Protecting lessees against market losses

How long have I been in practice? Far, far (far) too long to reveal. And throughout my illustrious career I have been a conveyancer, both commercial and residential. Something new has cropped up which shouldn't be new and which surprises me but shouldn't surprise me. This is the scenario.

My clients have agreed to take a 125-year lease of a commercial unit somewhere in the City of London paying a premium of £4.5m (with a not insubstantial rent to boot, but that is irrelevant for the present purpose). Lenders' lawyers are not yet involved but will be shortly.

In the meantime, I must satisfy myself, on my client's behalf that, inter alia, the lease is marketable and will prove a satisfactory security for the loan.

Cover for loss

The lease contains what must be a relatively bog-standard insurance clause. That allows for the eventuality that, if the building is destroyed and it is not possible to rebuild for whatever reason, the insurance proceeds are divided equitably between all the interested parties including my client. However, the insurance cover is, as always, for the rebuilding value (not the market value at the time).

If this disaster were to arise the lease would fail, presumably by way of frustration or as stipulated in the lease, by the lessor's notice to terminate. Either way, the lease comes to an end.

In such a situation, my client not being the freeholder, his interest dies with the building leaving him with his share of the insurance monies worth say, £0.5m, and the rest of his investment in ashes. I have been searching for insurance cover for the difference in loss but, so far, have not found an insurer (so if you know of one or you are one please let me know). Otherwise, what options are there if the lessor is refusing to change the wording of the lease in this regard (or, perhaps can't - in my particular case the landlord is not the freeholder but the long leaseholder of the whole development and their own lease attached a draft of the commercial lease by which they are obliged to abide).

I have pointed out how unfair such a situation would be - the lessor would have the ground back to build something that planners would not object to, such as a whole block of flats without a commercial interest and then re-sell my client's space at a huge profit. I suggested some sort of clause to allow for my client to retain an interest in the superior lease commensurate with the share in the market value of the unit as it bears to the total market value of the development as at the date of death of the first building. I don't think they would have countenanced that but, again, Fate has been fickle to my client.

Special purpose vehicle

There is an agreement in place with all the (residential and commercial) lessees that the head leasehold interest is to be transferred to a special purpose vehicle (SPV) in which each of them will have one share i.e. irrespective of their market interest in the development. So even with this added bonus, there will be a shortfall.

What is slightly more alarming (my client has not yet committed nor will do so without clearance from the lender's solicitors) is that this scenario is equally applicable to residential long leases where the lessees do not have a share in the freehold. I admit the eventuality is tiny - but so is Chancel repairs and thre is standard cover nowadays - but the same danger may be on the horizon.

What suprises me is that I cannot recall this ever being raised as a problem, whether for a buyer or a mortgagee! How does a borrower pay back his/her mortgage when the building is gone and is not going to be rebuilt within whatever period is stipulated and without a share in the freehold? Far be it from me to suggest any freeholder is waiting with bated breath for such a disaster but why has this never been seen as an issue until now? Not even by me! Answers please before my own block is hit by an insured risk, or Heaven forfend, an uninsured one.

Howard Salter is a partner at Statham Gill Davies Solicitors (Howard.Salter@sgdlaw.com)