The Law Commission

 


PART VII

DERIVATIVE INTERESTS

7.1     The forfeiture of a tenancy terminates all interests which derive out of it: "the branches fall with the tree".^[1] As a result, sub-tenancies fall in on termination of the head tenancy, and mortgages of the leasehold interest meet the same fate. This rule, an assertion of the proprietary nature of the landlord's right, is justifiable on both practical and theoretical grounds^[2] and we continue to support its retention.^[3] In so far as it has potential to operate unfairly against those, such as sub-tenants and mortgagees, with interests which are dependant on the continuation of the tenancy, its effect can be mitigated by permitting such parties to apply to the court for "relief".^[4]
7.2     Under our proposed scheme, the effect of an absolute termination order will be to terminate, together with the tenancy which is the subject of the landlord's action (hereafter "the proceedings tenancy"), all interests which derive out of it. Many of those holding such interests will however be entitled to claim relief from the court. Applications for relief should be heard concurrently with the landlord's application for a termination order. The decision of the court on the claim for relief may affect the disposition of the landlord's application. If, for example, the court decides to vest the proceedings tenancy in the claimant, it would not be appropriate to make an order terminating that tenancy, and the vesting order would be the sole method of disposition. If, however, the court decides to grant a new tenancy to the claimant, then it would be necessary to make an order terminating the proceedings tenancy.
7.3     The tension underlying this area of law arises out of the competing interests of the landlord, who wishes to terminate the tenancy and to recover possession free of encumbrances, and of the persons who wish to preserve their interests in or over the tenancy. The two principal classes of those holding derivative interests are sub-tenants and mortgagees. It will be immediately apparent not only that their interests are very different but also that their motives in seeking relief may be quite diverse. The sub-tenant is likely to wish to preserve his or her right to continue in occupation, whereas the mortgagee will be essentially concerned about the protection of his or her security in the property.
7.4     As a general proposition, an encumbrance over the land may reduce its utility and its value. Not only will this render the landlord likely to oppose a claim for relief by an encumbrancer, it may also result in resistance to that claim by others who are seeking to obtain relief themselves. At the same time, the person who has been enjoying the right in question - and who may have paid for it - stands to lose a great deal from termination of the tenancy on which it depends.
7.5     Relief from forfeiture tends to take two particular forms under current law: an order granting a new tenancy to the claimant (on whatever terms the court thinks fit)^[5] or an order retrospectively vesting the old tenancy in the claimant.^[6] The First Report recommended that the court should be empowered to grant one other form of relief: an order preserving the claimant's interest. The 1994 Bill added one further possibility (to facilitate such preservation orders): an order that the landlord grant a tenancy to him- or herself.
7.6     As we have explained in Part V, we recommend that in every case the landlord shall be required to serve a pre-action notice on the tenant. It will be necessary, if relief is to be meaningful, that wherever possible those persons who are entitled to apply to the court for relief should be served with this notice. At the same time, we do not wish to make unrealistic demands of the landlord. A balance has to be struck between protection of those who would have realistic claims to relief from the consequences of termination of the tenancy and support of the landlord who is seeking to preserve his or her legitimate commercial interests. The wider the range of persons which we permit to claim relief, the greater the risk that some will not be served with the notice and that termination of the tenancy may occur before they are made aware of what is going on.
7.7     It must also be realised that it is one thing to permit a person to apply for relief, it is quite another for the court to grant it. The wider the range of claimants, the likelihood is that there will be more unrealistic applications than at present. It should not therefore be thought that an expansion of rights to claim relief will be inevitably matched by a greater willingness on the part of the courts to grant relief. Proceedings may be time consuming, and therefore expensive, as the landlord and those parties with possibly competing claims to relief ask the court to decide the appropriate hierarchy of interests following termination of the head tenancy.
7.8     There are three central issues, which are inevitably interrelated, on which we require to focus:

(1) who may apply for relief;

(2) how potential applicants are to be informed of the landlord's actions and of their rights to apply for relief;

(3) what forms of relief may be granted.

Who may apply for relief

7.9     The current law does not clearly list those who may apply for relief from forfeiture. The statutory jurisdiction contained in section 146 of the Law of Property Act 1925 refers to lessees, under-lessees and persons "deriving title" under them, without answering the question "title to what?".^[7] It has been held to cover mortgagees by sub-demise and chargees by way of legal mortgage on the ground that they are treated as if they were under-lessees.^[8] Recent case law has highlighted the problem of equitable chargees, who are currently considered to be outside the statutory jurisdiction but who can nevertheless circumvent the consequential difficulties by applying for "indirect relief".^[9]
7.10     There is no doubt that the current law is unclear and that any reforming legislation must set out clearly who should or should not be able to intervene when the landlord is seeking to terminate the tenancy in order to claim relief from the court. The central issue on which we must seek the views of consultees is how widely they consider the class of persons entitled to claim relief should be drawn.
7.11     In our view, there is little doubt that sub-tenants should be entitled to claim relief. We do not believe that this class should be restricted to "lawful" sub-tenants, thereby denying entitlement to apply to those to whom the premises have been let in breach of a covenant in the head tenancy. The unlawfulness of the sub-tenancy will however be a factor of which the court should take account in determining whether, in the exercise of its discretion, relief should be granted.^[10]
7.12     We also believe that mortgagees should be entitled to claim relief. Those who lend money on the security of leasehold interests will often seek to protect their position in the event of forfeiture of the tenancy by claiming relief from the court. We consider it essential to any future statutory scheme that those with security interests over the tenancy should be entitled to apply to the court to ensure that those interests are protected appropriately.
7.13     The shortcomings of the current law as it applies to equitable chargees have been highlighted by two recent decisions of the Court of Appeal. In Croydon (Unique) Ltd v Wright, Butler-Sloss LJ stated:

