Bell & Scott Property Update, June 2007

Welcome to the June 2007 issue of Bell & Scott Property Update.

Property Update provides a round up of relevant case law and other items which we consider may be of interest to those in the property industry.

In this month's issue we comment on a recent case which looked at what someone has to prove to meet the legal requirement of having an interest to enforce a title condition which restricted the commercial use of a property within a residential development. We also comment on a recent case which concerned a landlord’s right to challenge a Creditors’ Voluntary Arrangement put in place by an insolvent tenant and its solvent parent company which had the effect of depriving landlords of a valuable right to rely on guarantees of lease obligations given by the parent company.

Recent Decisions

No B&B's in this Street, Please

When can you stop your neighbour using their house for a business purpose?

The recent Sheriff Court decision in the case of Barker and Others v Lewis highlights the need to prove that the value and the amenity of your property is being seriously affected if you want to stop your neighbour doing something which is prohibited by a real burden in the title deeds of a development.

In 2005, Mrs Lewis bought one of five houses in a farm steading conversion, just outside St Andrews, from a developer. She hoped to use her home to run a bed and breakfast in addition to just living there. The developer had created a Deed of Conditions over the steading development which stated that each house was to be used as a domestic dwelling house for one family only. There was also a prohibition against activities which would cause disturbance to other owners within the development. Mrs Lewis’s solicitor had obtained a letter from the developer giving its consent to her proposed use of her house as a bed and breakfast. No approach was made to obtain the consent of the other 4 owners (“the Barkers”). Mrs Lewis disclosed her intentions to the Barkers at the first meeting of the owners some two weeks after moving in. The Barkers would not give their approval. Nevertheless, Mrs Lewis started to take in guests in the summer of 2005. Between June 2005 and November 2006, she welcomed some 350 guests ( 247 per annum). The Barkers raised an action to stop Mrs Lewis continuing to use her property as a bed and breakfast.

The Barkers argued that Mrs Lewis’s use of her property was contrary to the title condition in the Deed of Conditions (use as a domestic dwelling house only). In addition, they argued that the existence of the bed and breakfast had brought about an increase in (i) the volume of traffic coming into the development; and (ii) the noise levels generally and, more particularly, at early and late hours in the day, and that these activities amounted to material detriment to the value and enjoyment of their properties. Mrs Lewis argued that though the Barkers had title to enforce the title conditions, they had failed to convince the Court that the existence of the bed and breakfast would have the effect of reducing the value of their houses. In addition, the incidents of disturbance of enjoyment were not of such significance and substance to detract from their enjoyment of their properties.

On the evidence put to the Sheriff, he decided that Mrs Lewis could continue with her business.

Paul Reilly, a Partner in our HouseBuilding Team, comments:

On the face of it, this gives some guidance and comfort to developers who have to consider whether or not someone who owns adjoining land can enforce title conditions against their neighbour and thereby cause problems, costs and delays in development projects.

The question of the potential rights of third parties to enforce title burdens has been a recurring issue since the coming into force in 2004 of the Title Conditions (Scotland) Act 2003 (“the Act”) which codified the law on the subject.

Though we no longer have Superiors to worry about, third parties have a right to enforce a title condition if certain criteria are met – one of the most common being that the properties in question are all subject to the same or similar conditions. This is the situation where a development has a Deed of Conditions in place. In this case, the Sheriff had no difficulty in establishing that the Barkers had title to enforce the title condition against Mrs Lewis.

However, this case is the first one to emerge which examines the question of interest to enforce. That is the next hurdle you have to get over once you have established a title to enforce a real burden.

The Act set down a statutory rule which provides that an interest to enforce exists where “failure to comply with a real burden is resulting in, or will result in, material detriment to the value or enjoyment of the person’s ownership of” their property. The key words are “material detriment” and “value”. Also, an interest to enforce a title burden must be related to the property itself, as a property, rather than being based on subjective personal considerations.

