I. INTRODUCTION TO THE LEGAL FRAMEWORK
There is only one form of ownership of real estate in Scotland: that of outright ownership; however, property held on outright ownership – known as ‘heritable property’ – can either be used by the owner or occupied by a tenant under an occupational lease. Investment leasehold interests can also be granted, typically either for a premium and subject to a nominal rent, or a rent calculated with reference to the actual or potential income derived from the occupational tenants. Most investors in property in Scotland, as elsewhere in the United Kingdom, are likely to be interested in property that is occupied by a tenant on a full repairing and insuring lease. In this way, the investor will receive a revenue stream from the rental income paid by the occupational tenant, who will also be responsible for all costs of repair and maintenance of the property and insurance of the property against normal risks such as damage or destruction by fire, flooding and storm damage.
Ownership of real estate may also be held in common by two or more owners. Each owner will hold an equal share in the property along with the other owners, unless some alternative division of shares is specified in the title to the property. Such shares are referred to as pro indiviso shares (i.e., undivided), the effect being that each of the owners has an indivisible share of the whole of the heritable property in question.
i System of registration
Registration of title to real estate in Scotland currently operates by reference to two separate systems: the original Register of Sasines, which is a register of deeds, and the newer Land Register of Scotland, which is a register of title (or interests) set up by the Land Registration (Scotland) Act 1979. The plan-based Land Register is gradually replacing the Register of Sasines. Both registers are overseen by the Keeper of the Registers of Scotland, and are accessible to the public.
The Land Register is based on the Ordnance Survey (‘OS’) map, and for real estate to be registered in the Land Register it must either be delineated on a plan or sufficiently described so that it is capable of being plotted onto the OS map. When property that is recorded in the Register of Sasines is sold, that transaction will induce first registration into the Land Register. It is only by having title recorded or registered in one of the Registers that an owner of real estate obtains a real right to the property, that is, a right that is protected from challenge.
Title that is recorded in the Register of Sasines does not benefit from any state guarantee. Once title to real estate is registered in the Land Register, a state guarantee, known as the ‘keeper’s indemnity’, is available against certain defects and challenges. This is not a comprehensive guarantee, and there are a number of statutory exceptions to the indemnity. Short leases (less than 20 years) and some other rights do not require to be registered to be effective. Such overriding interests will bind a purchaser and should be uncovered by a solicitor’s due diligence process.
ii Choice of law
Real estate may be characterised as heritable, or immoveable property. Generally, for immoveable property the choice of law will be the lex situs, that is, the law of the country in which the property is situated. For the purposes of any dispute, land and buildings on land are immoveable. Where a right has both moveable and immoveable elements, such as the right of a heritable creditor to recover monies secured by way of a standard security (fixed charge over real estate), the right is categorised as immoveable by virtue of the security.
Real estate law in Scotland is different from real estate law in England, Wales and Northern Ireland, and consequently specialist advice will be required where other jurisdictions are involved; however certain areas of law such as taxation apply throughout the United Kingdom (although see Section VIII, infra, regarding the proposals in the Scotland Bill).
II. OVERVIEW OF REAL ESTATE ACTIVITY
Unsurprisingly, the Scottish investment market has witnessed lower levels of investment activity over the year in review. There is competition for those assets that are considered to be prime from both UK and foreign investors. Economic conditions remain uncertain given the Eurozone crisis and cuts in spending to reduce the UK budget deficit. Debt finance is difficult to obtain on acceptable terms and is acting as a further constraint on activity; however, property does remain an attractive asset class for many investors who are either familiar with the sector or who are looking to diversify their portfolios.
There is an appetite from many annuity and pension funds for investments let on long leases to local authorities, universities and other highly rated entities. Typically, the rent in such transactions is reviewed in accordance with increases in the retail prices index with suitable collars and caps applying.
Occupational demand is subdued across most of the key markets with the exception of several supermarket operators looking to increase their market share, budget hotel operators mainly in city centre locations and the Aberdeen market where the energy industry continues to drive demand. With a few limited exceptions, there is little speculative development activity.
Foreign investment in Scotland has continued as investors seek safe havens in the UK property market. Exchange rates have also encouraged such investment and while sterling’s trade-weighted average is down, UK property remains attractive to foreign investors.