One might have thought that an issue which might be crucial to creditors who obtain charging orders over leases of property would have been decisively determined many years ago. It seems to me astonishing that the holder of a charging order over a lease is said to be unable to be heard in forfeiture proceedings and powerless to obtain any relief or protection of the asset which is the object of the charging order. If that is the state of the law, it raises a serious question mark over the value of a charging order over leases and reveals a serious gap in the enforcement process.^[11]

7.14     In the same case, Sir Christopher Staughton expressed the view that it would usually "be manifestly unjust to deprive the holder of a charging order ... of any right to apply for relief from forfeiture."^[12] This view was subsequently supported by Chadwick LJ, and, by inference, Hale LJ, in Bland v Ingrams Estates Ltd.^[13]
7.15     In our view, it is essential that some clarity is restored to this area of the law. It seems to us that once a creditor has taken the initiative and has obtained a charging order over the debtor's leasehold property, that creditor's security interest should be protected at least in so far as permitting an application for relief in any proceedings by the landlord to terminate the tenancy. In our view there is a strong case for making clear that equitable chargees should be entitled to claim relief. We emphasise that entitlement to apply would not be determinative of the question whether relief should be granted in the circumstances of the case. That would remain a matter for the exercise of judicial discretion.
7.16     We provisionally propose that entitlement to claim relief should be conferred on sub-tenants and mortgagees, whether legal or equitable, and also on equitable chargees of the tenant's interest in the premises.
7.17     If we were to draw the line there, those entitled to claim relief would all have, in the terminology of the First Report, "derivative proprietary interests".^[14] Sub-tenants may legitimately wish to claim the right to continue in possession, and both mortgagees and chargees may legitimately seek to preserve the security they enjoy over the property.
7.18     The First Report did however go some way further. In particular it recommended that the derivative class should also include those holding incorporeal hereditaments and those with enforceable rights to acquire sub-tenancies, mortgages and so forth.^[15] We are concerned that this definition may be too broad. It seems to us that it covers a potentially very wide range of persons, many of whom will be extremely difficult for the landlord to discover, and many of whom will have little realistic chance of being granted any meaningful form of relief by the court.
7.19     According to Megarry and Wade, the principal incorporeal hereditaments are rentcharges, annuities, advowsons, tithes, easements, profits a prendre and franchises.^[16] The mischief at which this proposed extension is directed has not been fully articulated. A tenant may have granted an easement to an adjoining owner, let us say to drive across the tenanted land. This easement will subsist for no longer than the duration of the tenancy, and unless the tenancy is terminated prematurely, it will come to an end when the tenancy expires by effluxion of time. If, however, the landlord terminates the tenancy for tenant default, the person holding the benefit of the easement ("the dominant owner", as he or she owns the "dominant land") stands to lose out. Applying the general rule, all interests which derive out of the tenancy will terminate at the same moment as the tenancy itself, and the dominant owner will no longer be able to exercise his or her rights over the property (for which payment may well have been made). Should, in these circumstances, the person who stands to lose the benefit of the easement be entitled to claim relief from the court?
7.20     Clearly, it was felt at the time of the First Report that this question should be answered in the affirmative. However, such a proposition is not without difficulty and does raise some complex and exquisite problems. What relief would the claimant seek from the court? The claimant has suffered loss in that he or she can no longer use the easement as a result of termination of the tenancy. The only truly appropriate remedy would be an order preserving the easement for so long as the tenancy would have lasted had termination not taken place. The claimant is not likely to want, nor is the court likely to grant, a new tenancy or for that matter the vesting of the old tenancy of the premises.
7.21     We are not aware of any cases in which a person claiming the benefit of an easement over the tenanted premises, or a holder of any other incorporeal hereditament, has applied for relief from the consequences of the forfeiture of the tenancy over which his or her interest prevails. We wonder therefore whether there is really any need in expanding the derivative class in this way.
7.22     In the light of these reservations, we seek the views of consultees as to whether a person who has the benefit of an easement over the tenant's interest in the property - or any other incorporeal hereditament - should be entitled to claim relief. We also seek the views of consultees as to whether any other persons, such as those with the benefit of an option or right of pre-emption over the tenant's interest, should be entitled to claim relief.

How claimants can be better informed of the landlord's actions.