Various factors may be relevant to what amounts to “material detriment”. One will be the level of seriousness of the breach. Another will be the physical distance which lies between the property which is affected by the title burden and the property which wishes to take the benefit from that burden. For example, the owner of a house at one end of a large residential development would not have an interest to enforce a title burden, contained in a Deed of Conditions for the development, which prevented a house owner at the opposite end of the development building a conservatory.

In this case, the Sheriff accepted that the Barkers were inconvenienced on a personal level by the breach of the burden. The Barkers had maintained a log book containing what were, in their view, “undesirable incidents” which had occurred over a period of time. The Sheriff considered the nature of these incidents and how often they had occurred. That evidence suggested that there was no material detriment, which must relate to a reduction in the value and the enjoyment to be taken from ownership of the property itself, rather than being personal to the sensibilities of the individual occupant of the property.

The Sheriff accepted that for the purposes of interpretation of the legislation “value” means “market value”. The failure of the Barkers to lead their own evidence on the effect of the breach of the real burden on the value of their properties was critical. As a result, the Sheriff accepted Mrs Lewis’s surveyors’ argument that the bed and breakfast business had no effect on the market value of the adjoining houses. The fact that the Barkers may have felt some loss in value (or enjoyment) in a subjective sense was irrelevant.

Objective rather than subjective factors are the important ones. In particular, in seeking to establish the existence or otherwise of material detriment, considerable weight will be given to valuation evidence on the effect of a breach on the market value of the property which the real burden is protecting.

On the basis of this case – where the pursuers were, after all, immediate neighbours of the defender - it seems that establishing an interest to enforce a title burden may be more difficult than was previously considered.

No Guarantees

Landlords must move quickly to protect their guarantees if a CVA could be unfairly prejudicial

The case of The Prudential Assurance Company Limited and PRG Powerhouse (“Powerhouse”) caused considerable anxiety in the investment property sector by raising the possibility that a company voluntary arrangement (“CVA”) could allow a third party guarantor to escape liability. A CVA is a statutory procedure designed to help struggling companies.

Pacific Retail Group (“PRG”), a New Zealand company listed on the New Zealand Stock Exchange, had granted lease guarantees to landlords covering Powerhouse’s lease obligations. Powerhouse was a subsidiary company of PRG. Powerhouse got into financial difficulties resulting in closure of some 35 stores throughout the UK . The Directors of Powerhouse proposed a CVA under the Insolvency Act 1986, which offered some creditors better prospects of recovery than others. In essence, the main body of creditors would continue as such with a hope of being paid in full if the business consequently turned itself around. However, the landlords of the 35 closed stores which had lease guarantees were to be treated differently. They were to receive what amounted to 28p in the £1 owed to them in respect of all current and future liabilities. This would come from a fund provided by PRG. Acceptance of the compromise meant the landlords would forfeit their rights to rely on the PRG guarantees. These were, of course, much more valuable and would have provided a greater return since PRG was solvent. The CVA scheme was passed by a majority of the creditors of Powerhouse. It was, therefore, binding on the landlords who did not carry sufficient voting numbers to defeat the scheme. The landlords then challenged the validity of the CVA in the High Court on the basis that (i) the CVA could not directly release the liability of PRG under the guarantees; (ii) the CVA could not preclude the landlords from enforcing the guarantees and (iii) the CVA was unfairly prejudicial to the landlords.

The judge ruled that the CVA, as proposed, was invalid because it was “unfairly prejudicial”. The stripping out of the guarantees, by the CVA, left the landlords in a much less advantageous situation than in a normal insolvency situation. However, the guidance from the court meant that if a CVA is written in such a way that is not unfairly prejudicial then landlords could be deprived of the guarantees. Guarantees may therefore be suspended by a CVA in certain circumstances. Where a landlord believes that the CVA is unfairly prejudicial, it is essential that they challenge such proposals within the 28 day period set down in the Insolvency Act.

