The need for residential developers in joint venture arrangements to have secure and appropriate exit strategies is nothing new. As legal advisors we recommend at the outset that this is considered when structuring the transaction as each joint venture will be different and each will need a bespoke strategy to be implemented once the joint venture has achieved its purpose and the parties are ready to go their separate ways.
What is new, is the impact that the Building Safety Act 2022 (BSA) will have on those previously tried and tested strategies in the context of developing new Higher-Risk Buildings as part of such joint venture arrangements. We may well find a reduction in appetite for persons or companies to take on the management of Higher-Risk Buildings with substantial ongoing building safety duties. This is particularly important to consider on traditional build to sell schemes (which is the focus of this article) where the traditional developer model is to build out the scheme, sell the apartments and then exit the arrangement without taking on any long-term management role for the estate. If a developer has not exited in the right way and in the right timeframe, they may be left indefinitely with the duties imposed by the BSA, some of which attract weighty criminal sanctions for non-compliance.
The options available to the developer will depend on the manner in which the developer holds its land interest. If the developer owns the freehold, there is the option to transfer the freehold ownership to a resident-owned management company, which would effectively give the occupants a share in the freehold and consequently pass on building safety obligations to the individual leaseholders. Whilst this has been the usual route for developers to take, giving the owners the responsibility to manage their own estate, there does appear to be a growing reluctance from residents to take up the option of becoming directors and taking responsibility. This presents an additional challenge when trying to exit even where the strategy at the outset was to hand over the management company to the residents after the sale of the final unit.
It is worth noting that the General Election is imminent, and it is expected that Labour's manifesto will include wholesale leasehold reform which would result in the abolition of residential leasehold ownership to be replaced with a commonhold system (which is widely used in Australia and across Europe). Notably, it is expected that this would apply to new and existing schemes and so perhaps where a developer has previously failed to exit or have an appropriate exit strategy in place and retains a landlord interest, this promised reform may serve as an alternative route to exit. However, this is certainly not a reliable fall-back given Labour's recent announcement that it would require more time in which to bring forward this legislative reform.
If the developer has been granted a headlease from the freeholder, it will need to ensure that the headlease can be assigned to a resident-owned management company or alternatively, has the benefit of a put option to require the freeholder to take a surrender of the headlease after the sale of the final apartment.
Traditionally, there has also been the option to transfer the freehold or assign the headlease to a professional management company, but with the abolition of ground rents and potential reforms to recoverability of service charges, the market for this may rapidly diminish.
It is becoming more common for developers to partner with local authorities on regeneration schemes where the local authority is the freeholder of the site. In this case, it might be the local authority that is the natural person who is best placed to take on the long-term estate management, especially if they have an interest in a large proportion of the apartments (e.g., as affordable housing). If the local authority does not retain any interest or only has a small proportion of the apartments within the estate, it may be that a resident-owned management company is set up, with the local authority taking a proportionate share of the votes where applicable.
The particular exit strategy chosen will depend on the circumstances in each case and it is recommended that these are discussed early on to both protect each party's interests but also to ensure that there are appropriate measures in place to ensure effective estate management for the future occupiers of the estate and to ensure the ongoing vision of the place that was the objective at the outset.
The options to exit will always need to be considered alongside any legal issues arising from company law, rights of first refusal and reforms to service charge costs recoverability (particularly those to be effected by the Leasehold and Freehold Reform Act 2024) and it is clear that these will need to be at the forefront of negotiations and part of transaction structuring to ensure developers are not left with unexpected or unintended but substantial obligations and liabilities.
As a final note, developers should be aware of Building Liability Orders which were introduced by the BSA to broaden the scope of liability beyond the original parties where equitable and just to do so, so thereby imposing liability on companies associated with the company originally carrying out the works. Developers should be aware that those liabilities will remain with the developer or group companies of the original developer (where the developer was a shell company or SPV set up purely to carry out the development) irrespective of whether they have successfully divested themselves of their land interest.
If you would like any advice or to discuss any matter referred to in this article further, please contact your usual Trowers contact.