Large residential developers are starting to rebuild their development land banks and, as with the commercial sector, location is one of the key considerations of any acquisition. The trend of developing houses in preference to the development of flats has continued over the past year.
There has been significant investment in renewable energy projects in Scotland and the UK in 2011, with further investment in the pipeline across the industry expected.
III. DEVELOPMENTS IN PRACTICE
i Scottish parliament and land law reform Domestic legislation in Scotland has been the responsibility of the Scottish parliament since 1999, when powers were devolved from the UK government in Westminster. Westminster retains legislative responsibility for reserved matters, including corporate law, fiscal, economic and monetary policy, competition, transport and energy.
Since 1999, there have been a number of fundamental changes to Scottish real estate law enacted by the Scottish parliament. Developments in competition and energy law enacted by the UK parliament also affect Scottish property interests.
One of the key changes to Scottish property law in recent years is the abolition in 2004 of the feudal system of landholding, seen as increasingly anachronistic in modern society. Under this system, land was held and occupied by ‘vassals’ under a feudal ‘superior’ to whom the vassal owed duties such as performance of obligations, for example, erecting buildings or the requirement to pay regular sums of money (known as feuduty). Prior to abolition, feudal superiors had the opportunity to reallocate enforcement rights in respect of feudal conditions onto other property owned by them, with the result that although the feudal relationship of superior and vassal has disappeared, many formerly feudal title conditions are still in existence. The right to claim payment of feuduties has now expired.
ii Land reform
The Scottish parliament has pursued a vigorous programme of land reform, from its inception. A flagship policy of the parliament was the transformation of public rights of access by Part 1 of the Land Reform (Scotland) Act 2003, which extended statutory access rights to ‘everyone’ to encompass (1) the right to be on land (including inland waters, canals and the foreshore) for recreational purposes, or carrying on a relevant educational activity, or carrying on a commercial activity, provided it is an activity that is capable of being carried on uncommercially, and (2) the right to cross land.
Access rights must be exercised responsibly, and there is power to exclude or restrict land from the exercise of access rights (e.g., for the purposes of defence or national security). Also excluded is ‘sufficient adjacent land’ next to a house so that the occupants of the house can have a reasonable amount of privacy. This will normally mean the garden around a house.
iii Title conditions
Title to most real estate in Scotland is affected by title conditions, such as obligations to maintain property (e.g., a boundary wall or fence) or to permit access over land, or restricting the use of land or buildings for particular purposes. The most common types of title conditions are (1) real burdens – which impose an obligation on the owner of the property to do something, refrain from doing something, enter or make use of property, or provide for management of property; and (2) servitudes – which entitle the owner of one property to use another property in some way, for example, for access or to lay pipes or for support.
The rules relating to creation, enforcement, variation and termination of such real burdens, formerly governed by common law, made up of case law and custom, are now codified in the Title Conditions (Scotland) Act 2003. Under the previous system it was not always clear who had rights to enforce performance of real burdens, but the requirement under the 2003 Act for dual registration of real burdens against both the burdened and the benefited properties means this is no longer a difficulty for burdens created after 28 November 2004.
Burdens created prior to that date may be subject to rules contained in the 2003 Act that create implied enforcement rights, which can often require extensive title investigations to try to identify benefited owners. Such investigations can occasionally be inconclusive, and other routes considered, such as title indemnity insurance or an application to the Lands Tribunal of Scotland.
iv Tenement law
Tenement property is a building, or part of a building that comprises two related flats that are, or are designed to be, in separate ownership and are divided from each other horizontally. They can consist of entirely commercial property, entirely residential or a mixture. The law governing ownership and maintenance of common parts of tenements is now governed by the Tenements (Scotland) Act 2003, which introduced a model scheme of management of tenement properties, which applies to all tenement properties in Scotland, except to the extent that specific provision is made in the title to the tenement in question. The practical significance of this is that now all existing tenement titles have to be read against the background of the Tenement Management Scheme and the 2004 Act.
