Protection for lenders under shared ownership leases

Those readers with experience of shared ownership leases will no doubt be familiar with the now not-so-recent case of Richardson v Midland Heart Ltd [2008] L&TR 31, which highlighted the precarious position of those who seek to take their first step on the property ladder via the mechanism of shared ownership. But what are the implications of that decision for mortgage lenders?

The Midland Heart decision

In the Midland Heart case, Ms Richardson paid a premium of £29,500, representing 50% of the market value of the property, to acquire a shared ownership lease of a property for a term of 99 years from Midland Heart’s predecessor. The lease reserved an annual rent of almost £1,500 and contained the usual “staircasing provisions” enabling Ms Richardson to acquire further “shares” in the property and eventually to acquire the freehold, although Ms Richardson did not take advantage of these provisions.

Some years into the lease, Ms Richardson was required by family circumstances to leave the property, and soon after housing benefit stopped paying the rent under the lease. Rent arrears accrued, and Midland Heart brought possession proceedings based on ground 8 of Schedule 2 to the Housing Act 1988, following service of a section 8 notice. When the case came to be heard, the outstanding arrears exceeded the amount laid down by ground 8 and a mandatory possession order was made.

Ms Richardson brought a claim seeking a declaration that she held a 50% interest in the property and an order for sale or an account of 50% of the proceeds of sale. She argued, firstly, that as a result of the premium she had paid, Midland Heart held the freehold interest on trust for themselves and for her in equal shares. Alternatively, she argued that she had both an assured tenancy under the 1988 Act and a long lease which had not been properly brought to an end by forfeiture proceedings.

Jonathan Gaunt QC, sitting as a Deputy High Court Judge in the Birmingham District Registry, rejected both arguments. He held that Ms Richardson had only a leasehold interest in the property. She had an option to acquire the freehold once the staircasing provisions had been exercised in relation to the other 50% of the property, but she had not exercised that option. Further, her leasehold interest was simply an assured tenancy and nothing more (albeit one with a term of 99 years), being a tenancy to which section 1 of the Housing Act 1988 applied and which did not fall within any of the exclusions in Schedule 1 to that Act. 

Accordingly, a shared ownership lease can be brought to an end by court order under section 7 of the 1988 Act. The only qualification is that, as the lease will generally still be within the fixed term, the conditions in section 7(6) must be satisfied – namely, that the ground relied upon is ground 2, ground 8, or any of the grounds in Part II of Schedule 2 other than ground 9 or ground 16, and that the tenancy makes provision for it to be brought to an end on the ground in question, whether by way of a provision for re-entry, forfeiture or determination by notice or otherwise. Since a shared ownership lease invariably contains a forfeiture clause similar to those typically found in long leases, it will generally be vulnerable to termination by a simple possession action in the event that rent arrears arise or an obligation of the tenancy is broken.

The position of lenders

This will often be a draconian result for the tenant. Midland Heart did in fact offer to repay to Ms Richardson her original premium of £29,000 (less rent arrears and costs), but strictly speaking where a shared ownership lease is terminated the tenant will not be entitled to the return of their premium – never mind any capital appreciation there of. In effect, the termination of a shared ownership lease can represent a substantial windfall for a landlord.

The decision in Midland Heart received surprisingly little attention to begin with. However, its impact is now reasonably well appreciated amongst property lawyers – although a quick Google search reveals that most websites promoting shared ownership still describe it as a “part-buy, part-rent” arrangement, which is of course a dangerously misleading statement. Even the Homes and Communities Agency (formerly the Housing Corporation), which approves the form of most shared ownership leases, uses such terminology on its website and in its “Key Information for Shared Owners”, in direct contradiction to its “Important Notice” to tenants that if there is a failure to pay the rent or to perform the tenant’s obligations under the lease, the landlord may be entitled to terminate the tenancy with the result that the tenant will lose any shares in the property which he had acquired.

Rather less consideration, however, has been given to the position of lenders in relation to shared ownership leases. In the Midland Heart case, Ms Richardson provided her 50% premium upfront without the assistance of a mortgage, but in the majority of cases tenants under shared ownership leases raise their premium by way of borrowing on the security of the lease. Given that, as we have seen, the shared ownership lease is not particularly secure, one might legitimately ask why lenders are prepared to lend on such security, when they might stand to lose it in the event the tenant defaults on the rent of otherwise breaches the terms of the lease in some way. In the immediate aftermath of the Midland Heart decision, various commentators posed that precise question.

