Modifying covenants: Unlocking value in leasehold land

19th February 2020

Will Cousins and David Manda explain a recent case which reminds tenants that a landlord’s refusal to modify or discharge a covenant which restricts development or limits the value of leasehold land may not be the end of the line.  Will and David offer practical advice for unlocking potential in a leasehold portfolio.

Why is this case of interest?

It is well known within the real estate/development industry that the Upper Tribunal (UT) has jurisdiction to modify or discharge restrictive covenants affecting freehold land in accordance with section 84 of the Law of Property Act 1925 (LPA 1925). It is, perhaps, less widely known that this jurisdiction can also extend, in certain circumstances, to leasehold covenants by virtue of section 84 (12) LPA 1925. Section 84 (12) can provide the owner of a long leasehold interest with a mechanism to override restrictions on use, and thereby unlock additional value in its portfolio.

Restrictive covenants can prevent leasehold land being used for a particular purpose. Such restrictions may restrict the type or even density of development that can take place. Often the restrictions will be historic, yet their existence can have a significant impact upon the marketability and value of land.

Any party wanting to vary or relax such covenants will either need to come to an agreement with the beneficiary (which might involve the payment of a substantial premium), or ask the UT to exercise its jurisdiction to discharge or modify restrictive covenants.

The lease must be for a term of over 40 years with at least 25 years expired; and the leaseholder must be able to show that one of the grounds in section 84 applies, namely:

• the covenant is obsolete;
• it impedes some reasonable use of the land;
• the beneficiaries expressly or impliedly agreed to the release or modification; and/or
• no injury will be caused.

The recent Berkeley Square case [1] is a worked example of the UT’s approach to section 84 applications.

What are the practical implications?

This case is a clear reminder that, where a landlord will not agree to modify a covenant, a tenant may be able to make an application for modification which, if successful, could save any development plans or otherwise unlock value in leasehold land.

In such applications, evidence will be key.  The UT will consider all relevant circumstances and will make a decision on the particular facts.

If planning consent has been obtained for a proposed development and/or where it can be shown that the covenant in question does not secure practical benefits of substantial value or advantage to the landlord/beneficiary, a tenant/applicant is likely to succeed.

Similarly, however, it is important when considering a section 84 modification application, to take into account the nature of the landlord’s objections and their legitimacy. If the landlord owns any neighbouring property or if the restrictions form part of a wider leasehold scheme, for example, it may well be reasonable for a landlord to rely on the covenant to exert control and to restrict uses that it may deem undesirable or in conflict with its own interests.

Importantly, though, the ability merely to extract financial gain from the enforcement of a leasehold covenant should not provide the landlord with a good reason to oppose the application.  A landlord refusing to agree a modification requested by a tenant should always ensure they are able to justify, with evidence and in light of the section 84 (12) grounds, why the covenant is required.

It is worth noting that the UT’s power to modify or discharge a restriction is discretionary and that an application may be granted in cases where only one (or more) ground is satisfied.

What happened in the Berkeley Square case?

The tenant held a long lease of 45 Berkeley Square (the Premises). The freehold was held by the landlord, who was also the freeholder of the adjoining premises which included Annabel’s, a private members’ club located at 46 Berkeley Square. The lease, which was due to expire in 2070, contained a covenant which restricted the use of the Premises to offices with ancillary residential accommodation on the fourth floor.

The tenant sought to implement a planning consent it had obtained to change the use of the Premises to a private members’ club. However, the landlord would not agree.  The landlord argued that modifying the covenant to allow implementation of the tenant’s planning consent would be detrimental to its estate management, and that opening another private members’ club would have a negative impact on Annabel’s.

The tenant applied to the UT for modification of the covenant under the following grounds:

• There was no demand for office properties of that size and kind (grade I listed), hence the covenant was obsolete. (This argument was rejected by the UT, however, because demand was limited rather than non-existent, therefore the covenant was not actually obsolete.)
• There were multiple private members’ clubs in the area and the tenant had already been granted planning consent. The covenant therefore impeded reasonable user.  The UT accepted this argument.
• Modifying the covenant would cause no injury to the landlord. On the evidence, it was unlikely that another members’ club would diminish the value of the landlord’s reversion (in fact its value may even be increased), and use of the Premises as an office conferred no practical benefit on the landlord.  The UR agreed and accepted this ground.

The UT therefore decided that the tenant’s request for modification would succeed.

WM Comment

If you would like any advice or assistance in connection with the enforcement, modification or discharge of any restrictive covenants – whether that be in relation to freehold or leasehold land; and whether it be in relation to commercial negotiations or legal recourse via an UT application – please do not hesitate to contact Will, David or any of our Real Estate transactional or dispute resolution specialists.

[1] Berkeley Square Investments Ltd v Berkeley Square Holdings Ltd [2019] UKUT 0384 (LC)