The Tenement Management Scheme applies to both existing and new tenement buildings. It provides principally for certain parts of a tenement, such as the roof, foundations, solum and external walls, to be common parts for the purposes of maintenance and repair, regardless of ownership of these parts. These parts are referred to as ‘scheme property’.
v Energy performance certificates
An energy performance certificate (‘EPC’) for a building states the energy efficiency of that building and provides carbon dioxide ratings in bandings from A to G, similar to energy ratings for domestic appliances. The EPC also includes recommendations for the cost-effective improvement of the energy performance of the building, but these are not mandatory. EPCs are required for new buildings in Scotland, under building regulations, which provide that an EPC is to be a fixture within a building.
Existing buildings in Scotland are governed by the Energy Performance of Buildings (Scotland) Regulations 2008, which provide that when the building is to be sold or let, the owner of the building must make a copy of a valid EPC available, free of charge, to a prospective buyer or a prospective tenant.
In the case of public buildings (both new and existing) with a floor area of more than 1,000 square metres, an EPC must also be publicly displayed.
Following the recast of the European Energy Performance of Buildings Directive (EPBD2) in 2010, the Scottish government consulted in 2011 on changes to the EPC regime in Scotland (see section VIII, infra).
In 2010 a new arbitration regime was introduced in Scotland, thoroughly modernising the system to make it fit for purpose in a contemporary commercial environment. The Arbitration (Scotland) Act 2010 makes the process more accessible for both domestic and international disputes.
The 2010 Act introduced a comprehensive codified set of Scottish Arbitration Rules, designed to make the process quicker, clearer and more cost effective, making Scotland an attractive option for arbitrating on international disputes, as well as a realistic domestic alternative to dispute resolution through the courts.
The rules consist of a combination of mandatory rules, which will apply to all arbitrations, and discretionary rules, which can be applied or disapplied with the prior agreement of both parties to the contract, although, in the absence of an agreement to the contrary, the discretionary rules will apply by default.
vii Competition law – application to real estate
Following the coming into force of the Land Agreements Exclusion Revocation Order in April 2011, the Competition Act 1998 and, in particular, the Chapter 1 prohibition, are now relevant to land agreements. Chapter 1 is based on Article 101 of the Treaty on Functioning of the European Union and prohibits agreements between undertakings that may affect trade within the United Kingdom and that have as their object or effect the prevention, restriction or distortion of competition within the United Kingdom.
An example of a real estate arrangement that may be caught by the Chapter 1 prohibition is a lease of a unit in a shopping centre that contains a non-competition provision preventing a landlord from granting a lease of another unit to a competitor. The effect on UK trade must be appreciable, a rough estimate of the threshold being a combined market share of 10 per cent for horizontal agreements and 15 per cent for vertical agreements. Following the repeal of the exclusion order, companies must self-assess land agreements for compatibility with competition legislation. The Office of Fair Trading (‘the OFT’) has provided guidance, which focuses on land use restrictions, especially where both parties are competitors.
The real estate sector is, however, still adjusting to the changes and consequently, the full ramifications of this change in the law remain unclear. Investors should be aware that the OFT can order parties to an agreement to cease or modify activities and impose fines of up to 10 per cent of a company’s UK turnover for up to three years.
viii Carbon Reduction Commitment Energy Efficiency Scheme (‘CRC’)
The CRC scheme aims to improve energy efficiency and cut emissions in large businesses and public-sector organisations having significant electricity use. The scheme requires participants to buy ‘allowances’ as well as put in place systems to monitor and report their energy use and carbon dioxide emissions. The scheme is generally perceived as overly complex and precisely how the allowance market will function is yet to be seen. Similarly, the time frames for compliance have been subject to numerous changes and it is not yet clear how the costs will be divided between landlord and tenant; however, it is likely that landlords who arrange (and pay for) supplies of energy for their tenants will be responsible for accounting for that energy under the scheme, while tenants who arrange their own energy supplies will be responsible for accounting under the scheme. Obligations are imposed at group level, and thus there is likely to be a significant administrative burden involved in apportioning costs (and benefits) of the CRC within group organisations in relation to their respective property holdings, as well as the more obvious financial impact on organisations caught by the scheme.
ix Lease accounting proposals
There are proposals under international accounting standards (IAS) (and possibly UK generally accepted accounting principles (GAAP)) to change the way leases are treated for accounting purposes, by bringing operating leases onto the balance sheet, which will eliminate the accounting distinction between operating leases and finance leases. The Finance Act 2011 (at clause 53) confirms that changes to the accounting treatment of leases will not affect their tax treatment, at least for the moment.
