Time to change the "20 Year Lease Rule"?

The feudal system of property ownership in Scotland was abolished in 2004, so that property owners can no longer bemoan many of the limitations imposed on the free enjoyment of their property by feudal "superiors", and in particular the feuduties which a feudal superior could extract from them. 

However, the road to feudal abolition began much earlier, with the Land Tenure Reform (Scotland) Act 1974, which, amongst other things, began the process of phasing out feuduties payable to superiors, by prohibiting the creation of new feuduties.

27th April 2010

The feudal system of property ownership in Scotland was abolished in 2004, so that property owners can no longer bemoan many of the limitations imposed on the free enjoyment of their property by feudal "superiors", and in particular the feuduties which a feudal superior could extract from them. 

However, the road to feudal abolition began much earlier, with the Land Tenure Reform (Scotland) Act 1974, which, amongst other things, began the process of phasing out feuduties payable to superiors, by prohibiting the creation of new feuduties.

The "20 Year Lease Rule"

As part of this phasing out of feuduties, the 1974 Act also introduced what is commonly referred to as the "20 Year Lease Rule". This rule, in summary, provides that it is a condition of every "Long Lease" (i.e. a lease greater than 20 years in duration) that no part of the leased property will be used as a private dwellinghouse unless that use is ancillary to a different principal use of the leased property which is something other than residential.

The reason for introducing this 20 Year Lease Rule was understandable at the time. There was a concern that landowners would be able to circumvent the phasing out of feuduties by granting Long Leases (for say 999 years) to a "homebuyer" instead of selling or feuing the property in the normal way to the homebuyer. The landowner, as landlord, could replicate the recurring feuduty payment in the form of a rental payable under the Long Lease of the residential property, and so evade the effect of the statutory phasing out of feuduties. 

Difficulties with the "20 Year Lease Rule"

As any frustrated golfer will appreciate, introducing a change designed to correct a flawed golf swing often leads to the creation of an entirely new problem. Similarly, while the 20 Year Lease Rule successfully prevented the circumvention of the phasing out of feuduties, it has created its own practical difficulties.

Consider, for example, the limitations which the Rule places on the funding and financial appraisal of residential developments.

Suppose a landowner/developer wishes to procure the construction of residential accommodation with a view to leasing that accommodation on a long term basis (e.g. for 25 years) to a third party organisation (such as an educational institution or housing body). That tenant organisation would then, in turn, grant short term leases of the accommodation to individuals looking for temporary residential lodgings.

Landowner's/developer's perspective

From the landowner/developer's perspective, this type of transaction structure is an attractive one. The construction and subsequent lease by the landowner of the accommodation to a third party organisation of suitable covenant strength (on a 25 year term) could transform the land into an attractive "investment" asset which may be sold on the open market. The fundamental problem, of course, with this arrangement is that such a 25 year lease would be in breach of the 20 Year Lease Rule. This transaction structure may therefore be jeopardised, as the 25 year duration of the lease to the organisation can often be a key element of the landowner's (and its funder's) financial appraisal of the proposed development, and the ultimate "investment value" of the land asset which is created.

Tenant's perspective

The 20 Year Lease Rule may also create difficulties for the tenant organisation in these circumstances.  In order for the tenant to grant a fixed security over its interest in the lease in favour of the tenant's funder, the lease must be greater than 20 years in length, as leases of 20 years or less are not capable of being registered in the property registers. The 20 Year Lease Rule prevents this from being possible, and so the tenant is effectively thwarted from using its interest in the lease as security for the purposes of raising finance. At a time when borrowing has become ever more challenging, such a "technical" restriction is unfortunate.

Scottish Government consultation

This example is only one of a number of transaction structures which are hindered by the 20 Year Lease Rule, which, along with the associated 20 Year Securities Rule (which restricts the duration of Standard Securities), places restrictions on long term interest hedging, bond funding, shared equity and ownership, Islamic funding and home reversion plans. 

The Scottish Government has recognised that both 20 Year Rules are increasingly outmoded, and it is in the process of undertaking a public consultation (as part of its wider consultation on the provisions of its proposed Housing Bill) to ascertain whether the 20 Year Rules should be amended, and if so, in what ways.

A simple solution?

One possible "solution" to the 20 Year Lease Rule is simply to abolish the rule altogether. As previously explained, the rule was first introduced in 1974 to deal with the potential circumvention of the abolition of new feuduties. In the present day, feudalism has been abolished in its entirety and feuduties no longer exist. There is also now a prohibition on leases for periods of more than 175 years, which effectively removes the risk of landowners attempting to recreate feudalism by granting exceptionally Long Leases to homebuyers and collecting replacement "feuduties" by way of rental. Thirty-five years on, it is questionable whether the 20 Year Lease Rule is still required at all.

The abolition of the rule would remove an impediment which currently stands in the way of a number of inventive deal structures involving residential accommodation. As the Scottish Government has observed, this could become important, as the availability of public sector funding across the UK is likely to reduce significantly over the next few years, while the demand for housing of all tenures, particularly affordable and private rented housing, continues to increase. The financial viability of privately funded residential accommodation (by means of inventive transaction models) should therefore not be unnecessarily limited by a rule of law designed to cater for a problem which no longer exists.

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