Selling a Freehold Interest in Flats – Section 5 Notice

04/09/2018
If you're a freeholder and considering selling a freehold interest in flats, you'll firstly want to get a RICS freehold valuer to give you an up-to-date valuation of what your interest is worth.

Then, you must - with a few exceptions discussed below - serve a Section 5 Notice on qualifying tenants (explained below) which gives them the option to buy that interest on the terms set out in the Notice. This is known as the Right of First Refusal. Selling a freehold is a technical area of law so click here to ask us a question if you need help.

If you do have to offer a right of first refusal to the leaseholders, you:
  • must serve formal notice on the qualifying tenants telling them what you are intending;
  • must provide time for them to consider the offer; and
  • cannot sell to another party during that time, nor offer the interest to anyone else at a price less than that proposed to the qualifying tenants or on different terms.
It's a criminal offence for you to breach these legal obligations without reasonable excuse. If you dispose of your interest without providing the Right of First Refusal, the qualifying tenants can serve a notice on a new owner demanding details of the transaction, including the price paid. They can then take action to force the new owner to sell to them at the price they paid.

This article considers:


Selling your Freehold?

The right of first refusal is a complex area of law but our expert RICS Freehold Valuers and Freehold Sale Conveyancing Solicitors can help you: call us on 0333 344 3234 (local call charges apply).

*Fixed Fee – No Sale No Fee – On all Major Lender Panels **RICS Surveyors – Local Knowledge – Same Week Availability



    1
    Why should you start by booking a RICS freehold valuation?
Naturally you need firstly to have an expert RICS valuer give you an appropriate up-to-date freehold valuation for your flats; you'll either need it for your open market sale (and right of first refusal notice) or to gauge whether a successful bid at an auction (more below) is a fair reflection given current market conditions.

You can find out much about what's involved here - Freehold Valuation for Collective Enfranchisement

Fixed Fee, No Sale No Fee with a 5 out of 5 rating

 
    2
    When don't you have to offer a Right of First Refusal?
You don't have to offer a right of first refusal when:

  • When the proposed sale purely concerns a single flat.
  • When you're disposing your interest to an associated company, for example where the freehold is transferred to another company which has been associated with the parent company for at least two years.
  • When you're not the immediate landlord to whom rent or ground rent is paid and who will be entitled to vacant possession of the flat when the lease expires. Where a landlord has a lease for less than seven years (or longer, but which is terminable within the first seven years) his landlord is also subject to the RFR in relation to those premises. So you can, as a freeholder, dispose of your freehold to a sub-landlord who is the rent collector without offering it to the flat-owners first.
  • When you are selling along with at least one other from your own family and you're selling to a different combination of the same family.
  • When you are an exempt resident landlord. This is where:
  • The building is not a purpose built block, for example a converted house, which has been converted into flats since its original construction; and
  • You genuinely live in the building as your only or principal residence and have done so for more than 12 months.

Selling more than one building? You'll need to serve a separate notice for each one.

For each separate building you are looking to dispose of, you'll have to serve qualifying tenants their own separate notice of right of first refusal. If you don't, it's a criminal offence and you face a fine of £5,000 if you're convicted.


 

    3
    What is the Right of First Refusal process?

Overview

  • Essentially you serve a Section 5 Notice on your leaseholders, giving them the opportunity to buy the freehold from you on the terms set out in the notice (price etc.).
  • If a majority (over 50%) of your leaseholders wish to acquire your freehold on those terms, then that majority must serve a Counter Notice on you to that effect within the time limits set out in the Notice. The Counter Notice must contain certain essential information.
  • If the Counter Notice is not served or is served late, you are free to sell the freehold to anyone else within the following 12 months, provided that the terms are no less favourable than those set out in the Section 5 Notice.
  • If a Counter Notice is served by a sufficient majority of leaseholders, they then have a further period within which they can, if they wish, form a company to purchase the freehold.
  • The Landlord and Tenant Act 1987 sets down other timetables relating to the drafting and preparation of documents leading through to completion. If the leaseholders do not enter into a binding contract to acquire the freehold with a set time period from when the contract for sale is issued, they will be taken to have withdrawn and you are free to sell to someone else.
  • The leaseholders don't normally have to pay your costs, unless it is a specific term of the deal you offer in the Section 5 Notice. However, there is an exception if the leaseholders withdraw, or are taken to have withdrawn, after a set point in the process in which event they would be liable for your costs after that point.
  • If you opt to sell your freehold interest via public auction, there's a separate procedure to follow (see below).
  • If you don't comply with your obligations to offer the leaseholders the right of first refusal and sell to a third party, you're committing a criminal offence for which you are subject to an unlimited fine. In addition, the leaseholders have the right to acquire the freehold in these circumstances from the third party who bought it, on the same terms.

Our freehold sale solicitors can help you with this process, from drawing up a Section 5 Notice right through to subsequent freehold sale conveyancing of your flats - call 0333 344 3234 (local call charges apply).