x Insolvency and real estate
Company voluntary arrangements In general, a company voluntary arrangement (‘CVA’) allows a company to come to an arrangement with its creditors over the payment of its debts. A CVA can be proposed either by the directors of the company, an administrator or a liquidator. The arrangement requires the approval of 75 per cent or more by value of the creditors at the meeting to approve the proposals. As a creditor, a landlord will be invited to the meeting and receive details of the proposals. A landlord will be eager to get the most commercially attractive outcome possible, although the relative flexibility of a CVA may frustrate the landlord’s objectives.
The English case of Moutant & Co Trustees Limited and another v. Sixty UK Limited (in administration) and others (‘Miss Sixty’) demonstrates that a landlord may be able to challenge a CVA on the basis that it is unfairly prejudicial. In this case, the tenant’s liabilities were guaranteed by a parent company and the CVA released the parent company from the guarantee. This was held to be unfairly prejudicial as the CVA did not adequately compensate the landlord for the loss of the parent-company guarantee. Miss Sixty also reiterates the position established in Prudential Assurance Company Ltd & Others v. PRG Powerhouse Ltd & Others. Miss Sixty protects the value of parent-company guarantees generally as it provides comfort to landlords that such guarantees are unlikely to be undermined by similar terms in a CVA.
Rent as an expense of the administration
A further insolvency issue that has been the subject of recent rulings in both the Scottish and English courts relates to the treatment of a rent payment that falls due while a company is in administration. The English case of Goldacre (Offices) Limited v. Nortel Networks UK Limited (in administration) established that where a company in administration uses a leasehold for the benefit of its creditors, any rent that falls due during the period of use will be ranked as an expense of that administration. This is significant because an expense of an administration is almost always discharged in full. The decision in the subsequent Scottish case of Cheshire West and Chester Borough Council v. Springfield Retail Ltd (in administration) brings the position in Scotland in line with the position in England and Wales. It also establishes that the granting of a licence to occupy by an administrator will constitute use for the duration of the licence.
Goldacre and Cheshire West reflect a shift in policy, as previously the treatment of rent in these circumstances was on a case-by-case basis (i.e., balancing the prejudice to the landlord with the benefit to the creditors). Although these cases are good news for landlords, the benefit may be limited if administrators choose to vacate such leases or time administration appointments directly after rent falls due. The full implications of Goldacre and Cheshire West are likely to become clearer through subsequent case law.
IV. FOREIGN INVESTMENT
Overseas investors are able to own, sell and lease real estate in Scotland without restriction. Tax may be payable on income derived from such real estate investments. A legal opinion may be required to confirm that a foreign investor has legal power to enter into a transaction involving property in Scotland, to deal with the property and to sign the relevant documents.
Some international investors operate in a regulated environment where, for instance, the custodian bank of the fund requires to approve, inter alia, the disposal of the property in question. There may also be a need to ensure that an entry in the relevant land register is made to allow the custodian of the fund an ability to monitor this. Unlike some other jurisdictions in the United Kingdom, the Scottish Land Register will not accept the registration of such a limitation, however this issue can be addressed satisfactorily in other ways.
V. STRUCTURING THE INVESTMENT
There are a number of alternative structures available in both Scotland and in England and Wales for direct or indirect investment in real estate. How best to structure such investment is likely to be dictated by tax considerations, taking into account both UK tax legislation and that of the investor’s own jurisdiction. There are, however, a number of advantages and disadvantages to each structure that may also prove critical depending on the investor’s particular objectives.
i Corporate entity
Corporate entities are desirable because a body corporate can hold assets in its own name and grant floating charges. There is potential for flexibility in terms of share structure, and there can be the advantage of limited liability. More generally, corporate entities are widely recognised and can promote a strong and legitimate identity. There is, however, a lack of confidentiality compared with other investment structures, as well as the added administrative burden of complying with the relevant regulatory framework. There is also a lack of tax transparency, as a corporate entity is likely to be assessed for corporation tax and capital gains. As a result, it may be expedient to base the company offshore.
ii General partnership
While property co-ownership does not itself create a partnership, carrying on the business of active, joint management of property may well constitute a partnership; it is a matter of substance rather than form. Most partnerships, however, will be subject to a written agreement regulating the terms. In Scotland, a partnership has a distinct legal personality that is separate from the individual partners, and so can own property in its own name. More usually, however, the partners will hold title to property as trustees for the firm.