Built-in protection for lenders

In fact, the answer is twofold. Firstly, the typical shared ownership lease¹ has long contained a provision obliging the landlord to give a lender a certain period of notice prior to any possession proceedings being brought. This provides the lender with a window of opportunity in which to try to secure the continuation of the lease. Where the ground for possession is ground 8 – or indeed ground 10 or 11, which also relate to rent arrears – the solution is obvious; the lender will generally step in and pay off the arrears to satisfy the landlord, in much the same way as lenders in relation to long leases will do when faced with forfeiture proceedings.

But what about a case where possession is sought on the basis of a breach of the lease which the lender cannot remedy? An example might be unlawful sub-letting. In this situation, there is a degree of protection available to a lender – at least in the case of modern shared ownership leases. Since 2010, housing associations offering shared ownership leases must include within the lease certain “fundamental clauses”, one of which is known as the “mortgage protection clause” (MPC).  

The MPC protects a mortgage lender from a significant loss by entitling the lender to acquire the remaining share of the property retained by the landlord and then dispose of 100% of the equity in the property at the best price reasonably obtainable. If the amount owed to the lender by the tenant following that final acquisition will exceed the amount realisable by the lender on the sale of the property, then the lender is entitled to deduct at least some of, if not all of, their loss from the amount that would otherwise be payable to the landlord as the price for acquiring the remaining share of the property. Thus, the landlord effectively compensates the lender for some part of any loss incurred by the lender, and the tenant will then be liable to pay the landlord back.

Acting for lenders where the built-in protection is not enough

In general, this slightly convoluted process appears to protect the position of lenders reasonably well, and lenders seems content to lend against the security of shared ownership leases provided the lease contains the mortgage protection clause. However, the MPC is not a complete solution to the difficulty described above. As the foregoing paragraphs suggest, there is a cap on the loss which can be recovered by the lender, so they may not necessarily be compensated in full where a property has decreased in value. Further, the MPC is only effective where a lender is willing to step in and purchase and sell the property. In any event, there remain older shared ownership leases which do not contain the MPC.

Where an MPC does not exist, or cannot be relied upon to provide a satisfactory solution, it is suggested that a lender’s best course of action is to engage promptly with the landlord once possession proceedings are threatened and attempt to negotiate an outcome which avoids the lender losing the value of its security. It may well be that in many cases the landlord is prepared to pay the lender the sums owed to it upon sale of the property, as was promised to Ms Richardson in Midland Heart. The success of shared ownership schemes, which are frequently touted as the future of home ownership for lower to middle income families, depends on there being mortgage finance available in respect of shared ownership leases, and providers cannot really afford bad press which might discourage lenders from lending.

And where negotiations do not succeed? It will sometimes be the case that a landlord proceeds to issue a possession claim in respect of a shared ownership lease. In this situation the lender will wish to make representations to the court in respect of the impact of a possession order on them, and a timely application to be joined to the proceedings ought to be made. The landlord (and indeed the tenant) may not be thrilled by the increase in costs which may well result from a lender’s involvement in the proceedings, but it seems unlikely, given the direct effect which a possession order will have on a lender, that such an application would be refused. Indeed, lenders in such a situation have succeeded in obtaining permission both to provide written submissions and to make oral representations at trial. It is suggested that where possession is sought on a discretionary ground in Part II of Schedule 2 to the Housing Act 1988, the question of reasonableness which the judge must decide ought to include consideration of the lender’s predicament if a possession order were to be made together with all other relevant circumstances. It may be that, ultimately, the appropriate outcome is a possession order conditional upon the landlord undertaking to repay the lender the sums it is owed on sale of the property.

Above all, when acting for a lender in relation to a shared ownership lease, the points to remember are to ensure, when the lease is being entered into, that it contains the MPC and a covenant obliging the landlord to notify the lender of any proposed proceedings, to respond promptly to any suggestion that the landlord may seek possession to see if a negotiated settlement can be reached, and to engage proactively with court proceedings by seeking to become a party where necessary.

1 Model forms are produced by the Homes and Communities Agency