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Section 13 Notices and Is the deal closed? The use of the 'Subject to Contract' formula by Dr David Smith of Pain Smith Solicitors*

PainSmith Solicitors Legal Update

30th October 2007

Section 13 Notices

Most agents and landlords will be familiar with the need to serve a section 13 Notice to increase the rent in periodic Assured and Assured Shorthold tenancies. However, they may not be aware that it is perfectly possible to get round the provisions of s13 with a little forward planning. A recent Court of Appeal case has highlighted this point. .

It is important to understand the purpose of the Section 13 procedure. It is intended to allow landlords to have a means of increasing rent during periodic tenancies. It was envisaged that this would be important as the Housing Act 1988 specifically allows for periodic tenancies to occur and continue for substantial time periods. However, the process is specifically subject to certain controls to prevent landlords getting rid of tenants by massively increasing the rent. This control process is the right for the tenant to refer the rent proposed by the section 13 notice to a Rent Assessment Committee for them to determine whether that rent is a fair market rent for the property.

In this, there arises a problem. The Rent Assessment Committee ("RAC") is not always entirely consistent. Indeed, they are not under any requirement to be. Their decisions are also difficult and expensive to appeal against and there is no right of appeal at all in respect of decisions made by the RAC in regard to the appropriate level of rent.

However, the RAC does not have absolute jurisdiction. Subsection 5 of section 13 states: (5) Nothing in this section (or in section 14 below) affects the right of the landlord and the tenant under an assured tenancy to vary by agreement any term of the tenancy (including a term relating to rent). There is therefore nothing that prevents a landlord and tenant making some form of agreement about the rent. The most obvious way of doing this is to renew the tenancy for a new fixed term but it is not the only option. If it is anticipated that a tenancy will become periodic then an appropriate clause can be included to increase the rent periodically.

It is important to realise that this is an either/or option, there is no third way. So, for example it is unacceptable for a landlord to increase the rent by writing letters to the tenant. Without specific agreement between the parties such an increase will be void. Equally, it is impossible for a landlord and tenant to agree to involve the RAC when it should not be. As Lord Neuberger said in Riverside Housing Association v White "the jurisdiction of a rent assessment committee is entirely statutory. As a matter of law, statutory jurisdiction cannot, unless the statute so provides, be reduced or enlarged by parties by consent." In other words the section 13 procedure must be used unless there is some other form of agreement to alter the rent. If such an agreement exists then the section 13 process cannot be used.

Turning to rent increase clauses in more detail, it is sometimes thought that these must act to increase the rent by a specific amount such as set percentage or in line with the Retail Prices Index (RPI). This is not the case. In the recent case of Contour Homes Ltd v Rowen Lady Justice Arden said "to reach the conclusion that the only sort of contingent rent review clause which is included is one which provides for an increase of a specified fixed amount upon the happening on the contingency involves writing words into section 13(1)(b), and I would therefore hold the judge was wrong to limit the clause to fixed amount rent review clauses." In this case the clause simply set out that the landlord would serve a notice increasing the rent by an amount to be set out on that notice which would not exceed the market rent at the time. Therefore there is no reason why an agent cannot have a relatively simple clause increasing the rent by a 'market' percentage to be determined by the agent. Such a clause would have the effect of setting aside the section 13 notice process and avoiding the vagaries of the RAC.

Using a 'market increase' also avoids the unsatisfactory effects of the RPI. In fast moving areas the increase in RPI falls well below that being achieved in the market. Central London is a prime example of this issue as rents are increasing by as much as 10% per annum in some areas while RPI has gone up by a paltry 3-4%. In such cases using a clause with an RPI increase is not really in the landlord's best interests.

In summary, agents should consider incorporating some form of rent increase clause into all Housing Act tenancies. This will allow for an increase without having to deal with section 13 notices or the RAC. However, it is important that such a clause is drawn up properly and allows for a large enough increase to protect the landlord's interest as, if it is incorporated, it must be followed and the section 13 process will not be available as an alternative

PainSmith Solicitors Legal Updates are provided for information only and are not legal advice. If you do have a legal problem, you should talk to a lawyer or adviser before making a decision about what to do. You may wish to use the CLS/CDS Directory (www.justask.org.uk/public/en/directory) to locate an adviser. The information provided here is written for people resident in, or affected by, the laws of England and Wales only. You should note that date given in the update and be aware that the information given may become inaccurate due to changes in the law or its implementation.

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30th October 2007

Is the deal closed? The use of the 'Subject to Contract' formula

Many agents will be familiar with the phrase "Subject to Contract" or some similar formulation as a method of accidentally making a representation to the tenant which was not intended. This way any offer made is subject to its incorporation in the final lease agreement. However, there some other consequences of the use of this phrase which are not so favourable and it may not always be the best course of action.

First it is worth examining precisely what the Courts understand the situation to be when the "Subject to Contract" formula is used. The Courts construe the formula in accordance with the conveyancers understanding of the phrase. This is that a negotiation for a conveyance of land which is expressed to be 'subject to contract' is not complete until there is an exchange of contracts. There is an entire set of procedures for such exchange which are set out and agreed between solicitors. It is this position that allows for such situations as 'gazumping' where the seller suddenly pulls out of a deal because they have had a higher offer. In the case of Salomon v Akiens, the Court of Appeal had to consider whether this formulation should also be applied to a lease agreement. The Court was clear that there was practically no circumstances in which a negotiation for a lease should be seen as any different from that for a sale and therefore the 'subject to contract' formula should apply equally to both.