7.23     No system can be fail-safe. While it is laudable that we should strive to ensure that as many sub-tenants and mortgagees as possible are made aware of the threat to their interests in the property, it is not always feasible to contact every single potential claimant. That said, it is obvious that the right of the derivative class to apply for relief during the process of termination depends for its effectiveness on the particular claimant being aware of the landlord's intentions. Ensuring that members of the derivative class have an effective right has resulted in attempts to invoke the inherent jurisdiction of the High Court in order to fill the gaps left by the legislation.^[17] The First Report recommended that a court should not normally allow a tenancy to terminate unless and until it is satisfied that all members of the derivative class will have their interests preserved or have had the opportunity to apply for relief.^[18]
7.24     The First Report considered that effect should be given to this overall objective by two principal means. First, the landlord should be entitled to serve upon the head tenant an "information notice" requiring information about all members of the derivative class of whose existence he or she knows and also to serve upon any member of the derivative class a similar notice requiring information about those members of the derivative class who derive title in turn from him or her.^[19] Secondly, the landlord should be entitled to serve upon any member of the derivative class a "warning notice" indicating that termination proceedings were being taken and that they could result in the ending of his or her derivative interest.^[20] Failure to respond to or comply with the "information notice" would entitle the court to order disclosure, to debar the tenant or the member of the derivative class from defending the action or claiming relief, and to order costs to be paid by the tenant.^[21] Failure to respond to the "warning notice" would result in the recipient who failed to seek relief within two months being barred from doing so thereafter.
7.25     The weakness of the "information notice" scheme is that its efficacy depends upon the tenant responding to the landlord's notice. Where the tenant has abandoned the premises, or simply does not intend to take any steps to defend the landlord's proceedings, service of this notice on the tenant is unlikely to be of any avail to the landlord, or indeed to the derivative class. Without the necessary basic information, the landlord cannot take the further step of serving a warning notice on those who may hold a derivative interest. We believe this would leave those who hold such interests too vulnerable.
7.26     We are now of the view that the onus of ensuring that the landlord discovers about the existence of those who have derivative interests should rest with the derivative class. In our view, the new statutory scheme for the registration of title to land can and should be utilised in order to achieve our aim.
7.27     The First Report recommended that, at the hearing of a landlord's application to terminate a tenancy, the court being asked to make an absolute or remedial order should be obliged to consider whether there are holders of derivative interests and their position. If it appears that there are members of the derivative class, the court should not make a termination order unless and until each such member has had the opportunity to apply for relief.^[22]
7.28     For the reasons set out in Part V, we recommend that it shall be a mandatory requirement for the landlord to serve a pre-action notice on the tenant. Those who come within the derivative class should as a matter of principle also be served. It would however be unreasonable to make this an absolute requirement on the landlord, as there will be some members of the derivative class whose interests will be very difficult, if not impossible, to discover. It would be unsatisfactory if the landlord who has terminated the tenancy may be subject to a claim for relief by a person whose interest was not reasonably discoverable and who subsequently appears and wishes to challenge the order which has been made. At the same time, it would be unsatisfactory for the landlord to place sole reliance upon the enquiries made of a head tenant who may no longer occupy the premises and who is unlikely to be concerned with the protection of those holding derivative interests.
7.29     The question is, therefore, what is it reasonable to expect the landlord to do? There are in our view three specific steps which a landlord should be required to take in order to protect the position of those with derivative interests. First, where the leasehold title is registered- and this will be much more common following the coming into force of the Land Registration Act 2002- the landlord should carry out an official search against that title.^[23] Secondly, the landlord should serve the pre-action notice on all those, including those whose interests appear on the title register, whom he or she knows are members of the derivative class. That notice should require the recipient to inform the landlord of any persons whom that recipient knows are also members of the derivative class. Thirdly, the landlord must respond to any information concerning further members of the derivative class by serving a further copy of the pre-action notice on them.
7.30     A landlord will be treated as having knowledge of a member of the derivative class if, on the day on which the pre-action notice is served on the tenant :

(1) that person's interest would have been revealed by an official search of the Register of Title (where the tenant had a registered title) or of the Land Charges Register (where the tenant's title is not registered); or

(2) the landlord knows that the person is a member of the derivative class, for example by way of response to an information notice served upon the tenant;

(3) that person had previously notified the landlord that he or she was a member of the derivative class.

7.31     Similarly we must consider what it is reasonable to expect a member of the derivative class to do in order that they be treated as having effectively given notice to the landlord of their interest. Accordingly we propose that :

(1) where the interest is one that can be registered either against the title out of which it derives or, where possible, with its own title and it has been registered; or

(2) where the tenant's title is not registered, the interest is registered in the Land Charges Register; or

(3) where the interest cannot be registered, against title or with its own title, but the member of the derivative class has served notice in writing on the landlord identifying the interest and stating an address at which notices may be served on the member;

the member of the derivative class will be deemed to have given effective notice of their interest to the landord.

7.32     In such cases where the member of the derivative class has taken one or more of the steps set out above but has not been served with a pre-action notice by the landlord, the member may make an application to court to overturn any final order made in proceedings brought by the landlord. Alternatively, where the landlord has unilaterally recovered possession, the member may apply to have the matter brought before the court so that the question of relief can be considered. We view this as an appropriate sanction where the landlord has terminated the tenancy without taking appropriate steps to inform the derivative class.

What forms of relief may the court grant?

