A Guide to... The Right of First Refusal - Sale by Contract

When a landlord decides to sell his property containing residential flats to which the Right of First Refusal applies, he must, by law, offer it first to the tenants of the flats before offering it on the open market.

Who does this apply to?

The right of first refusal applies to the sale or transfer of a freehold where:

• The freehold property consists of at least 50% residential flats;
• The freehold contains at least 2 leasehold flat owners; and
• The leasehold flat owners are ‘qualifying tenants’.

If you own the freehold of a building on this basis, and you wish to sell your interest, you first need to serve a Section 5 notice on the leasehold flat owners, offering them the opportunity to purchase the freehold. This is known as the Right of First Refusal.

Which Freehold owners are exempt?

Resident landlords in a non-purpose/ converted building who have occupied their flat as their main residence for at least 12 months as of the date of disposal are exempt from the Right of First Refusal procedure.

Housing Associations and Local Authorities are also exempt.

What is a ‘qualifying tenant’?

Subject to some statutory exceptions, you are a qualifying tenant if you are a tenant of a flat in the building you wish to purchase. The main exceptions include:

• If you own 3 or more flats in the building;
• You are a protected shorthold tenant under the Housing Act 1980;
• You are a non-residential or business tenant; or
• You are an assured tenant.

What happens if the freehold owner does not serve a Section 5 notice?

If the freehold owner fails to serve a Section 5 notice, they will be committing a criminal offence.

The qualifying tenants will also have the right to acquire the freehold from the third party who purchased it on the same terms.

What types of Section 5 notice are there?

There are a number of different types of Section 5 notice depending on how the landlord wishes to sell their freehold interest. This article will deal with Section 5A, which deals with a regular contractual sale. Section 5B concerns sales at auction which has slightly different procedures that are not covered by this article.

What needs to be in the Section 5 notice?

Before serving a Section 5 notice, the freehold owner will obtain a valuation from a valuer who will provide a premium on which to base the Section 5 notice.

The Section 5 notice will usually be drawn up by a solicitor and will set out the key terms of the sale, such as the purchase price and deadline by which the qualifying tenants need to respond, which is usually 2 months from the date of the notice.

Who must be served with a Section 5 notice?

The landlord must serve a Section 5 notice on at least 90% of the qualifying tenants. For example, if there are 2 or 3 qualifying tenants, notices must be served on all of the qualifying tenants.

How many qualifying tenants need to respond?

If you are served with a Section 5 notice, we recommend you take legal advice due to the strict deadlines involved.

If over 50% of the qualifying tenants wish to purchase the Freehold on the terms in the Section 5 notices, then those qualifying tenants must serve a counter notice on the freeholder within the prescribed time limits.

The tenants have a further 2 months to nominate a purchaser.

Who purchases the freehold?

The most common entities that purchase a freehold are the qualifying tenants as individuals or in the form of a company.

A maximum of 4 people can be listed as the registered owners. If there are more than 4 purchasers, a company can be set up to purchase the freehold in which the relevant flat owners will be members.

What happens if the counter-notice is not served by the deadline?

If the counter notice is served late, then the freehold owner is free to sell to a third party at any time in the following 12 months, but only if the terms are the equivalent to or at a value greater than that contained in the Section 5 notice.

What other deadlines are there?

The landlord must issue the draft contract within 1 month of the service of nomination notice of the purchaser of the freehold.

The nominated purchaser has 2 months from the date of receipt of the contract to exchange and pay the deposit (not more than 10% of the premium on the Section 5 notice). Completion would then follow exchange as per a normal sale and purchase transaction.

This deadline can be extended by agreement. However, if the leaseholders do not meet the relevant deadlines then they will be deemed to have withdrawn from the purchase process and the freeholder will be free to sell to a third party.

Who pays the legal costs?

Unless specified in the Section 5 notice, each side usually bears their own costs. However, if the leaseholders withdraw from the process they will often have to bear the costs of the freehold owner.

If the freehold owner withdraws, they cannot sell their interest before starting the Right of First Refusal process again.