcels of the Gilbert Estate located in the village of East Dean had been sold off by DG's predecessors in title and when the parcels were sold, restrictive covenants were imposed for the benefit of the retained land.G and C both owned plots of land in East Dean, which were subject to restrictive covenants imposed in 1960 in favour of parts (but not all) of the Gilbert Estate not to build on the land without written licence, such licence not to be unreasonably withheld.G and C each wanted to build a detached house on their respective plots. They obtained planning permission and applied for DG's consent in accordance with the covenant. DG refused consent on the basis that it would have a detrimental effect on the amenity value of the Estate and could threaten the future use and commercial value of neighbouring land. G and C claimed this was unreasonable, because DG had taken into account matters that were irrelevant, including the impact on land that didn't have the benefit of the covenant and the views of third parties who occupied other land.The High Court found that DG had not unreasonably withheld consent. Although the first reason was unreasonable (because not all of the Gilbert Estate had the benefit of the covenant), the second reason stood alone (it was a decision that DG was entitled to reach as it related to neighbouring land that did have the benefit of the covenant), and it was not invalidated by the first (bad) reason.

Practical implications: A lot of the case law on 'reasonableness' relates to the decisions (in terms of both outcome and process) of public law bodies, such as local authorities. The Court had to consider this in the context of a private individual for the first time and the judgment provides some guiding principles where consent is required under a freehold restrictive covenant.Those with the benefit of such covenants should think carefully about the reasons they give for refusing consent and should set them out clearly at the material time. Where there is some doubt, or maybe different considerations come into play in the decision-making process, take legal advice from our Property Litigation Team to ensure you have a robust position.

Restrictive covenants - obsolete covenants: HAE Developments Ltd v The Croft Ealing Ltd

Key points:

• It is possible to apply to the Upper Tribunal (Lands Chamber) to modify or discharge a restrictive covenant
• The Upper Tribunal can modify or discharge a covenant if certain statutory grounds are made out, including that the covenant is obsolete, and that no injury would be caused to the benefiting owner(s)
• When considering whether a covenant is obsolete, the Upper Tribunal will take account of changes in the character of the burdened land, changes in the character of the neighbourhood and other material circumstances
• The Upper Tribunal can order the applicant to pay compensation to the benefitting owner(s)

HAEDL obtained planning permission to demolish a house on Park Hill in Ealing, and to build a three-storey building to accommodate eight flats. The house was built on land that had previously formed part of the garden of a large adjoining Victorian residence, called The Croft, which stood in substantial grounds. When the property was sold off in 1955, a covenant was imposed in favour of The Croft, restricting use of the property to a single dwelling house. HAEDL applied to discharge or modify the covenant on various grounds, including that it was obsolete.Over time, there was a lot of development in the locality, with large houses being converted into flats. The rest of The Croft was developed in the 1960s to provide 11 flats and 22 maisonettes within four three-storey blocks, along with 33 garages and spacious grounds.The freehold of The Croft was owned by a company (TCEL) in which the tenants of the flats and maisonettes held shares. TCEL and 26 of the 33 tenants objected to HAEDL's application, on the basis that the covenant protected them from intensive development that would result in overlooking, loss of light and potential nuisance from things like additional noise and traffic.The Upper Tribunal found in favour of HAEDL. The local area had changed considerably since the covenant was imposed. HAEDL's proposed development was consistent with the development plan and was in keeping with its surroundings and the pattern of development nearby. The covenant was imposed at a time when The Croft was a substantial house with a large garden and the then owner did not want a block of flats next door. As The Croft had itself then been converted into flats and maisonettes, the covenant was rendered obsolete.

Practical implications: Regular readers of this bulletin will know that we are used to seeing cases involving the discharge or modification of covenants on the basis that they impede a reasonable use of the burdened land. Here we have a decision based on obsolescence, but the Tribunal also considered the 'no injury' ground. In this case, the covenant would not have prevented overlooking and loss of light (as a newly-erected single dwelling would likely have had the same - or even greater - impact) and the objectors' concerns about additional noise and nuisance were not substantiated, particularly in light of all the other development that had happened in the vicinity. In addition, traffic and parking issues had been addressed in the planning permission. As a result, the Tribunal did not award compensation (the objectors were seeking around £500,000 in total) because there would be no loss.