7.33     The First Report offers a scheme which operates irrespective of the level of the court before which proceedings to terminate the tenancy have been brought. It is broadly facilitative, conferring power on the court to grant relief to members of the derivative class which can respond to the particular circumstances of each case. It is intended to remove the current distinctions between types of breach of covenant.
7.34     In revisiting the recommendations contained in the First Report, we are concerned that careful consideration is given to the realistic demands and expectations of members of the derivative class. These will differ according to the nature of the interest which they hold. The two main protagonists, sub-tenants and mortgagees, for instance, will have different, and sometimes conflicting, objectives. Sub-tenants will be looking to ensure that they can retain their interest so they can continue in occupation, or assign or grant a further sub-tenancy, of the property. Mortgagees will essentially be wishing to safeguard their security such that they can realise the full amount of the debt if necessary by onward sale of the tenancy.
7.35     There are three powers which the Report recommends can be invoked by members of the derivative class:

(1) preservation of the derivative interest

(2) vesting the old tenancy in the claimant

(3) granting a new tenancy in favour of the claimant.

7.36     We shall consider each of these powers in turn, and then address how they might apply in relation to the two most important holders of derivative interests, namely sub-tenants and mortgagees.

(1) Preservation of the derivative interest

7.37     The First Report recommended that the court should have a limited power to preserve existing interests.^[24] This recommendation was consequential upon the recommendation that a landlord who is seeking to terminate a tenancy should have the power to preserve interests which derive out of it. The advantages of this power, which does not exist under current law, are explained as follows in the First Report:

If, for example, the landlord is the freehold owner of a large block of flats which he has let, as a whole, to a head tenant who has failed to perform his obligations under his tenancy, the landlord may wish (or may acknowledge that it is only fair) to preserve the sub-tenancies of the individual flats. But under the present law he cannot do so: if the head tenancy is forfeited all the sub-tenancies will inevitably terminate, together with all the mortgages which may be secured upon them, and everyone will have to start all over again. As a result, a large number of new tenancy and mortgage documents may have to be prepared and executed (and often registered) and, although these documents may not need to be so long as the original ones (because they can be made supplemental to them), they will attract the same stamp duties and (if they have to be registered) the same Land Registry fees.^[25]

7.38     Preservation means that the interest in question does not terminate with the tenancy but continues in the hands of its existing owner. Such relief would also have the effect of continuing those interests which derive in turn from the interest which is preserved, irrespective of the consent of those holding such interests. As we explained:

On balance we think it right to make no requirement of unanimity on the part of holders. The power would be discretionary in any case, and if fewer than all the holders sought its exercise the court would have to decide whether it was right in all the circumstances to impose it upon unwilling participants for the sake of those who were willing; but the court would bear in mind that to do this would merely be to ensure the continuance of a situation which would, but for the head tenant's breach of obligation, have continued anyway.^[26]

7.39     The logistics of preservation is well expressed in the First Report in terms which we support:

... the effect should be similar to that produced by the present law on the surrender of a head tenancy. If the head tenant had created a mortgage, the head tenancy would be preserved in the landlord's hands in so far as was necessary to safeguard the interests of the mortgagee. Subject to that, sub-tenants would move one rung up the ladder, and the estate of the landlord would be deemed the reversion expectant on the first such sub-tenancy in order to preserve the same incidents and obligations as if the head tenancy had remained.^[27]

7.40     It should be noted that the fiscal advantages of preservation referred to in the First Report are, as a result of changes in taxation law, now illusory. Since 1994, surrenders by operation of law have attracted the imposition of stamp duty.^[28]
7.41     The First Report recommended that the landlord should have power to preserve all the interests deriving out of the head tenancy.^[29] In addition, the landlord should have power to preserve "a complete branch" of derivative interests, his or her power to pick and choose interests being limited by the principle that he or she must preserve all the other derivative interests, inferior or superior, which subsist to any extent in the same property or in one part of that property.^[30] A similar principle would be invoked where the court, rather than the landlord, decided to exercise its power of preservation.^[31] It is eminently sensible. It ensures that the leasehold structure is maintained so far as is possible. It discourages both landlords and the court from "cherry picking".
7.42     We support the recommendation that as a matter of principle and, subject to other statutory requirements, there should be no necessity for notification to be given to those holding derivative interests that those interests are being preserved. The preservation would become effective through incorporation in the order of the court.^[32] We do however have reservations about the effect of exercise of the power of preservation on the respective liabilities of landlord and tenant under a mortgage,^[33] and shall return to this difficult area below.^[34]

(2) Vesting the old tenancy in the claimant

7.43     A specific example of a preservation order which may be given distinctive statutory treatment is the conferment of power in the court to vest the head tenancy (which has been the subject of the landlord's attempt to terminate) in a claimant for relief.^[35] While it would be implicit in such an order that the head tenancy was itself terminated as against the old tenant, its effect would be that the claimant assume all the rights and obligations of that head tenancy.
7.44     This is described in the First Report by analogy with assignment: the order would take effect "as if the former [sc the old tenant] had assigned it to the latter [sc the claimant]".^[36] Although exercise of this power would not operate in itself to preserve interests deriving from the head tenancy, it would be open to the court to order the grant of new subsidiary interests to those members of the derivative class who had applied for relief.^[37] The recommendations contemplate that the claimant may obtain, by virtue of a vesting order, a term longer than that to which he or she was entitled under the sub-tenancy.^[38]

(3) Granting a new tenancy to the claimant

7.45     The grant of a new tenancy to the claimant is the most common form of relief presently conferred. While the establishment of new powers to preserve interests and to vest the proceedings tenancy in the claimant may result in this order being made less frequently, it will remain an important component of the court's jurisdiction.
7.46     We endorse the following recommendations which were made in the First Report on this subject:

