Right of First Refusal – What is it, Who is Eligible and How does it Work?

Right of first refusal (RFR) is invoked when the freeholder (landlord) wants to sell their interest in a building that is subject to RFR legislation and they are required under the Landlord and Tenant Act 1987 (the “1987 Act”) to offer this interest to the leaseholders first.

This can be the entire freehold, part of the building or common parts. In most cases such a disposal would ensure that leaseholders have the right of first refusal, however, there are some exemptions such as the grant of a single tenancy, disposal to an associated company or a sale by two or more persons of the same family to a different combination of the same family.

There are several requirements that need to be met for RFR to apply:

• The building must have a minimum of two flats;
• Have more than half of the flats must be owned by “qualifying tenants”;
• No more than 50% of the building must consist of non-residential properties.

Qualifying Tenants:

This is probably one of the most important factors yet also one of the simplest. To qualify for RFR, a tenant must be a leaseholder or in some cases have entered a fixed or periodic tenancy. The right does not apply to Assured Shorthold Tenants (most common tenancy type when letting a residential property) or Assured Tenants; it also excludes non-residential tenancies (i.e. business, agricultural etc.).

If a tenant owns all 3 flats in the freehold (complying with the criteria for the building) they will not qualify and therefore not be able to trigger the right of first refusal.

The Freeholder/Landlord:

The landlord is the immediate landlord, in other words, the person to whom the leaseholder is paying their ground rent and the one who is entitled to regain possession of the property once the lease has expired.

The RFR may not apply if the landlord is a housing authority such as councils, housing associations, charitable housing trusts and certain resident landlords.

For the resident landlord to be exempt, he would have to satisfy two conditions: the building cannot be a purpose build property and they must live in the property as their main and only residence and have done so for at least 12 months.

The sections:

The means of disposal dictates which of the five notice forms needs to be served on the tenants and these are:

Section 5A – sale by contract

Section 5B – sale by public auction

Section 5C – a grant of an option or right of pre-emption

Section 5D – sale not pursuant to a contract

Section 5E – sale for a non-monetary consideration

I’ll focus on sale by contract or auction as they are the most common means of disposal by some distance.

Sale by contract (5A):

Step 1 – Offer:

The freeholder has to notify the qualifying tenant by serving notice to offer them the possibility to purchase the interest that they want to dispose of. This notice gives the tenant a minimum of two weeks to accept or reject the offer given at a specific price.

Step 2 – Acceptance:

As mentioned earlier, in order to accept an offer, more than 50% of the qualifying tenants need to be on board and this should be done within the allotted two months, following which, they will have another two months to create a company to hold the freehold and communicate it to the freeholder via a nominated purchaser.

The nominated person will then have a period of two months to sign the contract which will also include the payment of a deposit (which is no more than 10% of the figure stated in the notice).

Finally, exchange needs to take place no later than 7 days from receipt of the signed contract.

Step 2 a – Non-acceptance:

Once the notice has been served and the tenants do not wish to purchase the freehold within the provided two months, the landlord is then entitled to sell the freehold on the open market. There is however a restriction on the sales price of the asset; the landlord cannot offer it at a lower price than originally presented to the leaseholders.

Sale by public auction (5B):

The process under section 5B is somewhat different to the sale by contract and has the following timeline:

1. The landlord serves notice of offer specifying the terms but does not include a price. The notice has to be served on at least 90% of the qualifying tenants (or all but one if the number is equal or less than 10). This must be served between 4 and 6 months before the auction day.
2. The tenants have two months to respond. Provided that more than 50% of the qualifying tenants accept the offer the tenants then nominate a purchaser.
3. At least 28 days before the auction, the landlord notifies the nominated purchaser of the date of auction.
4. Auction: the landlord agrees a conditional contract with successful bid.
5. Within 7 days the landlord sends the contract to the nominated person.
6. Within 28 days, the nominated person has to sign the contract and fulfil its conditions.
7. Within 28 days, the landlord in return has to sign the contract or may to withdraw. 

What happens if the landlord fails to give right of first refusal?

In a situation where the landlord hasn’t offered a right of first refusal to his leaseholders, providing that it all complies with the requirements, the qualifying tenants have the ability to request the terms of the contract to the new freeholder by service and “information notice” giving tham a month to provide the information required.

In principal, the qualifying tenants have the possibility to force the new freeholder to sell the freehold at the same terms of purchase as he acquired it.

In the event that a landlord fails to serve a notice under section 5, they are committing a criminal offence subject to a level 5 fine on conviction which means up to £5,000.

Peter Barry can assist with valuing the freehold of your block of flats to ensure you are making the right decision under the RFR. We can also assist with determining how much each leaseholders should pay in to acquiring the freehold. If you would like to discuss the above please feel free to contact us either by calling 020 7183 2578 or via email.