In this edition we take a look at the Supreme Court’s decision in a test case on business interruption insurance; the latest on VAT and termination payments; significant residential leasehold reforms in the pipeline; and proposals to improve the energy performance of residential property through lenders.
Business interruption insurance test case – Supreme Court outcome
Arch Insurance (UK) Ltd v The Financial Conduct Authority and others  UKSC 1 is one of eight appeals in proceedings brought as a test case by the Financial Conduct Authority (FCA), the regulator of the appellant insurers. Its significance is such that it was leapfrogged from the High Court to the Supreme Court, where judgment was handed down on January 15, 2021.
The FCA sought a determination on issues of principle relating to policy coverage in respect of claims by policyholders for business interruption losses arising in the context of the COVID-19 pandemic and the consequent measures taken to combat transmission.
The Supreme Court was asked to decide on the correct interpretation of the terms of 21 representative policies. The FCA estimates that, in addition to the particular policies chosen for the test case, some 700 types of policy across over 60 different insurers and 370,000 policyholders could potentially be affected.
The relevant terms of the representative policies essentially fell into four categories:
- “Disease Clauses" (clauses which can be triggered by the occurrence of COVID-19, typically within a specified distance of the insured’s premises);
- "Prevention of Access Clauses" (clauses triggered by public authority intervention preventing access to, or use of, premises as a result of COVID-19);
- "Hybrid Clauses" (clauses which contain wording from both Disease and Prevention of Access Clauses);
- “Trends Clauses” (clauses which, in general, provide for business interruption losses to be quantified by reference to what the performance of the business would have been had the insured peril not occurred).
The Supreme Court also considered what causal link must be shown between business interruption losses and the occurrence of a notifiable disease and the significance, when quantifying business interruption losses, of the effects of the pandemic on the business before cover was triggered.
In the High Court, while there was no overall “winner” or “loser”, the court found in favour of the arguments advanced by the FCA on behalf of policyholders on many of the key issues. The Supreme Court, in a detailed judgment running to 112 pages, has gone further in favour of policyholders, for example by ruling that cover may be available for partial closure of premises as well as full closure and may also be available when restrictions have been imposed but are not legally binding.
The FCA has stated that: “We will now work with insurers so that they rapidly conclude their claims processes on claims that the Supreme Court has said should be paid, providing interim payments wherever possible.”
The Supreme Court’s judgment is being distilled into a set of declarations. The FCA has also stated that it will publish a set of Q&As for policyholders to assist them and their advisers in understanding the test case.
For further details please read our Briefing on the case.
Full steam ahead for residential leasehold reforms
The new year has got off to a flying start in terms of residential leasehold reforms in England. On January 7, 2021, the Ministry of Housing, Communities & Local Government announced a package of measures described as “part of the biggest reforms to English property law for 40 years”.
By way of background, the Law Commission of England and Wales published a series of reports last year setting out recommendations intended to transform home ownership in England and Wales and to tackle some of the well-publicised problems faced by existing leaseholders, such as escalating ground rents.
The ball was left in the Government’s court, and it has responded. Details are sketchy at the moment but the proposed reforms include:
- A right for leaseholders of houses and flats to extend their lease by a maximum term of 990 years at a zero ground rent.
- Making it cheaper, fairer and easier to exercise leasehold enfranchisement rights (being leaseholders’ right to buy their freehold or extend their leases), with an online calculator to make it simpler for leaseholders to find out how much it will cost them to do so.
- The establishment of a “Commonhold Council” to encourage the widespread take-up of commonhold.
The Law Commission would like to see commonhold as the default form of home ownership in place of residential leasehold. However fewer than 20 commonhold developments have been established since its introduction in 2002, despite the fact that they enable flats to be owned on a freehold rather than leasehold basis. A significant part of the problem is that commonhold is seen by developers as inflexible and by lenders as unattractive from a security perspective. Presumably addressing these issues will be part of the new Council’s remit.
- Restricting ground rents in new leases to zero.
Controversially, the announcement extends this proposed restriction to retirement leasehold properties. This reverses a statement made by the Government in July 2019 that retirement properties would be exempt, not least in acknowledgement of the fact that in their case, “ground rent income is sometimes used to recover the development costs of the communal facilities contained within”.
In recognition of this U-turn it is stated that the commencement of the restriction insofar as retirement properties are concerned will be deferred and come into force 12 months after Royal Assent.
As to timing, there are few details as yet and the only specific information is that legislation to restrict ground rents in new leases to zero will be brought forward in the upcoming session of Parliament. However it is emphasised that the Law Commission’s other recommendations will translate into law “as soon as possible”.
Real estate tax: Update on VAT and termination payments
Following HMRC’s revised guidance on VAT and termination payments which was published in September 2020 and covered in the September edition of our Real Estate Focus, there has been an ongoing dialogue between HMRC and a number of representatives from industry and professional bodies. A particular area of concern was the retrospective nature of the changes.
As a result, HMRC has taken advice and has said that it is expecting to revise its position. In the meantime, the September 2020 guidance will not be acted on by its staff. It is expected that the revised policy will no longer apply retrospectively, which would be welcome news. Draft guidance is currently under consideration, and the position in respect of dilapidations remains unclear.
We hope to be able to provide a further update on this in the next edition of Real Estate Focus.
Please speak to tax partner Julia Lloyd or another member of our real estate tax team if you would like to discuss this.
“Improving home energy performance through lenders”
Improving energy performance in buildings remains high on the Government’s agenda.
Insofar as the residential sector is concerned, in general terms, landlords in the private rented sector (PRS) cannot let (or continue to let) a property unless it has an Energy Performance Certificate (EPC) rating of at least E.
On September 30, 2020, a Government consultation was published seeking views on proposals to set a higher bar for residential PRS properties. The preferred option includes raising the minimum EPC rating to C with a phased trajectory for achieving this, requiring new tenancies to achieve a C rating from 2025 and all tenancies from 2028. The consultation closed on January 8, 2021 and we await its outcome.
The Government now wants to go further given that “owner-occupied and privately rented homes account for 83% of homes in England and 84% of homes in Wales and are some of the worst performing in terms of energy efficiency”. At the tail end of 2020 it therefore published a further consultation on improving home energy performance, this time through mortgage lenders.
In broad terms the proposals are two-fold:
- Proposals for raising awareness of the energy performance of lenders’ portfolios, including an annual public disclosure of portfolio-wide energy performance information relating to domestic properties, with the government publishing ‘league tables’ of lenders.
Voluntary disclosure is proposed in the short term, but transitioning to mandatory disclosure in 2023 at the earliest.
- Proposals for improving the energy performance of lenders’ portfolios using a “target-based approach”, the preference being a voluntary target of a portfolio average of EPC Band C by 2030, but with mandatory targets as a fall-back measure if insufficient action is taken.
The consultation also covers wider issues that need to be taken into consideration, such as the risk that these policies might disincentivise lending to energy inefficient properties, and asks whether lenders should be required to check that privately rented properties comply with EPC regulations.
The closing date for the consultation is February 12, 2021.