(1) The form of order should require the parties to enter into a new tenancy document setting out fully the terms and obligations.^[39]

(2) The court should have power to appoint a person to execute any tenancy or counterpart on behalf of any party who is unable or unwilling to execute it him- or herself.^[40]

(3) The new tenancy should not exceed the old head tenancy in length.^[41]

(4) The court should be empowered to order the grant of a new tenancy of the whole or part of the property comprised in the head tenancy or of an interest in it.^[42]

(5) In fixing the rent under the new tenancy the court should have regard primarily to the rent formerly payable for the claimant's interest and to the rent payable under the head tenancy and (due allowance being made for any difference in the extent of the property) should not fix a rent higher than the greater of these figures unless special circumstances exist.^[43]

(6) Where the grant of relief to a derivative interest holder prevents the landlord from recouping his or her losses from the property itself, relief may be on terms that that person makes good the loss sustained by the landlord (for example paying off arrears of rent under the proceedings tenancy), in full or in part, either by requiring that a payment be made or by increasing the rent payable under the tenancy being granted.^[44]

(7) If the new tenancy is of part only of the property comprised in the head tenancy, the power should not be exercised so as to make good more of the landlord's loss than was fairly attributable to that part.^[45]

(8) Relief may also be on terms that the claimant, being a member of the derivative class, should grant new interests to any other such persons who had applied for relief.^[46]

(9) In general, the court should have power to grant relief upon such conditions as to costs, expenses, giving security or otherwise, as in the circumstances of the case the court may think fit.^[47]

Relief for sub-tenants

7.47     Where the claimant for relief is a sub-tenant, the machinery is relatively simple to apply. The sub-tenancy is essentially the same in nature as the head tenancy out of which it is derived. In so far as intermediate tenancies may be terminated, the sub-tenant can be elevated within the leasehold superstructure.

Example.

A grants a head-tenancy to B who in turn grants a sub-tenancy to C. The premises are in turn sub-let to D. If A then terminates the head-tenancy for tenant default, the derivative sub-tenancies will also terminate. C and D may however apply for relief. They may ask the court to vest the proceedings tenancy in themselves, or to grant a new tenancy (for a term no longer than that of the proceedings tenancy) to themselves.

7.48     As the nature of the interest for which the claimants apply is the same as that which has been terminated, there are no significant difficulties in re-designing the leasehold matrix subsequent to termination.

Relief for mortgagees

7.49     Much greater difficulties arise in relation to a claim for relief by a mortgagee of a leasehold interest. The underlying problem which besets attempts to deal with mortgagees' applications for relief is that the purpose of their interest, that of security, is very different from the purpose of the leasehold estate which is itself subject to the mortgage. To state the obvious, the mortgagee has a contractual relationship with the tenant upon whose leasehold interest the loan is secured. In the event of the tenant's interest being terminated by the landlord, the mortgage will fall in. The contractual "creditor-debtor" relationship will subsist, as evidenced by the continuing liability of the former tenant to pay instalments on the mortgage.
7.50     Once the tenancy on which the mortgage has been secured has been extinguished, the question of the continuing proprietary rights of the mortgagee is inevitably one of complexity. To be effective as a security, there must be a proprietary interest to which the mortgage is attached. As it was put in the Report annexed to the 1994 Bill:

To preserve the mortgage without preserving, or replacing, the interest on which it was secured would be futile: in such a case, if it became necessary for the mortgagee to realise his security there would be no action he could take because the security would be non-existent.^[48]

7.51     At present, relief is usually granted to mortgagees by means of an order vesting a leasehold interest in the mortgagee.^[49] This may be the forfeited tenancy, or it may be a new tenancy.^[50] Where the mortgagee is granted such a tenancy, it is unlikely that they will wish to go into possession. They will usually assign the tenancy for a premium and put the proceeds of sale towards the discharge of the mortgage debt.
7.52     The First Report contemplates three possible means of relief for mortgagees:

(1) an order preserving the hierarchical structure of interests, including the interest of the mortgagee;^[51]

(2) an order vesting the proceedings tenancy in the mortgagee, thereby preserving all or any interests which derive out of it;

(3) an order granting a new mortgage (or a new tenancy) of an interest in the whole or part of the property.

Dealing with the extinction of the mortgaged interest

7.53     Where the tenancy which forms the subject matter of the mortgage is terminated, the mortgagee may, as we have seen above, apply to the court for relief. In many cases, that tenancy will subsist following the determination of the proceedings. This will occur if the court orders that the tenancy vest in a claimant for relief or that the tenancy, among other interests, be preserved. Where the tenancy does not survive, however, there is a real problem for a mortgagee whose interest has been secured on the tenancy. How can that mortgagee retain a meaningful security?
7.54     This problem was not answered in the First Report, but the 1994 Bill suggested, by way of solution, that the court should have power to grant a new tenancy purely in order to provide security for the mortgagee. The new tenancy would be granted by the person who would have granted the tenancy on which the mortgage should have been secured, and the new tenancy would be granted to that person.
7.55     By way of illustration, where L granted a tenancy to T over which M had a mortgage securing an advance, and L terminated T's tenancy for tenant default, M would be entitled to claim relief from the court. The court could then order that L should grant a new tenancy to L purely for the purpose of providing M with a tenancy on which the mortgage can be secured.
7.56     This proposed mechanism was introduced in order to avoid the outright vesting in the mortgagee of the interest forming the security, in contravention of the principle embodied in section 86 of the Law of Property Act 1925. While the mechanism is perfectly logical, we now consider that it may be better in practical terms to create an exception to that principle rather than adding to the complexity of the termination orders scheme. The mechanism poses several unanswered questions as to the terms of the tenancy granted by the landlord to him or herself (relevant if the mortgagee goes into possession) and as to the extent of the liabilities of the various parties. Without wishing to labour the point, we are no longer confident that the artificiality of this device can be justified by its usefulness.
7.57     We therefore propose not to proceed with the recommendation (contained in paragraph 2.24 of the 1994 Bill) that the court should be able to order the landlord to grant a new tenancy to himself for the purposes of providing a mortgagee with continuing security.

