Conversion of offices to residential use: It's not just about planning law

Tribunal decision highlights role of restrictive covenants 

In the decision of the Upper Tribunal at the end of August, a local authority owner was unsuccessful in preventing the relaxation of a restrictive covenant limiting the use of one of its buildings to offices only, to allow a future residential use.

The local authority (Basingstoke and Deane Borough Council) had granted a 150 year lease of an office block in 1985 allowing it to be sublet in order to generate rental income and was entitled to 15.5% of the net annual income received from tenants in the building.

The building became vacant in 2013 and was bought by the applicant in 2015. The building was in a serious state of disrepair. The applicant wanted to convert the building into 114 flats but the Council wanted it restored to the condition needed for re-letting it as office space. It was agreed that mere repair of the building was insufficient to achieve this and a major refurbishment would be needed before it would be lettable in the market.

Did the office only covenant provide benefit of substantial value or advantage?

The tenant (a developer) who had acquired a long lease of the town centre building and had applied to modify the covenant under Section 84(1)(aa) of the Law of Property Act 1925 on the grounds that the covenant restricting the use of the building to offices only did not secure to the landlord any practical benefits of substantial value or advantage to them.

There was debate over whether the value of the Council’s reversion would be enhanced more by an office refurbishment or a conversion to residential occupation. The rental values assumed by the Tribunal for the office refurbishment marginally exceeded those for the residential conversion but were considered more at risk of interruption. The Council also argued that the restriction secured other substantial benefits by preserving its ability to enforce office-only covenants in head leases of other local buildings in its portfolio, to prevent them from being converted to residential use as well. The Council argued too that there were broader economic advantages for the town of retaining office use in preference to residential in the town.

The Tribunal confirmed that the mere existence of a restriction could not in itself be of practical benefit for the purposes of the Section 84 application. What mattered was the preservation of the continued office use of that building and the continuing receipt by the Council of 15.5% of the net rental income.

In considering whether there were other substantial advantages to justify upholding the restrictive covenant, the Tribunal recognised that “substantial advantages” could be wide ranging and not just limited to purely financial issues. This provided some hope for the Council as did the Tribunal’s view that the fact that arguing for the wider social and economic benefits to be considered was legitimate. Issues affecting the prosperity and amenity of the wider neighbourhood could be relevant benefits secured by the covenants, which any landlord could argue for, whether private sector or public sector, so the Council was not prohibited from fighting on those grounds even though as a local authority their role was wider than that of landlord only.

However, after detailed examination the Tribunal concluded that preservation of this pattern of covenants limiting buildings to office use within the Council’s area did not confer any substantial beneficial advantage to the Council.

Several factors counted against the Council.

First, the Council’s own activities went a long way to undermine the Council’s position and indicated that their objection to conversion from office to residential was not that significant. The original proposal to provide flats for letting on assured shorthold tenancies at open market rents was taken seriously by the Council when made by the previous owner, so seriously that they undertook a joint marketing exercise in February 2015 describing the building as “permitted development rights opportunity”.

In addition, this building had been excluded from the original area sought to be protected by an Article 4 Direction overriding PD Rights to convert from office to residential. Attempts to bring the building into the Article 4 area were only made after the later proposal for development of the building was received. If the building was so important as an office location, it would no doubt have been in the Article 4 direction area from the beginning.

The Council had even included the building in its own strategic housing land availability assessment in 2015, indicating that they saw its future as residential not commercial. The Tribunal felt able to take the planning issues into account when looking at the conduct of the Council as landlord as it clearly indicated its strategic intention.

Arguments against the setting of a precedent, were dismantled by the Tribunal who carefully examined the other buildings in the area and a different approach adopted by the Council itself to protection of these areas in planning terms (via the Article 4 direction). In carrying out this examination they concluded there was no likelihood that a favourable decision in this case would significantly affect the future prospects of similar covenants being overturned on other buildings in the area.

The decision

The Tribunal therefore concluded the retention of the building in office use would not make a significant contribution to the economic wellbeing of the town, thereby undermining the Council’s objection and enabling the Tribunal to order modification of the covenant to permit residential use.

Issues to consider

The significance of this decision is that it acts as a reminder to developers when considering conversion of offices to residential use (whether taking advantage of permitted development rights or otherwise) to also take into account the existence of the restrictive covenants on use contained within either the freehold or, as in this case, leasehold titles.

The case also is an example of the impact that the detailed background of any particular case has on a decision and how hard it is to apply a particular outcome as a general principle.

The decision of this Tribunal is not a green light for a comprehensive removal of office-only covenants. The Tribunal considered a series of competing arguments and came to their decision in this case in favour of the tenant. In another case, the decision could easily have gone in favour of the landlord.

Can a restriction on sub-letting be a “restriction as to user” under section 84?

The application at the Tribunal was not entirely successful for the proposed developer, in that they had also sought to modify another covenant in the lease which required that every sub-letting of any part of the building should be on terms including a full market rent which were approved in advance by the landlord. The requirement for consent was subject to a proviso that consent could not be unreasonably withheld or delayed. Undoubtedly the conversion of the building into over 100 smaller residential units would make compliance with this covenant a major administrative burden.

The Tribunal decided that this covenant, although relating to the subletting of the building, was nevertheless a covenant which contained a restriction “as to the user” of the land in question and therefore gave them jurisdiction to consider the application. However they decided that the control on subletting was not obsolete for the purposes of Section 84 of the Lawful Property Act and therefore should be retained in place. This means that the full subletting procedure would have to be complied with unless the Council agrees a streamlined approach.

Unfinished business

The Tribunal pointed out that the Council could have taken a more aggressive approach to enforcement of the tenant’s covenants to repair the building (where there had been clear non-compliance) and to seek to sub-let the building as offices, which were contained in the Lease (where non-compliance was at least arguable). The successful tenant in this case may still have a fight on its hands.

Shaviram Normandy Ltd v Basingstoke and Deane Borough Council, Upper Tribunal, 30 August 2019