What is a Qualified Covenant?
Leases of property usually include a series of obligations (covenants) by the tenant not to do things. These typically relate to assignment (transfer) of the lease, sub-letting the property or what the property can be used for.
Qualified covenants in leases are covenants where the absolute restriction on the tenant from doing something is tempered by the ability for the tenant to do so once the landlord’s prior consent has been obtained. In turn, the landlord covenants to act reasonably in considering whether to consent to the tenant’s request. (In the lease, the clause is usually worded “…such consent not to be unreasonably withheld or delayed”.)
In Sequent Nominees Ltd v Hautford Ltd, the issue of qualified covenants came before the United Kingdom Supreme Court. (The Court delivered their judgment on 30th October 2019.)
Case Background
The tenant had a lease of a mid-terrace building at 51 Brewer Street, London W1. The property consists of six floors, including a basement. The size of the basement and ground floors are bigger than any of the upper floors.The lease was completed in April 1986 but was granted for a term of 100 years commencing on 25th December 1985, at a peppercorn rent. The tenant paid the landlord a premium of £200,000.00 for the lease.
The lease allowed the tenant to use the property for:
“…one or more of the following purposes (a) retail shop (b) offices (c) residential purposes (d) storage (e) studio…”
At the time the lease was granted, the ground floor and basement of the property were in retail use, the first and second floors were used for storage and as a staff area (in connection with the retail use on the lower floors) and the top two floors were in occasional residential use.
The permitted use of the property under planning laws was: ground floor and basement – retail; first and second floors – office/ancillary and top two floors – residential.
In their lease, the tenant promised not to apply for planning permission without first obtaining the landlord’s consent. The landlord in turn was obliged not to unreasonably withhold consent.
As the tenant wanted to apply for planning permission to change the permitted use of part of the property, from business to residential use, the above qualified covenant became the main issue for consideration by the courts.
Between 2013 and 2015, the tenant carried out building works on the four upper floors of the property so that each floor was converted into a self-contained flat. Although these works were carried out with the knowledge of the landlord, the landlord reserved its right to refuse an application for permission to apply for a change of the permitted use under the lease, in respect of the first and second floors of the property. Once the buildings works had been completed, the top two floors at the property had been let to residential tenants but pending the grant of planning permission authorising the change of use, the first and second floors remained vacant.
The Tenant’s Application for Consent
In April 2015, the tenant applied to the landlord for their consent to apply for planning permission to change the use of the first and second floors at the property to residential. (Remember the lease already allowed those two floors to be used for residential purpose but there wasn’t any planning permission in place permitting this use.)
The landlord refused to consent to the tenant applying for the change of use planning permission, reasoning that doing so would increase the risk of a successful claim to enfranchise the freehold. Without admitting that an enfranchisement claim would then necessarily succeed, the refusal letter (sent by the landlord’s solicitor) continued:
“The effect of a successful claim to enfranchise would not merely damage the reversion; it would deprive our client of its reversion in the [property] entirely. Furthermore, it would deprive our client of control for estate management purposes of the block containing the [property], which would have an adverse impact on the value of our client’s investment in the block.”
In the litigation proceedings in the lower courts, it became evident that the tenant was indeed positioning itself so that they could mount an enfranchisement claim in the future. The landlord’s concerns, as above, would thus become a reality.
When the case was heard by the Court of Appeal, Sir Terence Etherton MR said, if the landlord did not have the protection under the lease, as afforded by the qualified covenant, then any third party could apply for planning permission for the change of use. Since the planning permission, once granted, attaches itself to the property, the tenant would not have been in breach of the terms of the lease (having not applied for planning permission itself), yet benefited from the now permitted change of use, which in turn would enable the tenant to enfranchise the freehold.
Apart from objecting during the consultation stage of the planning application process, the qualified covenant in the lease was the only other protection that the landlord had against the very real risk of the tenant enfranchising the freehold. During the proceedings in the lower courts, it became clear that the likelihood of planning permission for the change of use being granted (if it had been applied for) was high.
The issue for the Court to consider
The appeal centred around the reasonableness of the landlord’s decision to refuse consent. The Supreme Court’s judgement considers various case law and statutes surrounding this matter, of which, there is a huge body of work.
One of the phrases that stood out to me from Lord Briggs’ judgement is:
“…damage to the reversion is the quintessential type of consideration rendering reasonable the refusal of consent…”
The Supreme Court’s Decision
In the view of the majority of the judges of the Supreme Court in this matter, the risk to the landlord that they may at some point in the future ‘lose’ their freehold interest through the enfranchisement process was reasonable justification to refuse consent to the tenant, applying for planning permission to change the use of the property.
The Dissenting Judges
What I find interesting in this case, is that out of the five judges that considered this case, two judges disagreed with the above judgement. The dissenting judges agreed with the Court of Appeal’s judgement that the only factor that should be considered on whether the landlord had acted reasonably in withholding consent is the other provisions in the lease itself rather than any extraneous matter. In explaining their dissent, the judges opined that when the lease was granted, the parties had not contemplated the risk of enfranchisement so it should not now factor that into the consideration process.
Lord Briggs, in delivering the majority verdict in this matter, reasoned that when the lease was entered into, the law on enfranchisement did not, at that point in time, allow for the tenant to enfranchise the freehold, because the tenant was a company and not an individual. The law changed in 2002 and permitted a company tenant to enfranchise the freehold. Lord Briggs opined that the development in the law should have some bearing in the consideration process.
What do you think? Do you agree with the majority verdict or the dissenting voices?
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