the mortgagee as tenant

7.58     The main remedy obtained by mortgagees in forfeiture proceedings has been the conferment of a tenancy (either the grant of a new tenancy, or the vesting of the forfeited tenancy) on the mortgagee. While we accept that it may contravene the above principle, it is a pragmatic remedy which appears to suit lenders.
7.59     It is however a remedy which can give rise to difficulties. Despite the termination of the tenancy over which the mortgage has subsisted, the mortgagee will remain entitled to claim against the mortgagor tenant under the covenant to repay.^[52] The tenant may contend in turn that payment of the sums outstanding to the mortgagee should as a matter of principle entitle the tenant to redeem the mortgage and to recover the secured property where the mortgagee has yet to dispose of it.
7.60     In Chelsea Estates Investment Trust Co Ltd v Marche,^[53] Upjohn J held that where an order is made granting a new tenancy to the mortgagee,^[54] that tenancy is to be treated as "substituted security" in recognition of the continuing contractual relationship between mortgagee and mortgagee. ^[55] The tenancy will remain subject to the mortgage and hence the mortgagor's equity of redemption. Where the mortgagee sells the tenancy, he holds any surplus proceeds on trust^[56] for the mortgagor or any other person entitled to the equity of redemption^[57].
7.61     This perfectly logical and unexceptionable protection of the mortgagor's rights may have one rather unfortunate consequence flowing from the nature of the security. If the mortgagor, that is the former tenant, discharges the mortgage debt during the period the tenancy is vested in the mortgagee he or she may apparently be entitled to recover possession. The landlord may therefore find that the tenant whose tenancy had been terminated has, as a result of discharging his or her indebtedness to the mortgagee, recovered possession of the property. This result was aptly described by Upjohn J in Marche as "strange",^[58] and by the Law Commission in the First Report as "startling".^[59]
7.62     It is concern at this result which has led the Commission to propose two possible reforms in the course of this project. We have re-examined these proposals, and we are unconvinced that either would constitute a material improvement on the current law. We feel that there is something to be gained by focusing upon the result which has been found problematical and by considering whether there should be some reformspecifically directed against that result.
7.63     In the 1968 Working Paper, it was proposed that where a vesting order was made in favour of a mortgagee, the court should be entitled to order that the mortgagee would hold the tenancy free of the equity of redemption.^[60] The apparent advantage of such a remedy is that it would achieve a "clean break". From the date of the grant of the tenancy the mortgagee would hold directly from the landlord, and the tenant would have dropped out of the picture. The danger with such a remedy is that the mortgagee will be over-compensated. As it was put in the First Report, "the new tenancy might be worth more than the debt".^[61] This effect could itself be addressed by the court ensuring that the tenancy granted to the mortgagee is of equivalent value to the sum outstanding. It would be open to the court, for instance, to grant a term shorter in length than that of the terminated tenancy to represent the interest of the mortgagee. While this may involve the court in conducting a valuation exercise, this could be effected with appropriate expert evidence.
7.64     As, however, the First Report went on to demonstrate, the "clean break" is more apparent than real, unless some action is taken to deal with the further problem identified in Marche by Upjohn J:

If [the] new lease is not treated as part of the mortgage security, then I can see no reason in law why the mortgagee should not keep his new lease and at the same time sue the [former tenant] for the whole mortgage money under the covenants in the mortgage...^[62]

