Court of Appeal redefines 'building' under tenants' right of first refusal

The case between SGL1 Ltd and FSV Freeholders Ltd concerned Fox Street Village, a residential development in Liverpool comprising five blocks. Block A was a refurbished warehouse with its own utilities, standing separately from the other blocks. Blocks B, C and E shared similar design, utilities, a single plant room and boiler, while Blocks C and E shared a single entrance and staircase. Block D had been demolished.

Under section 5 of the Landlord and Tenant Act 1987 a landlord proposing to dispose of the freehold of premises containing qualifying tenants' flats must first offer the premises to those tenants on the same terms. Where a disposal involves more than one building, section 5(3) requires the landlord to sever the transaction so as to deal with each building separately. The landlord served two section 5 notices — one for Block A and one for Blocks B, C and E. The qualifying tenants did not accept either offer and the freehold was sold. The tenants subsequently claimed the right to acquire the blocks, arguing that the notices were invalid because all the blocks constituted a single 'building' and should have been the subject of a single notice.

At first instance, the judge agreed with the tenants, following the 2005 High Court decision in a case between Long Acre Securities Ltd and Karet. In that case, the judge had found that the word 'building' under the 1987 Act could encompass one or more structures where the occupants of qualifying flats shared the use of premises such as yards, gardens, outhouses and communal areas.  Although the Long Acre case was in fact answering a slightly different question, it has become a leading authority on the meaning of ‘building’ under the 1987 Act and when severing a transaction.

The Court of Appeal allowed the appeal and held that Long Acre was wrongly decided. It rejected the previous approach on several grounds, noting in particular that while section 5(3) requires a transaction to be severed so as to deal with each building separately, it does not dictate how amenity land must be parcelled. A landlord may choose to include shared amenity land with one building rather than another, or split it as it sees fit. Legal easements and quasi-easements over shared amenity areas will pass with the land, thus protecting the tenants. The court said the previous test represented "the tail wagging the dog".

The court acknowledged that it was difficult to formulate a single test for when separate structures constitute one 'building' but held that it may help to ask whether structures are within a "functionally integrated built envelope" — in other words, whether a structure could be unplugged from the rest of the development and stand on its own. Applying this test, the court found that Block A was a separate building, while Blocks B, C and E formed a single building because they shared a plant room, utilities, entrance and staircase, and Block B could not function independently without the installation of new plant and facilities. The section 5 notices served by the landlord were therefore valid.

Ian Morgan, a property dispute resolution expert with Pinsent Masons, said the ruling was welcome for bringing clarity to what could previously be a confusing test to administer. "The previous test for what was or was not a building could become quite technical and difficult to explain or justify. The court was faced with trying to reconcile 13 different factors just to work out whether something was or was not a building," he said. "The new judgment is likely to be easier to apply, but the treatment of communal areas will need to be given consideration up front, as relying on easements is all very well in legal theory but in practice, questions around who is responsible for managing those common parts, who gets paid and how much, are foreseeably likely to need working through. "

The decision gives landlords greater flexibility in structuring disposals of multi-block residential developments. The fact that occupants of different structures share the use of yards, gardens, car parks or other appurtenant premises does not necessarily mean those structures must be treated as a single 'building'. When serving section 5 notices, the landlord may have greater ability to decide what to include and may parcel shared amenity land with one building rather than another as commercial considerations dictate, allowing blocks to be marketed individually to different purchasers.

However, Ian Morgan said that the decision also raises questions for investors and landlords who have previously relied on Long Acre when putting in place leasehold structures.

“Those who are preparing to make a disposal of premises within scope of the 1987 Act or who may have section 5 notices currently in flight, may wish to seek advice - particularly since section 10A creates various offences for breach, without reasonable excuse,” he said.

“Lord Justice Lewison concluded the judgment by stating that there was no perfect answer under the 1987 Act and noted that the relevant Secretary of State has the power to make regulations in relation to various parts of the 1987 Act, and invited them to consider doing so.”