The key advantage of using a partnership is tax transparency, while the main disadvantage is the unlimited liability of the partners in relation to partnership debts.
iii Limited partnership
In a limited partnership a proportion of partners can be ‘limited partners’, who have limited liability according to the amount of their capital contributions. This limited liability is particularly advantageous when coupled with the tax transparency that a limited partnership offers. In addition, the capital contribution can be minimal and the general partner, who holds the property deals with it on a behalf of the partnership and retains the associated liability, can be a limited company with a nominal issued share capital. A limited partnership, however, must comply with the Limited Partnerships Act 1907 and a limited partner would be liable if involved in the management of the partnership. This may prove unduly restrictive for investors looking to actively manage their real estate investments.
Limited partnerships incorporated in Scotland enjoy separate legal personality. This enables them to own property and other assets in their own names, enter into contracts, sue or be sued, borrow money and grant certain types of securities. Limited partnerships incorporated elsewhere in the United Kingdom do not enjoy these benefits.
iv Limited liability partnership
Limited liability partnerships (‘LLPs’) are governed by the Limited Liability Partnerships Act 2000 and combine limited liability for members with the tax transparency of a partnership. LLPs are not subject to the same legal restrictions as limited partnerships and as such partners are able to actively manage the business of the LLP. Additionally, an LLP is a body corporate (having a legal entity separate from that of its members) and so there are no issues as to the legitimacy of floating charges, which in contrast can be problematic for general partnerships. The main downside is that in general the LLP must be operated by a lawful person in accordance with the Financial Services and Markets Act 2000 (‘the FSMA’).
v Property unit trust
A property unit trust is an open-ended fund that allows pooled investment and is tax-efficient as capital gains are tax-free, although income is taxed. A unit trust is governed by a trust deed, and as such may be an unfamiliar structure to certain foreign investors. One of the principal drawbacks is the requirement for authorisation under the FSMA. Offshore unit trusts are reasonably popular, the most common being a Jersey property unit trust, which is usually closed-ended and can have further tax advantages as a result of its offshore status. Nevertheless, there may still be local regulatory supervision that could restrict investors. Similarly, the fact that it must be managed outside the UK may be undesirable for certain investors.
vi Luxembourg and other offshore vehicles
Offshore vehicles can potentially take advantage of a lighter regulatory regime and thus minimise tax liabilities. As well as Jersey (the Jersey property unit trust mentioned above), popular offshore locations include Guernsey, the Isle of Man, the British Virgin Islands and the Cayman Islands. Alternatively, locations such as Luxembourg provide regimes where ‘full’ tax is paid, often with the benefit of tax treaties. It is necessary in either case to ensure that appropriate tax advice is sought, both locally and in relation to UK antiavoidance legislation (as well as any other jurisdiction relevant to the investor).
vii Listed property company
Investing in a listed property company offers a popular means of investing in UK real estate. In addition to the characteristic of corporate entities summarised above, listed property companies can benefit from a high profile and augmented credibility as well as greater liquidity. The drawbacks include stringent regulatory and filing obligations and a general lack of confidentiality. In addition, listing is expensive and places extra pressure on company management to perform. The investor also has limited control over the underlying real estate.
viii Real estate investment trust
A real estate investment trust (‘REIT’) is a relatively new form of property-specific investment vehicle in the United Kingdom based on an investment structure first developed in the United States. REITs are tax efficient as they are exempt from tax on income and capital gains; distribution of profits to shareholders is treated as income rather than corporate dividends. In order to gain REIT status a company must comply with a number of conditions, including a requirement to be listed on a recognised stock exchange (which currently excludes AIM) and proof of property rental business characteristics. In addition, the various conditions must be complied with on an ongoing basis. The timing of the introduction of REITs in the United Kingdom in 2007 hampered the performance of the REIT market. Nevertheless, REITs provide a vehicle for liquid, property-focused investment. If current government proposals to reduce barriers to entry come to fruition, REITs may well be instrumental in preserving and bolstering the estate market by providing a viable presence in the listed sector.