Qualifying conditions

For a right of first refusal to exist, there are certain requirements:

Premises
  • Your building must be in some way separate in the vertical sense; i.e. it can be a detached or a semi-detached building but not floors of flats above a shop.
  • The building must contain at least 2 flats.
  • No more than 50% of the premises can be in non-residential use.
  • More than 50% of the flats in the premises must be held by ‘qualifying tenants'.

Qualifying Tenants
Right of first refusal only concerns qualifying tenants, which include leaseholders and most fixed or periodic tenancies, but specifically excludes shorthold or assured tenancies, business and agricultural tenancies, tenancies which are dependent upon employment (and any sub-tenants of any of these).

If you have a tenant of 3 or more flats in your building, they don't qualify.

Disposals

This term simply refers to your intended sale, which can include selling the interest, the freehold or a headlease or a proposal to create a new headlease.

Some disposals are exempt:
  • the grant of single tenancies
  • putting up your interest as security for a mortgage
  • bankruptcy sale to a receiver, liquidator or trustee
  • disposal to a company associated with you
  • sales to the Crown or Government departments

Types of Section 5 Notice

There are 5 different types of Section 5 Notice, however only two of them are relatively common, these are:
  • Section 5A - simple sale by contract; and
  • Section 5B – sale by public auction
Click to find out about the other 3 types of Section 5 Notice

Serving the Notice

  • You've complied with your legal obligations if you serve your Section 5 Notice on not less than 90% of the qualifying tenants.
  • If there's less than 10 qualifying tenants, you have to serve your notice on all but one of them - so if there's only two tenants, serving it on one will do.
  • You also have to serve your offer notice on any established Right to Manage company.
  • If you have to serve your notice to different tenants at different times, the final acceptance date becomes that on the last notice served.

    4
    What is the procedure for selling on the open market (Section 5A)?
The notice must include the following:
  • the terms of the proposed disposal, that is the property and the interest being disposed of (the freehold, a headlease etc), the price and any deposit required;
  • a statement that the notice constitutes an offer by you to enter into a contract on the terms set out in the notice;
  • the date by which the offer may be accepted (the initial period) – this must not be less than two months from the date of the notice; and
  • a date for the nomination by the tenants of a purchaser (the nominated person) (click to find out more), which must not be less than a further two months.
If your qualifying tenants want to accept your offer, the majority must write to accept it (one vote per flat, more than 50% of qualifying tenants) and they have to serve their notice within the period set out in your notice, unless you agree a longer period.

If the qualifying tenants don't serve the acceptance notice or do it outside the offer period, you're then free to sell on the open market but only on the same terms as you offered to the qualifying tenants - you can't offer on different terms or at a lower price.

If the qualifying tenants accept your offer, they then have a further 2 months to inform you who their nominated person is i.e. the person, group or company which the qualifying tenants want to take up the interest. You can find out about how the qualifying tenants organise the nominated person and/or go for company formation within our collective enfranchisement article.

If the qualifying tenants have already decided on their nominated person, they don't have to take the above 2 month period - they can inform you straight away.

Once you've been informed who the nominated person is, you have to send them a contract within one month of being notified this fact.

The nominated person has 2 months to sign and return the completed contract and pay their initial deposit (cannot be more than 10% of the price).

After you've received the signed contract, you then have 7 days to exchange.

Please note these points:

  • The price you set is the offer notice isn't negotiable unless you decide to make it so and can't be challenged at a First-tier Tribunal (Property Chamber): it's 'take it or leave it', although you are bound to sell to other parties, if the qualifying tenants don't take the offer up, on the same terms for 12 months.
  • The qualifying tenants must be a majority of qualifying tenants throughout the process - if anyone drops out, the nominated person has to tell you and you're then free to sell on the open market as before, subject to doing so on the same terms for one year.
  • Either yourself or the nominated person can withdraw at any time up to exchange of contracts.
  • If you don't send or exchange contracts and subject to the time limits, it's deemed that you've withdrawn, which means you then can't sell your interest for 12 months. Similarly if the nominated person doesn't return the signed contract, then it's deemed that they've withdrawn and you're free to sell on the open market on the same terms.
  • If either you or the nominated person withdraws or is deemed to have withdrawn after the first 4 weeks of the nomination period specified in the offer notice, then the withdrawing party is liable for the other side's costs. There's no liability for costs if withdrawal occurs within the first 4 weeks.

    5
    What are the timescales for the open market procedure?
  • You serve offer notice, specifying terms and price on 90% of qualifying tenants, giving 2 months to respond.
  • More than 50% of qualifying tenants accept offer - no less than 2 months.
  • Qualifying tenants nominate a purchase - no less than 2 months.
  • You send contract to nominated person - no more than 1 month.
  • Nominated person signs contract and pays deposit - no more than 2 months.
  • You exchange contracts or withdraw - no more than 7 days.
  • Sale - conveyancing period to completion - any time from a few days to a few weeks or longer if desired/required.


    6
    What is the procedure for selling by auction (Section 5B)?
If you want to take the auction path to selling your interest you have to serve the appropriate notice between 4 and 6 months before the auction date.