Dawn Henderson, a Partner in our Retail & Leisure team comments:

Landlords certainly waited with bated breath for this decision, and can now breathe a sigh of relief – but only just! Although the Court ruled in their favour, this can only be considered a pyrrhic victory. The Court left the door open for a CVA to be used to “strip” landlords of parent company guarantees if written differently such that they do not unfairly prejudice landlords. It is a question of what is ‘fair’ in all the circumstances, which can be difficult to determine, giving rise to uncertainty. This case demonstrates once again the risks and pitfalls surrounding the whole concept of parent company guarantees. Unless landlords are prepared to spend a lot of time and money to prove that a CVA is unfair, they run the risk of losing the guarantee altogether. So what can landlords do?

• Landlords need to be more aware of a CVA and the implications it may have. If landlords want to challenge a CVA, then they need to know to move quickly if they want it set aside

• At the time of entering into the lease, landlords need to think more about spreading the risks. For example, the need for a rent deposit or bank or personal guarantees (or a combination) may be a serious consideration.

• Landlords need to be alert to the fact that a tenant’s covenant can change very quickly. As prevention is always better than cure, it is possible to mitigate risks from day one. For example, a ‘top up’ mechanism could be put in place whereby a deposit must be topped up at certain times.

• Landlords can request that the parent company enters into the lease with the subsidiary occupying under group share provisions;

• The parent and group company could take the lease in joint names.

Although the landlords in this case may be pleased, this ruling is not fantastic news for landlords generally. If anything, it has given more exposure to the potential for a CVA to strike at guarantees than would otherwise have been the case. We may see more such cases in the future. The upside though is that if landlords are proactive and think about such issues when granting leases then they will undoubtedly reap the benefit if a tenant does get into financial difficulty.

This case isn't great for tenants either. Tenants need to be aware that they may encounter difficulties at the Heads of Terms stage when being asked to satisfy landlords on covenant.

The full text of the decision is available from the English Courts Website here

News

How well will your Building Perform?

The Energy Performance of Buildings Directive (“the EPB”) came into force in Scotland on 1 May 2007 as part of the Building (Scotland) Act 2003. The EPB aims to address the EU’s commitment to reduce carbon dioxide emissions following the Kyoto Protocol. 160 million buildings in the EU use over 40% of Europe’s energy and create over 40% of its carbon dioxide emissions.

The EPB requires all EU countries to establish minimum energy performance standards for buildings. When buildings are constructed, sold, or leased in future, an Energy Performance Certificate, which is a more detailed version of the type you find on new fridges and tumble dryers, will need to be produced.

The only buildings which do not need to comply with the EPB are listed buildings, places of worship, buildings with a useful floor area of less than 50 sq.m and temporary buildings (intended to be used for no more than two years).

The Energy Performance Certificate requirement will not in fact be effective in the UK until January 2009. Before that date, the UK Government will introduce a standard formula to be used in measuring a building’s energy performance.

Though January 2009 may seem a long way off, owners, constructors and occupiers will increasingly become more focused on the issue of how well their buildings are performing. Ultimately, a poor performing building may be less attractive on the open market.

The full text of the Building Scotland Regulations can be accessed here and the EPB Directive here

A bill proposing to change the law relating to Empty Rates Relief on commercial properties in England and Wales was introduced to the UK Parliament on 10 May 2007. The Scottish Executive, which has control over rates and valuation in Scotland, did not follow suit which will result in different schemes operating north and south of the border.

Empty commercial property throughout the UK currently receives 100% rate relief for the first 3 months followed by 50% relief thereafter and empty factories and warehouses receive 100% relief at all times. Under the proposals for England and Wales, rates will be payable after six months for factories and three months for other commercial properties.

Far from it being perceived that this puts Scotland at an advantage, the industry believes that the proposals may have a detrimental effect on Scotland. It is feared that English and Welsh landlords could drop their rents to offload empty properties and this may make the Scottish sector look less competitive to tenants.

The new Bill appears to be a repeat of the situation in the 1970s when an empty rate was introduced in the form of penal rating surcharge. However, it didn't create new lettings and lead to the deliberate vandalising property to avoid rate liability.