Practical Consequences: What does this mean in practice? In the case of Longman v Viscount Chelsea the Court made clear that this means that the "relationship does not become binding … until there is an exchange of lease and counterpart, before which either party can withdraw". In other words, until both the landlord and tenant have signed the agreement, the agreement has been executed, and the signed agreement has been passed to the other side then either party is free to withdraw.

Ending the Formula: Of course, there are other ways in which the 'subject to contract' formula can be dealt with. The parties could agree that the formula should no longer apply which is a common device in commercial or high-value leases where the parties will enter into an agreement to make an agreement. Alternatively, the parties can perform an action which sets the formula to one side. The most obvious of these is provision of the keys and the acceptance of rent and deposit payments. The formula comes into force once either party expresses an offer or acceptance of an offer as being 'subject to contract' and will remain in force even if following correspondence does not bear the same formulation until it is specifically brought to an end as described above.

Recovery of Expenses: The use of the formula also has implications for the recovery of costs and expenses. Where a party expends monies on the basis of an agreement which is subject to the formula it will be very hard to recover any monies expended on the basis of that agreement. As the High Court made clear in Regalian Properties v London Dockland Development Corpn each party must accept that any monies spent are a calculated risk and there will be no recompense if no contract results. This is not to say that agents cannot take steps to ameliorate this risk and a welldrawn up holding deposit agreement is a great help in this regard. Despite the fact that costs cannot be recovered in respect of actions taken under a belief that a contract that is subject to the formula was to be entered into there is no reason why a separate agreement taking a holding deposit from an applicant cannot be enforced. Such an agreement would typically cover the costs of referencing, preparing the agreement and would therefore protect the landlord from incurring agents costs with no prospect of recovering them. Such an agreement has the added benefit of ensuring that the agent will be paid for their time as well!

Other Formulas: There are other, more limited, formulas of a similar nature which may also be of value. The most commonly seen of these is probably 'subject to references' or some such phrase. This will have an effect similar to the 'subject to contract' formula but will be more limited and will effectively expire once satisfactory references have been received or the parties make clear that they have moved beyond that stage. By choosing to ignore them and agreeing a finalised contract, for example. The exact point at which these more limited formulas cease to be effective is not as certain due to the lack of Court decisions on the topic. In each case it will have to be decided at what point it was intended that the formula should come to an end and whether actions were taken to make it clear that it should no longer be effective.

Practice Points: Agents should consider in every case what is best for their client. In higher value properties where the landlord is unlikely to wish to pull out of the deal unexpectedly it may be best to avoid use of the 'subject to contract' formula to ensure that the tenant is tied into the contract as early as possible. In other circumstances, where the landlord is uncertain of the tenant or may want to pull out of the deal it may be wise to use the formula in order to preserve the landlord's position. Alternatively, it might be best to start negotiations 'subject to contract' but then agree at a later stage that the deal is finalised and that the formula should no longer apply, although this may be difficult where a deal is moving fast. As always, agents should take great care in the representations they make and how they are made to avoid invoking or rescinding the formula unintentionally.

Points to note:

  • Once the Subject to Contract formula has been invoked it will stay in force until it is specifically rescinded or the lease or tenancy has been signed and exchanged.
  • Either party can withdraw from the contract without penalty while the formula is in force
  • Agents holding deposit agreements are not affected and therefore recovery can be made from this for expenses such as referencing etc.
  • The formula should not be used automatically in every case and should be tailored to the specific requirements of each letting.
  • Make sure you have a solid holding deposit agreement setting out what charges the tenant is liable to pay.

PainSmith Solicitors Legal Updates are provided for information only and are not legal advice. If you do have a legal problem, you should talk to a lawyer or adviser before making a decision about what to do. You may wish to use the CLS/CDS Directory (www.justask.org.uk/public/en/directory) to locate an adviser. The information provided here is written for people resident in, or affected by, the laws of England and Wales only. You should note that date given in the update and be aware that the information given may become inaccurate due to changes in the law or its implementation.

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*See also Duty of Landlords To Mitigate Loss It is a widely accepted principle of contract law that a party to a contract should Seek to mitigate losses brought about by another party's failure to fulfil their contract adequately (British Westinghouse Electric Coy v Underground Electric Railways Coy [1912] C 673). It is usually assumed that this principle a lies equally to landlords faced with a tenant who wishes to surrender his tenancy during the contractual term.For full article Click Here

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*See alsoSafety Glass and Defective Premises Act - The Information on a Court of Appeal decision (7th February 2007) regarding the Defective Premises Act 1972 For full article Click Here

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*See also Implementation of the Regulatory Reform (Fire Safety) England & wales) Order 2005 Click Here

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*See also Understanding Business Tenancies June 2007 Click Here

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*See also Going Smoke Free - England July 2007 Click Here

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* Articles courtesy of PainSmith Solicitors are a niche practice specialising in Landlord and Tenant Law. Based in Medstead in Hampshire, they are ideally situated to provide an efficient service to clients nationwide as well as those based in Central London and the Home Counties.

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