ix Property joint venture
As joint ventures allow parties to share risk they provide a particularly attractive investment structure while the availability of debt remains constricted, and investors are keen to mitigate risk exposure in a relatively muted real estate market. A property joint venture can be structured in whatever form the parties choose and in many cases involve more than two parties. Of course, as well as sharing risk, parties share gains and management and REIT provisions need to be considered carefully. A joint venture may also result in an additional layer of taxation on gains and thus it is common for tax transparent structures to be favoured. Such an arrangement, however, may have disadvantages; for example, it could compel foreign investors to submit tax returns.
VI. REAL ESTATE OWNERSHIP
The planning control regime in Scotland is used to regulate development, and is administered by local authorities (‘LA s’), as well as the Scottish Ministers (and in relevant cases, the national parks authorities). New buildings, changes to the use and appearance of existing buildings and other changes to the use of land usually require planning permission, although some minor development does not need a planning application if it consists of ‘permitted development’ because it is, for example, either inconsequential or uncontroversial, or relates to the existing use of land or buildings.
The planning system consists of three main elements:
a development plans, which lay out the ways in which places may change in future and policies that can be used for planning decisions;
b development management, which is the actual process involved in making decisions on planning applications, and must be directed by the developmentplan policies; and
c enforcement, which encompasses procedures to ensure that development is completed properly, and can be put into effect to take action when it has not.
The environmental issue of particular significance to investors is the contaminated land regime, which is set out in Part IIA of the Environmental Protection Act 1990 as amended by the Environmental Act 1995. Contaminated land is basically land that is causing or may cause significant harm to the environment or human health, and includes water pollution. There is an obligation on LA s to inspect their land in order to identify contaminated land. An LA or environmental agency (in Scotland, the Scottish Environment Protection Agency (SEPA)) must serve a remediation notice on the relevant persons requiring clean-up, investigation and monitoring of the contamination and it is a criminal offence to fail to comply with a remediation notice. In general, those who cause or knowingly permit land to become contaminated are responsible in the first instance; if no such person can be found the current owners and occupiers of the site may become liable. Remediation costs can be substantial and as such it is often necessarily to obtain specialist advice when dealing with land that is or may be contaminated.
Stamp duty land tax
The acquisition of real estate in Scotland may attract a tax known as stamp duty land tax (‘SDLT ’). This tax also applies in England and Wales.
SDLT is payable on a land transaction that is not exempt from charge. The tax is based on a percentage of the chargeable consideration, subject to minimum thresholds under which no tax is due. Payment of the tax is the responsibility of the purchaser, who must make a land transaction return to HM Revenue and Customs (‘HMRC’), on the appropriate form within 30 days of the effective date of the purchase, usually (unless the return is made using the HMRC online system) accompanied by the relevant tax.
There are two applicable percentages charged, depending on whether the chargeable interest is in residential or non-residential property, and is based on the ‘slab system’, meaning that once the threshold is reached, all of the consideration is chargeable at the higher rate.
A different approach applies in relation to SDLT payable on a lease, which is based on the value of the rent payable over the term of the lease (net present value), and if a premium is also paid, SDLT is also payable on the amount of the premium on the slab basis.
SDLT is subject to the proposals in the Scotland Bill (see Section VIII, infra, regarding these proposals).
Sales of land are in general subject to value added tax (‘VAT ’) if the sale involves a ‘new’ (completed within the past three years) or incomplete industrial or commercial building. In circumstances when the seller is liable to pay VAT on the sale of the land this liability may be passed to the buyer under the sale contract. The leasing or letting of commercial and industrial premises is exempt from VAT ; however, even if VAT would not otherwise apply, the seller or landlord can elect to supply subject to VAT . The landlord or seller can then recover the VAT charges on supplies of goods and services made in connection with the property concerned.
iv Finance and security
The only way of creating a fixed charge over heritable property in Scotland is by granting a standard security. Standard securities were introduced by the Conveyancing and Feudal Reform (Scotland) Act 1970, which contains a number of forms and styles of the documents and procedures that it introduced, including the standard security and forms for assignation, restriction, discharge and variation of a standard security.
