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Estate rentcharges: A cause for concern for secured lenders?

  • United Kingdom
  • Litigation and dispute management

15-11-2018

Estate rentcharges are affecting lending on new-build freehold residential properties with increasing frequency, mainly because of their widespread use by developers to fund work on communal areas.

As there is a risk that default could lead to a lender’s security being severely undermined or even forfeited, an understanding of the potential pitfalls of estate rentcharges is essential for residential lenders.

Whilst estate rentcharges may still only affect a relatively small proportion of the residential property market, the potential for a detrimental impact on the security means that lenders should factor this in when assessing risk during the underwriting process.

What is an estate rentcharge?

A rentcharge is a mechanism for a third party (the ‘Rent Receiver’) to secure payment of a sum of money or to enforce positive obligations against an owner (the “Rent Payer”) of property (the ‘Burdened Property’) which in the case of a residential lender will be the mortgage security. The rentcharge imposes a charge on the land which can be enforced to secure the obligations.  

The third party usually has no interest in the Burdened Property. Therefore the rentcharge provisions do not apply to rent or other payments (such as ground rent)  which arise  under a lease or other interest in a property

A rentcharge can be protected by registration at HM Land Registry and a lender funding the purchase or re-mortgage of a property subject to a rentcharge protected by registration of a notice, takes their interest subject to the rentcharge.[1]

The Rentcharges Act 1977  provided that all existing rentcharges are to be extinguished on 22 June 2037 and that no new rentcharges could be created.   The exception is an estate rentcharge.

An estate rentcharge is typically used in freehold residential developments in two ways.   Firstly,  as a means to enforce positive covenants on the Rent Payer - for example to maintain a boundary wall. Secondly, to impose a payment on the Rent Payer to contribute towards obligations imposed on the Rent Receiver - for example, in new-build housing developments which consist of multiple freehold plots where each individual property benefits from shared spaces which need to be maintained by the freeholder (or a delegated management company), each freehold unit is sold subject to an estate rentcharge payable by the individual purchaser of the plot to contribute towards the upkeep.

There is no statutory right to redeem an estate rentcharge and, other than in limited circumstances, the only way to terminate it is to negotiate an express release with the Rent Receiver, usually in return for a lump sum payment.  In new-build freehold residential developments, once in place, release of the estate rentcharge may prove difficult as it will defeat their purpose although it may be possible to negotiate revised terms of the rentcharge to overcome some of the pitfalls described below.

Pitfalls for lenders

Unlike financial obligations arising under a lease (such as service charges or ground rent), there is currently no statutory mechanism to challenge the level of charges imposed by an estate rentcharge. 

Whilst an estate rentcharge will often only require landowners to make  nominal or fairly insignificant payments, the automatic statutory remedies available to Rent Receivers on default (coupled with any express provisions within the rentcharge itself) can be severe and can have significant unforeseen consequences not only for the Rent Payer, but also for the lender because of their potential to prejudice a lender’s security.

Remedies on default include an action for debt against the Rent Payer.  In addition,  if the payment remains unpaid for 40 days,  there is a statutory right for the Rent Receiver to grant a lease to trustees over the Burdened Property for the purpose of raising monies to clear the arrears, interest and costs. There is no requirement to tell the lender that a lease is being granted and the lease will continue for its full term of years, even if the rentcharge arrears are  paid or the rentcharge redeemed in full.[2]

The registered rentcharge lease will be binding on any future purchasers and against a lender in possession.  This could significantly inhibit the value of the lender’s security because at any time the Rent Receiver could place tenants in the property , sell the lease to a third party or create a legal mortgage over it. Whilst title insurance might cover any quantifiable losses, it cannot force a Rent Receiver to cancel any lease it has granted. Some Rent Receivers will likely insist upon payment of a significant fee in order to surrender the lease.

Another remedy which can jeopardise the security of a lender is a statutory right of entry into possession of the Burdened Property until the arrears, interest and costs are paid.   As stated, there is no mechanism to challenge the amounts due other than to bring court proceedings and therefore whilst any dispute is unresolved, the right of entry subsists which will have a detrimental effect on the security.

In addition to this statutory right, it is also common in many rentcharges for there to be an express right of entry or re-entry for non- payment of the rentcharge or other breach of covenant which if exercised could lead to the Rent Payer’s interest in the Burdened Land (and therefore the security)  being forfeited. However there is some positive news for lenders, as relief may be granted to lenders under the court’s equitable jurisdiction which generally will be granted to the Rent Payer (or lender) if the breach (for non-payment of the rentcharge or other breach of covenant) is remedied.  In addition, in the case of a breach based on a covenant other than  for non-payment of rentcharge, a notice pursuant to S146 of the Law of Property Act 1925 must be served which gives the Rent Payer (or lender) the right to apply for relief under those provisions.  Nevertheless the threat of forfeiture and the time, cost and uncertainty of applying for relief may well have an adverse impact on the lender’s appetite to have such a property as security.

Alternatives available to estate rentcharges

A Deed of Covenant (‘the Deed’) between the developer/management company and the purchaser of the individual plot could be deployed to achieve a similar outcome to that desired by developers currently using estate rentcharges. The Deed could be protected by a notice on the Register.  However the burden (the obligation to pay the money due or to perform the positive covenants) will not pass with the land automatically upon sale, and each seller would have to agree an indemnity covenant with their purchaser.  This option still does not give the Rent Payer the right to challenge the amount of the rentcharge, however, the remedies for non-payment would not be as draconian as under an estate rentcharge.

An alternative course of action may be to open up dialogue between developers and lenders in order to create a standard form estate rentcharge document with an accompanying Code of Conduct. This would have the benefit of alternative, contractually agreed enforcement methods for Rent Receivers (for example, excluding the above statutory remedies) whilst also providing for notice periods which could be given to freeholders and lenders alike prior to any enforcement action being taken for arrears to be discharged or other breaches remedied. This would allow lenders to make a commercial decision on whether they wished to make a payment of the amount demanded and to debit this to the mortgage balance, in the same way that lenders currently respond to demands for ground rents and service charges in leasehold land.

Comment

In October 2016, the Council of Mortgage Lenders (now UK Finance) reported to the Law Commission that the law on rentcharges was urgently in need of reform.   In December 2017, primarily in the context of leasehold reform, the government announced that new measures would be introduced (for England only -  it remains to be seen what will happen in Wales and Northern Ireland) which include making sure that freeholders subject to estate rentcharges have equivalent rights to leaseholders to challenge unfair charges and to prohibit the owners of rentcharges from taking possession where the rentcharge has only been outstanding for a short time.  

Following on from this announcement, a consultation (applying to England only) opened on 15th October 2018 and is open until midnight on 26th November 2018. Whilst the government appears committed to introducing measures to ensure that freeholders subject to rentcharges (or equivalent charges in deed of covenants)  have similar protection currently available to leaseholders to challenge the level of rentcharges, the consultation does not expressly address the draconian rentcharge remedies which potentially jeopardise the security.

As things stand, the law remains unchanged and we suggest  lenders, when assessing their risk appetite,  should continue to scrutinise the use of estate rentcharges by developers when lending on new-build developments and factor this into their assessment criteria. It is, of course, in the best interests of both lender and customers alike, that communal spaces are maintained to protect property value - so there is an incentive too for lenders to explore alternative options.  Dialogue between lenders and developers is to be encouraged to avoid a stalemate scenario where the issue becomes a barrier to lending on new-build developments which would be detrimental to all involved. 


[1] Para 6, Schedule 2, Land Registration Act 2002

[2] Roberts and others V  Lawton [2016] UKUT 395  

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