7.65     That would of course be highly unsatisfactory to the former tenant, as they would remain liable as mortgagor under the covenants, but be denied the incentive of redemption on payment of the sum outstanding to the mortgagee. As the First Report noted,^[63] it would be possible to require that the mortgagee, as a condition of obtaining relief in these terms, should renounce entitlement to pursue the personal remedies against the mortgagor. That would, however, put the mortgagee in a somewhat invidious position, having to make a choice between proprietory security and personal action where the very attraction of lending on mortgage is the duality of remedy which is available. We can see that this proposal may therefore cause more problems than it solves.
7.66     The First Report recommended, instead, that the tenancy granted to the mortgagee should be held in such a way that the landlord, not the former tenant, should be entitled to the equity of redemption.^[64] There is certainly something to be said for this. It is the tenant's own default which has resulted in the current predicament. Had there been no mortgage secured to the tenancy, the tenancy would have been terminated, the property would have been re-let or sold by the landlord, and there would have been no question of the tenant recovering possession.
7.67     We are not convinced, however, that this is an entirely satisfactory solution either. As the First Report conceded, it is "at first sight hard on the former tenant, who would have lost his tenancy while remaining fully liable under the mortgage." We think that is if anything an understatement. It seems to us that the proposal does not adequately observe the basic tenets of mortgage law that the mortgage is no more than security and that the mortgagee should account to the mortgagor for any sums obtained which are not subject to covenant in the mortgage agreement. As a matter of principle, we believe that where the mortgagee is granted a tenancy on application for relief, it should be on the same basis, namely as security for the performance by the mortgagor of the mortgage covenants.
7.68     That is not to say that we agree that the defaulting tenant should recover possession as against the landlord in circumstances such as these by reason of redeeming the mortgage. Although we would be very interested to hear of the experience of consultees, we are not at present convinced that the problem is one which occurs with any frequency. This may be because tenants whose tenancies have been forfeited will rarely be able to find the necessary capital with which to redeem the mortgage. It may also be that redemption with these consequences is not realistic where the mortgagor's own default has caused the risk to the mortgagee's security.
7.69     It is necessary in our view that a balance is struck between the mutual rights and obligations of mortgagee and mortgagor and those of the landlord and the former tenant. We believe this can be most effectively achieved by separating out these two contractual relationships with this distinction then being clearly reflected in the terms of the order made by the court. That order should deal principally with the proceedings tenancy. It may direct either that this be terminated, with a new tenancy being granted in favour of the mortgagee, or that it should continue but be vested in the mortgagee. The court should also make an order for possession as against the defendant tenant. The effect of the latter order would be that the former tenant cannot subsequently acquire a right to possession as against the landlord.^[65] We do not consider this to amount to a clog on the equity of redemption as this part of the order does no more than regulate the right to possession as between landlord and former tenant.
7.70     As we have already explained in Part VI above, the court will have jurisdiction both to make a termination order and to make a possession order. In most cases, these will take effect concurrently. We believe that the effect of the possession order should be to close down the tenant's claim to be reinstated as tenant in the unlikely event of his or her redemption of the mortgage over the tenancy. If this is the case, there would be no necessity to make specific provision to deal with the problem identified in Marche, a problem which, for the reasons we have set out above, we believe is in any event more apparent than real.
7.71     We seek the views of consultees as to whether this is an appropriate means of balancing the respective rights of landlord, tenant and mortgagee following the termination of the tenancy which forms the mortgagee's security. The court would have a discretion as to the precise form of order, although we can see the advantage of structuring that discretion in the statute such that it must have regard to the consequences of the order on the various interested parties. We would also be interested to hear the views of consultees on those factors which they believe should be considered by the court as it exercises its discretion.

summary of provisional proposals in this part

effect of termination order

(1) An absolute termination order shall terminate, together with the proceedings tenancy, all interests which derive out of it.

who may apply for relief

(2) Members of the derivative class may however apply to the court for relief from the consequences of the termination order.

(3) The derivative class should include sub-tenants, mortgagees and chargees (whether their interests are legal or equitable).

(4) We seek the views of consultees as to whether other persons, in particular those holding an incorporeal hereditament (such an easement) or an option or a right of pre-emption should be included within the derivative class.

how claimants can be better informed of the landlord's action

(5) The landlord must serve the pre-action notice on all those persons who are members of the derivative class where:

(a) the person's interest would have been revealed by an official search of the register of title or the Land Charges Registry (as the case may be); or

(b) the landlord knows that the person is a member of the derivative class; or

(c) the person had previously notified the landlord that he or she was a member of the derivative class.

(6) A member of the derivative class will therefore be deemed to have given the landlord effective notice of the derivative interest :

(a) where it has been registered against the title out of which it derives;

(b) where it has been registered with separate title or in the Land Charges Register; and/or

(c) a member of the derivative class has served written notice on the landlord identifying the interest and stating an address for service.

what forms of relief may the court grant

(7) The court may make orders on an application for relief:

(a) preserving the derivative interest in question; or

(b) vesting the proceedings tenancy in the claimant; or

(c) granting a new tenancy to the claimant.

(8) The landlord may seek to preserve all interests deriving out of the tenancy which is being terminated or to preserve a complete branch of interests in relation to a part of the property subject of the tenancy.

(9) We seek the views of consultees as to the appropriate means of dealing with the effect of termination on the mortgagee's equity of redemption and as to the factors to which the court should have regard in deciding what order to make in the exercise of its discretion.

Note 1    Megarry & Wade (6th Ed 2000), 14- 142.    [Back]

Note 2    First Report, paras 10.3, 10.4.    [Back]

Note 3    First Report, para 10.2. The First Report recommended the exemption of regulated tenancies from the rule, and it would seem logical also to exempt assured tenancies. As we are now limiting our recommendations so that they do not apply to short residential tenancies, this is now of no import.    [Back]

Note 4    In this context, where an application is made to the court by someone other than the tenant, we intend to retain the term “relief”. The complexity of the various overlapping jurisdictions to grant relief is now considerable: see generally Part 1.    [Back]

Note 5    LPA 1925, s 146(4). This provision is applicable where the landlord is proceeding through the courts. The forfeiture may have been in respect of any breach of covenant.    [Back]

Note 6    LPA 1925, s 146(2). It is only recently that its application to sub-tenants (and therefore mortgagees) has been recognised: Escalus Properties Ltd v Robinson [1996] QB 231. It is not applicable where the forfeiture is forfeited for non-payment of rent, on which see Supreme Court Act 1981, s 38(2); County Courts Act 1984, s 138(5).    [Back]