LANDLORD AND TENANT ROUND-UP

Lease renewals - landlord's grounds for opposition: Milestar Ltd v Gandesha

Key points:

• If a lease falls within the protection of the Landlord & Tenant Act 1954 (LTA), a tenant has a statutory right to renew the lease at the end of the contractual term
• Landlords can oppose the grant of a new lease on various grounds - some relate to the conduct of the tenant and others are 'no fault' grounds

ML was the tenant of ground floor retail premises in various adjoining properties, held under three separate leases. G (the landlord) served notices under the LTA terminating the leases on 30 September 2020. The notices stated that any claim for new leases would be opposed on two main grounds - firstly, the tenant's persistent delay in paying the rent under all three leases (Ground b) and secondly, the landlord's intention (in relation to part of the property) to demolish or redevelop the property (Ground f).ML had not paid any rent for some time and contended this was because it had various cross-claims against G arising out of a wider family dispute. ML's position was that the rent was not considered 'due' for the purposes of Ground b because those claims should be set off against the rent arrears.ML also argued that Ground f was not made out, because there was no real prospect of G obtaining planning permission for the redevelopment.The County Court found in favour of G on both grounds. In relation to ML's argument about the cross-claims, the Court found that these were not sufficiently connected to G's claim for rent under the leases and could not be used as a defence of equitable set off (and, in any event, even if there had been a right of set off, the rent would still be 'due' under the leases). In relation to Ground f, ML didn't help themselves because the Court found their 'independent' planning expert not to be independent at all (he had, in fact, been instructed by ML to object to G's planning application!)

Practical implications: A couple of things to note for tenants - even a legitimate cross-claim might not save you from a landlord succeeding on Ground b and, when it comes to Ground f, make sure you choose your experts wisely!

Service charge - legal costs: Dell v 89 Holland Park Management Ltd

Key points:

• Service charge provisions in leases often contain a 'catch all' clause, with a view to enabling landlords to recover expenditure that isn't specifically identified
• The courts will apply the normal rules of contractual interpretation to these clauses
• The starting point is the actual words used and an objective test is applied for ascertaining the intention of the parties. The language used should be read in accordance with common sense

89HPML was the freeholder of a detached Victorian villa in Holland Park, which had been divided into five flats. Each flat owner held a share in 89HPML. Mr and Mrs D owned one of the flats.A neighbouring owner, H (described as 'a celebrity architect') wanted to develop an adjoining plot by building a dwelling that was largely underground, but with a 'glowing glass box' as its main architectural feature above ground. Under the terms of a covenant, H needed 89HPML's consent. 89HPML had withheld consent on various grounds and, after eight years of litigation, was found to have acted reasonably in doing so.The litigation had been funded by the tenants through ad hoc service charge demands (the total costs incurred by 89HPML were over £2.7M, of which around £430,000 had been demanded from each tenant). Mr and Mrs D decided they no longer wished to participate in the litigation and refused to pay further service charges to the extent that they related to the costs of the dispute. They applied to the Upper Tribunal for a determination as to whether the costs were properly recoverable under the service charge provisions in their lease.89HPML relied on a clause in the lease that enabled it to recover the expenditure incurred in employing persons or taking steps as may be 'necessary or advisable for the proper maintenance safety and administration of the Building'. The First Tier Tribunal found that the litigation costs were recoverable, and were reasonable, but the Upper Tribunal overturned this decision on appeal.

Practical implications: The courts are often required to consider 'sweeper' clauses in service charge clauses, as landlords and their managing agents seek to rely on them where an item of expenditure is not expressly covered. Such clauses are, by their nature, general, but the courts will look at the words used and the context of where the clause sits within the surrounding provisions. In this case, the clause relied upon appeared in a section of the service charge provisions dealing with the practical management and upkeep of the building. There were also different clauses which did deal expressly with legal costs for other matters, so it was a bit of a stretch on 89HPML's part! For further advice on service charge disputes, speak to a member of our Property Litigation Team. 

PLANNING POINTS

Permitted development rights - upwards development: Cab Housing Ltd v Secretary of State for Levelling Up, Housing and Communities

Key points:

• Under the General Permitted Development Order 2015, certain development can be carried out without the need for planning permission (permitted development rights - PDR)
• In 2020, the government introduced changes to the 2015 Order to facilitate upwards development in an attempt to boost the construction sector and get the housing market moving post-pandemic
• In some cases, prior approval is required and the 2015 Order sets out the matters a local planning authority must consider when determining an application for prior approval
• An applicant can appeal to the Secretary of State if prior approval is refused

In a conjoined case, three prior approval applications had been refused by the local planning authority and the appeals were refused by the Secretary of State's Planning Inspectors. The developments in question fell under Class AA of the Order (enlargement of a single dwelling house by the upwards addition of up to two storeys or one storey above a single storey building).Applicants must obtain prior approval in relation to various issues, including the impact on the amenity of any adjoining buildings, including overlooking, privacy and loss of light, and the external appearance of the dwelling house.The applicants argued that only the impact on properties contiguous with or abutting the subject property should be taken into account, and then only in relation to overlooking, privacy and loss of light. They also argued, in relation to the external appearance consideration, that this was limited to the design and architectural features.In this case, all three appeals were dismissed and the High Court gave some useful guidance on interpretation:

• The impact of a proposed development is not limited to its effect on overlooking, privacy and loss of light but may include other things, such as noise, activity and impact on outlook
• 'Adjoining premises' doesn't just mean properties immediately next door to the subject property, and local planning authorities can take account of the wider 'street scene'
• The assessment of 'external appearance' is not limited to the parts/elevations of the building that can only been seen from the highway, nor is it limited to the impact on the subject property - it can include impact on neighbouring properties or the locality more generally

Practical implications: As the amendments to the 2015 Order are relatively new, there is little case law on them, but whilst the intention behind the changes was to create a 'tick box' system to more easily facilitate development, there is still some room for interpretation...and there is an appeal outstanding, so we will revisit this matter when that has been heard!

TAX TIPS

SDLT - group relief: The Tower One St George Wharf Ltd v HMRC

Key points:

• Provided certain conditions are satisfied, group relief means no Stamp Duty Land Tax is payable on land transactions between members of the same SDLT group
• The seller and buyer must be members of the same SDLT group on the effective date of the transaction (usually, but not always, the completion date); companies are part of an SDLT group if one is the 75% subsidiary of the other, or both are 75% subsidiaries of a third company
• Group relief is not available if the relevant transaction is not effected for bona fide commercial reasons...
• ...or if the transaction forms part of arrangements, the main purpose (or one of the main purposes) of which is tax avoidance

A group of companies developed a site in London for residential development. The final part of the scheme involved the construction of a 50-floor tower block comprising around 220 high-spec residential units. For various commercial reasons, the group wanted to transfer the Tower to a separate special purpose vehicle to help manage the risks of the scheme, as well as to provide opportunity and flexibility around raising finance to fund the development.The group's tax advisors suggested a complex series of steps that involved transferring the property through various companies within the group pursuant to a number of different agreements all on the same day, resulting in a potential £44M-worth of corporation tax savings, plus an SDLT saving due to group relief.Unfortunately, HMRC enquired into the corporation tax return and disagreed with the tax advisors' analysis and the group ultimately accepted that there was in fact no tax benefit to the scheme. HMRC also looked into the SDLT returns and concluded that group relief was not available because the transaction formed part of arrangements the main purpose of which was the avoidance of liability to tax. HMRC assessed SDLT liability at £8M. The group appealed to the First Tier Tribunal, but was unsuccessful.

Practical implications: Although the Tribunal accepted that there were genuine commercial reasons for transferring the property, the main purpose of the whole scheme was to avoid tax liability. The fact that the scheme didn't actually work, and no tax was avoided, didn't detract from this. What is important was the motive, not the actual outcome.

VAT - transfer of a going concern: Haymarket Media Group Ltd v HMRC

Key points:

• A transfer of a business as a going concern (TOGC) can involve the sale of assets that would normally be taxable supplies, including land and buildings where the seller has opted to tax
• However, special VAT rules mean no VAT is chargeable where there is a TOGC
• Where payable, Stamp Duty Land Tax is calculated on the purchase price plus the VAT

HMGL owned the freehold of a property at Teddington Studios, which it had opted to tax. The property had been subject to two leases - one granted to a company within HMGL's group and one to a film company.In 2013, HMGL applied for planning permission to develop the property and the following year, planning permission was granted for the construction of 213 flats and six houses. HMGL then exchanged contracts to sell the property with the benefit of the planning permission, to PPL at a price of £85M.The two leases that the property was originally subject to had been terminated prior to the sale to PPL, but in order to obtain TOGC treatment on the sale, HMGL and PPL agreed that new leases would be granted over part of the site (actually to entities associated with PPL) so that when the freehold was transferred subject to the new leases, the sale would be treated as the transfer of a property letting business. HMGL did not charge VAT on the sale price.Four years after the sale completed, HMRC raised a VAT assessment of £17M as it did not agree that the sale was a TOGC, it was simply the sale of an asset not the supply of a business as a going concern. The First Tier Tribunal dismissed HMGL's appeal against the assessment.

Practical implications: Whilst HMRC had not alleged that the new leases the parties had entered into were a sham, the Tribunal did look at the substance, not just the form, of the arrangements and found that the leases didn't create 'true' tenants for the purposes of TOGC treatment. The commercial reality was that there had been no intention to transfer a property letting business (nor, indeed, a property development business, as PPL was not taking over a development project started by HMGL).The £17M VAT was in fact fully reclaimable by PPL as input tax, so it was not out of pocket in this respect. However, PPL had to pay an extra £680,000 in SDLT because the TOGC treatment didn't work. The decision is useful reminder of how planning to mitigate (or not) one type of tax can impact on the liability for another. If you are looking to structure a property transaction in the most tax-efficient way, contact a member of our Tax Team.