The 1970 Act also introduced a codified set of conditions – the standard conditions – that automatically apply to the provisions of any standard security, without the need to refer to it in the document. These relate to practical matters, aimed at preserving the value of the property, such as maintenance and repair, alterations and letting ofproperties as well as enforcement such as calling-up and notices of default. Most, but not all, can be varied to suit the lender’s specific requirements.
The enforcement rights of heritable creditors in the event of default by the borrower are also set out in the 1970 Act.
VII. LEASES OF BUSINESS PREMISES
To be valid in Scotland a lease must contain four essential elements: the parties, the rent; the premises; and the duration. Leases normally have a specified termination date, although it is theoretically possible for a lease to last forever as there is no rule in Scotland against the creation of perpetuities. Since June 2000, however, there has been a prohibition on the creation of new leases for a period of more than 175 years. There are no restrictions on increasing the rent as long as this is provided for in the lease. Normally this is achieved by setting out rent review provisions in the lease, allowing the landlord to review the rent at certain times throughout the duration of the lease.
In Scotland a lease is essentially a contract between the parties and there is very little by way of statutory provision affecting leases, in contrast with the position in England and Wales.
Many commercial leases will be set up on a full repairing and insuring basis; this means the tenant is responsible for the costs of all insurance and maintenance and repair of the premises. Provided they make due payment of the rent and observe the other obligations required under the lease, the tenant will enjoy security of tenure and may not be removed from the premises by the landlord.
There is no automatic right of renewal for a tenant at the end of the lease, although formal action has to be taken either by the landlord or the tenant to terminate the lease by serving notice to quit, otherwise the lease may continue by a process known as tacit relocation, by which a lease can continue from year to year or, if granted for a duration shorter than one year, that shorter period. The length of time appropriate for a notice to quit to have been effectively served depends on the circumstances, but usually is a period of no less than 40 days.
In very limited circumstances, a statutory right of renewal is available under the Tenancy of Shops (Scotland) Act 1949. This was designed to protect tenants of shop premises, by allowing the tenant to apply to the sheriff court for renewal of the tenancy where a notice to quit has been served on a tenant, and the tenant wants to continue the tenancy, but has been unable to get a renewal of the tenancy from the landlord on satisfactory terms.
In the absence of provision to the contrary in Scotland, on completion of an Assignation of a lease, the outgoing tenant (assignor) ceases to have any liability under the lease and does not remain jointly and severally liable with the new tenant (assignee) or any subsequent third party assignee. Scottish leases are not subject to authorised guarantee agreements, which are common in England and Wales.
Unless there is specific provision to the contrary, or a lease is interposed between what then becomes the head landlord and the sub-tenant, there is no contract between a head landlord and a sub-tenant. Consequently, if the head lease falls, the sub-tenant ceases to have any right to occupy. There is no right in Scotland for the sub-tenant to apply to the court to be granted a direct lease for the residue of the head lease term. Accordingly, a sub-tenant may seek to obtain a direct undertaking from the head landlord to enter into a new lease, should the head lease terminate.
iii Compensation for improvements
If a tenant has carried out improvements or alterations to leased property, in the absence of provision in the lease, there is no right to compensation. While the tenant may well be entitled – if not obliged – to remove tenant’s trade fittings and fixtures, any fittings and fixtures and improvements and alterations that are of a permanent nature may be deemed to have become part of the landlord’s property without compensation. The landlord will normally seek to have the option either to have the property reinstated or left with such additions without any compensation being due.
iv Termination on destruction or abatement of rent
In the event of material damage to or destruction of the property, and in the absence of contractual provisions being incorporated in the lease excluding the common law, a lease will terminate as a consequence of the principle of rei interitus. Common law would also entitle an appropriate abatement of rent in the case of partial damage. Most commercial leases provide for continuation notwithstanding damage or destruction, although it is common to find provision that in the event of the property not having been reinstated within a specific period of time (usually calculated by reference to the period of loss-of rent insurance cover) either party would have the right to terminate.