Note 7    First Report, para 10.25.    [Back]

Note 8    Ibid.    [Back]

Note 9    See paras 2.32 - 2.37 above.    [Back]

Note 10    First Report, para 10.27.    [Back]

Note 11    Croydon (Unique) Ltd v Wright [2001] Ch 318, 336.    [Back]

Note 12    Ibid, at p 330.    [Back]

Note 13    [2001] Ch 767, Chadwick LJ, para 57, at p784.    [Back]

Note 14    First Report, para 10.26.    [Back]

Note 15    First Report, para 10.26, and see, for slightly modified version, Law Com No 221, clause 23(1).    [Back]

Note 16    Megarry & Wade (6th Ed 2000), paras 18-004 et seq.    [Back]

Note 17    See for instance Abbey National Building Society v Maybeech [1985] Ch 190.    [Back]

Note 18    First Report, para 10.53, Recommendation (82).    [Back]

Note 19    First Report, para 10.54, Recommendation (83). For the purposes of exposition we shall refer to such a notice as an “information notice”, although it is not so termed in the First Report.    [Back]

Note 20    First Report, para 10.56, Recommendation (85). The notice would inform the recipient that he or she had the right to apply for relief, but that it would cease if it were not exercised within two months.    [Back]

Note 21    First Report, para 10.55, Recommendation (84).    [Back]

Note 22    Or the landlord has applied for preservation: 1994 Bill, clause 25(2). See also First Report, paras 10.59 - 10.64, Recommendation (86).    [Back]

Note 23    Where the title is not registered, the landlord should be required to carry out an official search of the Land Charges Registry.    [Back]

Note 24    First Report, para 10.33 et seq.    [Back]

Note 25    First Report, para 10.8.    [Back]

Note 26    First Report, para 10.34.    [Back]

Note 27    Recommendation (60).    [Back]

Note 28    Finance Act 1994, s 243. It is probable that the same will apply in relation to the new regime of stamp duty land tax being introduced by the Finance Act 2002.    [Back]

Note 29    Recommendation (59)(a).    [Back]

Note 30    Recommendation (59)(b).    [Back]

Note 31    Recommendation (68).    [Back]

Note 32    Recommendation (62).    [Back]

Note 33    Recommendation (63).    [Back]

Note 34    See paras 7.58 et seq.    [Back]

Note 35    Recommendation (69).    [Back]

Note 36    First Report, para 10.36.    [Back]

Note 37    Ibid.    [Back]

Note 38    This is not permitted under s 146(4) of the Law of Property Act 1925: see Factors (Sundries) Ltd v Miller [1952] 2 All ER 630.    [Back]

Note 39    Recommendation (72).    [Back]

Note 40    Ibid.    [Back]

Note 41    Recommendation (73).    [Back]

Note 42    Recommendation (74).    [Back]

Note 43    Recommendation (75).    [Back]

Note 44    Recommendation (76).    [Back]

Note 45    Ibid.    [Back]

Note 46    Recommendation (77).    [Back]

Note 47    Recommendation (78).    [Back]

Note 48    1994 Bill, para 2.22.    [Back]

Note 49    Law of Property Act 1925, s 146(4); County Courts Act 1984, s 138(9C).    [Back]

Note 50    Where relief is granted under LPA s 146(4), it must be by way of a new tenancy. Such a tenancy cannot operate retrospectively, and does not automatically reinstate existing derivative interests such as sub-tenancies: Official Custodian for Charities v Mackey [1985] Ch 168; Hammersmith & Fulham LBC v Top Shop Centres Ltd [1990] Ch 237. Where relief is granted under CCA s 138(9C) it may comprise the vesting of the forfeited tenancy in the mortgagee: UDT v Shellpoint Trustees [1993] 4 All ER 310.     [Back]

Note 51    This order may be made on the application of the landlord when seeking a termination order: see paras 7.37 et seq above.    [Back]

Note 52    The fact of a subsequent sale will not discharge the clear obligation to pay that arises under the covenant to pay contained in the mortgage deed. The mortgage debt becomes payable by the mortgagor on breach of that covenant. The limitation period for an action to recover the sum advanced is 12 years from the day on which the right accrued, Limitation Act 1980, s 20(1), while interest on the debt is subject to a 6 year limitation period, ibid, s 20(5), see Bristol & West Plc v Bartlett [2002] EWCA Civ 1181.     [Back]

Note 53    [1955] 1 Ch 328.    [Back]

Note 54    In the particular case, pursuant to Law of Property Act 1925, s 146(4).    [Back]

Note 55    Ibid, at p 339.    [Back]

Note 56    Banner v Berridge (1881) 18 Ch D 254.    [Back]

Note 57    For example where the tenant is insolvent and a liqiudator has been appointed.    [Back]

Note 58    Ibid, at p 339.    [Back]

Note 59    Para 10.47.    [Back]

Note 60    Proposition 10.10(3).    [Back]

Note 61    First Report, para 10.48.    [Back]

Note 62    [1955] 1 QB 328, 338.    [Back]

Note 63    See para 10.47.    [Back]

Note 64    First Report, para 10.48, Recommendation (79).    [Back]

Note 65    See Part VI, paras 6.7 et seq.    [Back]