Your notice has to include the following:
  • The principal terms describing what you're selling without mention of price or deposit and you don't have to state a reserved price.
  • A clear statement that your interest is to be sold by public auction.
  • That you're offering a contract with the nominated purchaser at the auction, assuming the latter wins.
  • That the qualifying tenants have a period of at least 2 months before the auction date to accept.
  • That the qualifying tenants have an additional 28 days to nominate a purchaser; this period has to end at least 28 days before the auction date. NB this differs from the open market sale procedure timetable, where 2 months is permitted.
You don't actually have to state the date of the auction in the notice although it's sensible to do so. If you don't you have to serve a further notice on the requisite majority, at least 28 days before the auction, which gives the date, time and place of the auction.

Your requisite majority of qualifying tenants have to accept the offer within the initial period you've set in your notice, unless you agree a longer period and subsequently have to notify you of the nominated person within the 28-day further period.

At least 28 days before the auction date, the nominated person has to send you a notice stating that they want to continue with the procedure. If they don't formally advise you of this intent via notice, then you can deem that the acceptance is withdrawn.

The tenants don't have to attend the actual auction and they're not required to make a bid; in fact, to do so will only drive up the price. Should a successful bid be accepted, the landlord has to send a copy of the contract to the nominated person within 7 days of the auction.

The nominated person then has 28 days to accept the contract and pay any requisite deposit. The overall result of doing so is that the nominated person, not the successful bidder, enters into the contract.

Please note the following:

  • The nominated person cannot challenge the price set by the auction - only you can agree to further negotiate the price after the auction.
  • If you withdraw your interest from the auction or it doesn't sell, then you cannot sell the interest in any way without starting the whole procedure again by serving a new Section 5 Notice.
  • If the qualifying tenants don't accept your offer or don't tell you whom the nominated person is or if the nominated person withdraws or is deemed to have withdrawn by not adhering to the time limits, then you're free to sell at auction within the next 12 months but you can't sell privately without serving a new notice: to do so is a criminal offence.
  • As before, if any qualifying tenants drop out such that there isn't the requisite majority anymore, then the nominated person has to withdraw.
  • The nominated person is deemed to have withdrawn if he doesn't accept the contract or pay the deposit.

There are other ways you can dispose of your interest, but these are relatively rarely used; for more information, click on Other Offer Notices


    7
    What are the timescales for the auction procedure?
  • You serve notice of offer specifying terms but no price on at least 90% of qualifying tenants - must be between 4 and 6 months before auction.
  • You have to allow the qualifying tenants 2 months to respond to the offer.
  • More than 50% of qualifying tenants accept the offer - no less than 2 months after receiving it.
  • Qualifying tenants then have no more than 28 days to nominate a purchaser.
  • You notify nominated person of date/place/time of auction - at least 28 days before the auction.
  • Nominated person has to inform you that they want to continue with the procedure - at least 28 days before the auction.
  • After a successful bid at the auction, you then have no more than 7 days to send your contract to the nominated person.
  • The nominated person than has no more than 28 days to sign the contract, fulfilling any conditions and return it.
  • You then have no more than 28 days to exchange contracts or withdraw.

Other Section 5 Offer Notices

Section 5C – where the landlord proposes to grant an option or right of pre-exemption on purchase of his interest

The notice must include the following:
  • the terms of the proposed disposal, the property or interest, the price etc.
  • a statement that the notice constitutes an offer by the landlord to dispose of the interest on those terms.
  • a period in which the offer may be accepted by the requisite majority.
All timeframes and subsequent procedures follow those of S5A

Section 5D – where the proposed disposal is not subject to a contract or option or right of pre-emption and is proceeding straight to the conveyance

The notice must include the following:
  • the terms of the proposed disposal, the property or interest, the price etc.
  • a statement that the notice constitutes an offer by the landlord to dispose of the interest on those terms.
  • the provisions for acceptance and nomination (as for S5A).

Section 5E – where the landlord proposes a non-monetary disposal

This could be where the landlord’s disposal is by way of a gift, or perhaps part of a deal with another landlord including its exchange for other land or rights.

The notice must include the usual details and information on the interest and terms of the disposal as required under sections 5A to 5D, whichever is applicable, but, of course, no price or other consideration unless any part of the disposal consists of money.

In addition it must state:
  • that the tenants may make an election under Section 8C of the 1987 Act accepting the offer of a non-monetary disposal (and explaining what this is); and
  • that the notice constitutes an offer which may be accepted by the requisite majority of qualifying tenants, for a nominated person to acquire the property.
The S8C procedure is rather complex but essentially it provides a right for the requisite majority to acquire the interest from the new owner, after the disposal, as though the landlord had not served the S5 notice. The tenants will have to pay the monetary equivalent of the interest and this is one of the few areas in the right of first refusal where the price may be determined by the Tribunal.


Selling your Freehold?

The right of first refusal is a complex area of law but our expert RICS Freehold Valuers and Freehold Sale Conveyancing Solicitors can help you: call us on 0333 344 3234 (local call charges apply).

*Fixed Fee – No Sale No Fee – On all Major Lender Panels **RICS Surveyors – Local Knowledge – Same Week Availability



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Collective Enfranchisement (the purchase of your freehold)
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