VIII. OUTLOOK AND CONCLUSIONS
i The Scotland Bill
The Scotland Bill is being considered by the UK parliament in 2011 and 2012, and is the outcome of the findings of the Calman Commission. The Bill provides for the transfer of significant tax and borrowing powers, from the Westminster parliament to the Scottish parliament at Holyrood, although not to the extent of giving financial independence to Scotland. Currently, the Scottish parliament raises around 15 per cent of its own budget, and with the new arrangements this is expected to increase to about 35 per cent. There is a substantial amount of detail to the proposals that will only be determined after future consultation. Further legislation and regulations are expected.
The main financial proposals are:
a a Scottish income tax will replace part of the UK income tax;
b SDLT and landfill tax will cease to apply, and the Scottish parliament will set levels of tax for land transactions and disposals to landfill for Scotland;
c other taxes may be created, or transferred to the Scottish parliament; and
d significant new borrowing powers will be available.
The new taxation powers in the Bill are general enabling provisions. The precise detail and arrangements for implementation will be set out in future secondary legislation.
Fiscal changes are the main, but not the only, proposals in the Scotland Bill. A number of other areas will be affected, allowing for greater devolution in some cases and a return to UK legislative responsibility in others.
ii Reform of land registration system
A far-ranging Bill introduced to the Scottish parliament at the end of 2011, will overhaul and improve the current system of registration of title to land. Highlights are the introduction of an advance notice system that will protect purchasers and security holders, and provisions enabling electronic conveyancing.
iii Conversion of long leases
There are statutory proposals before the Scottish government for the conversion of ultralong leases (leases for a duration of more than 175 years that still have more than 100 years left to run). The provisions will allow some leasehold conditions to become real burdens in the title deeds of the property enforceable by the former landlords. There are also provisions for compensation and additional payments to be paid to landlords, and landlords will be allowed to preserve sporting rights in relation to game and fishing.
iv Energy performance certificates
Changes to EPCs in Scotland will include the following:
a Property advertisements are to include the energy performance indicator of the EPC. Only the A to G performance indicator given on the EPC is to be stated in such advertisements in commercial media, which includes any particulars advertising a property for sale or rent in electronic or hard copy format.
b EPCs are to be more detailed in relation to each building being certified, including information on the cost-effectiveness of recommendations together with guidance as to how to implement the recommendations.
c EPCs are to be issued and displayed in buildings larger than 500 square metres, which are occupied by a public authority and are frequently visited by the public. After five years this threshold will reduce to 250 square metres.
d EPCs are to be displayed in commercial premises larger than 500 square metres that are frequently visited by the public and where an EPC has previously been issued. Guidance is to be made available to clarify the meaning of buildings that are ‘frequently visited by the public’, but this is likely to apply to non-domestic buildings where access to all or part of the building by members of the public is integral to the daily operation of the building and where members of the public would expect to be able to enter (such as shops, cinemas and health centres).
e A statistically significant percentage (a minimum of 2 per cent) of EPCs are to be checked by independent experts for quality assurance purposes. This process will be assisted by the creation by the Scottish government of an electronic register for the recording of all non-domestic EPCs.
v Climate change
Property and buildings are affected by many regulatory requirements for carbon emissions reduction. The carbon footprint of buildings is the source of around 50 per cent of greenhouse gas emissions in the United Kingdom. Consequently real estate is subject to increasing regulation, such as EPCs, in efforts to improve the energy efficiency of buildings and reduce emissions.
Complementing the UK Climate Change Act 2008 is the Climate Change (Scotland) Act 2009, which sets a challenging interim target for Scotland of 42 per cent of emissions reductions by 2020.
One of the key proposals for achieving this target, is the proposal for buildings to obtain an assessment of carbon and energy performance (‘AC EP’). Owners of nondomestic buildings will be required to carry out an assessment of the energy performance of their buildings, and the emission of greenhouse gases produced by those buildings, or by activities carried on within them, and then take steps to improve the energy performance of the building and reduce emissions.
Proposals for AC EPs have still to be finalised, but are likely to be required on sale or rental, or renewal of a lease of a building, and consist of three elements:
a an EPC;
b a recommendations report; and
c an action plan.
Once the AC EP has been obtained, the owners of the property can either carry out the improvement works to the building that the AC EP recommends, or opt to provide annual reports on the operational ratings of the building and display a certificate of those operational ratings within the building.