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Conversion of long leases to outright ownership in Scotland

A version of this guide first appeared in Estates Gazette

Conversion of long leases to outright ownership in Scotland

Tenants under certain  long leases in Scotland will automatically become the owners of the property from 28 November 2015. This guide outlines who this will affect and what steps they should take before the conversion takes place.

Long leases are relatively rare in Scotland and the Scottish Government estimates that about 9000 current leases will be affected..

The Long Leases (Scotland) Act 2012 will automatically convert the tenant's interest under certain long leases in Scotland to outright ownership on 28 November 2015. This latest legislation completes the Scottish Government's programme of modernisation of land law in Scotland which included the abolition of the feudal system in 2004. Landlords and tenants should consider the potential impact of the legislation and begin any discussions in good time to ensure that all relevant notices required under the legislation are served on time to protect the interests of both parties.

The use of long leases

In contrast to England abd Wales, long leases have never been popular in Scotland. There are two principal reasons for this:

  • the historic feudal system (abolished in 2004) provided an alternative to long leases by allowing the seller of property to create entitlement to a perennial income stream from the property and impose lease type controls on the use of the property by future owners; and
  • ownership of property in Scotland has always been capable of horizontal division, whereas in England and Wales such division required to be created under a lease structure.

The latest legislation complements previous legislation which served to prevent a quasi-feudal structure being created by means of long leases. In 1974, legislation restricted the maximum length of newly created residential leases to 20 years, with further legislation in 2000 restricting the maximum length of newly created commercial leases to 175 years.

The latest legislation will now operate to abolish those remaining historic long leases which the Scottish Government consider grant a tenant a right more akin to ownership than the right of a tenant under a lease. The result is that the landlord will have no further interest in the property and the tenant will become the owner.

What will happen

  • On 28 November 2015 the tenant's interest under a qualifying lease (see below) automatically converts to ownership
  • Tenants can choose to opt out of the legislation but landlords cannot
  • Compensation may be payable to landlords for loss of rent and other rights
  • Certain lease conditions will automatically convert into title conditions affecting the tenant's new interest in the property for the benefit of neighbouring properties. Other lease conditions may convert to title conditions on registration of a notice by the person entitled to enforce the condition
  • The landlord's title will be extinguished on 28 November 2015 and any standard security (legal charge) over the landlord's title will cease to have effect
  • Any standard security over the tenant's interest in a long lease will remain and the tenant will own the property subject to that security

Qualifying Leases under the Act

A qualifying lease must:

  • be registered
  • have originally been granted for a term of more than 175 years
  • have more than 175 years of the term left to run (if non-residential)
  • have more than 100 years left to run (if residential)
  • have an annual rent of £100 or less
  • not be a lease of a harbour in respect of which there is a harbour authority
  • not be a lease of minerals
  • not be a lease granted for the sole purpose of installing and maintaining pipes or cables

There was concern that the legislation would inadvertently deliver a windfall to tenants who had been granted long leases for development purposes at a commercial rent. The ascension of the tenant to ownership would result in the deposed landlord (often a local authority) being deprived of a valuable asset it wished to retain. To address this the legislation provides that for a lease to qualify for conversion the annual rent must not exceed £100.

Considerations for tenants

Tenants need to consider if their lease is a qualifying lease and, if so, the potential cost implications of the legislation for them. If significant compensation may be payable to the landlord then tenants can opt out of the regime by serving the appropriate notices no later than 28 September 2015. A tenant can opt back in at any time if circumstances change.

Tenants should bear in mind that some lease obligations (relating to services and facilities) will automatically convert to title conditions and that their landlords will also have an ability to convert other lease obligations to title conditions by serving the appropriate notice.

There has also been unfounded concern at the potential impact of the legislation on capital allowance tax treatment of Enterprise Zone schemes set up using long lease structures. Investors, who typically acquired a tenant's interest, can look to the provisions of the relevant tax legislation which give comfort that the relevant interest (for tax purposes) will convert from the tenant's interest to the owner's interest when the leasehold structure is extinguished.

Considerations for landlords

Landlords will need to review their portfolios to identify any qualifying leases. If there are any leases with variable rent, such as turnover rent, which may have exceeded £100 in the five years prior to 28 November 2015 the landlord can register a notice to exempt that lease from the conversion process.

Landlords should consider whether there are lease obligations in any qualifying leases which they require to convert to title conditions on the appointed day. Where there are qualifying leases the landlord should try to reach agreement with the affected tenants and agree which lease obligations will convert to title conditions and then register the appropriate notices.

Compensation for loss of rent is payable to the landlord, calculated by a formula set out in the legislation, provided the landlord makes a claim for compensation before 28 November 2017. Landlords should establish likely compensation now to ensure they fully understand what impact this legislation will have on them.

If rent is overdue under a long lease the landlord should take all necessary enforcement action to recover that rent prior to 28 November 2015. After then no proceedings for enforcement action may be commenced.