James and Samuel’s article was published in Property Industry Eye, 21 February 2023, and can be found here.
Michael Gove’s planned changes could lead to a seismic shift in the industry
There are a few bad apples, just don’t spoil the barrel.
Michael Gove has announced new plans to deal with the bad apples of the property world. Ignoble landlords who overcharge on insurance premiums whilst pocketing large commissions from brokers will be met with new restrictions on how much they can ask tenants for these services. These are ambitious plans indeed, but only mark the first step for a minister who has vowed to fundamentally reform English property law and remove leasehold interests entirely.
We would argue that these changes would lead to a seismic shift in the industry with unexpected repercussions for many reputable landlords. There will always be disreputable landlords who will try and evade scrutiny by tenants and look at ways of increasing revenue and changing the law will do little to convince those who have no interest in following it.
In the recently reported case of Various Leaseholders (Canary Riverside) v CRM and Octagon Overseas Limited, the leaseholders of a Canary Wharf residential tower block applied for their landlord and the managing agent to disclose details of the insurance scheme provided for them through their service charge. Additionally, they requested that the landlord disclose what proportion of their fees amounted to a commission from the landlord’s managing agent and insurance broker. The First Tier Tribunal (FTT) described the respondents’ lack of transparency about commissions as ‘lamentable’ considering that the ‘sums involved are large and constitute a very substantial percentage of the premium towards which leaseholders are asked to contribute’. With a greater number of similar cases making headlines in recent years, Michael Gove commissioned the Financial Conduct Authority (FCA), who regulate insurance brokers, to report on the matter.
The FCA report made a number of recommendations for Government. It suggests that it consider ways that leaseholders could be made parties to insurance contracts or for leaseholders to challenge insurance costs in a way that is straightforward and easily accessible. The FCA also state that they will review and publish detail of those brokers who charge the highest commissions and consider whether commission to landlords should continue in cases where they do not provide any additional benefit to tenants. They regard that a cap or limit on renumeration would ‘not be justified’ although this would be monitored. Finally, they suggest that government considers imposing an ‘enhanced legal requirement on freeholders and property managing agents to provide minimum information on the insurance policy to leaseholders.’
For those of us dealing with the underlying legal transactions, these are interesting recommendations although many of them already exist in some form. In the commercial property sphere, Michael Gove’s promise to ban landlords from taking commissions suggests that he fails to appreciate how market standard “full repair and insurance” (FRI) commercial leases operate. The evolution of the standard commercial lease since the 1970s has ended up with an institutionally acceptable investment where the costs of the day-to-day running of the property – namely insurance and service charges – are passed to the tenant in full so that the rent received by the landlord is pure profit. The insurance and service charge are not intended to provide any profit element to the landlord.
Commissions that landlords receive (or discounted premiums, the benefit of which the landlord does not pass on) may not be due to the avaricious desire of the landlord but rather relate to their ability to negotiate insurance on a far larger scale than the tenants ever could. A landlord with a large portfolio of properties will be in a far stronger position with brokers and underwriters than a single tenant and so typically are able to negotiate lower premiums for the insurance policy, for which arguably they should receive some benefit. Discounted premiums may also arise because of the additional work and management of property portfolio that the best landlords will carry out at their own cost. Restricting the full recoverability of insurance premiums on institutionally acceptable leases which provide the bedrock for secured loans and certainty of income for institutional investors, could have an unexpected and unintended impact on the wider market.
The higher insurance premiums due to commissions is especially hard on residential tenants who bear the brunt of the full cost often with little bargaining power or ability to change the status quo. Such a situation has rightly been historically unpopular. However, recent increases in insurance premia are not unexpected given additional risks due to the Grenfell Tower tragedy. Yet it seems unfair for all landlords – both commercial and residential – to be singled out for criticism, in a system that ensures significant benefits for both parties. As the FCA report explained, few landlords will look at commissions when considering which policy to choose and so it remains unclear how removing this might result in better value for leaseholders.
Any change on insurance commissions would have to reflect a fundamental change in how the insurance market operates. The large commissions reported in the FCA report reflect a marketplace where brokers do not work on retainer but instead operate solely from the policies they help to sign. To remove commissions, the government would have to change how brokers are compensated for their time, something that would be challenging to enact and lies beyond the powers of the FCA or the Secretary of State for Housing, Communities and Levelling Up. To place the blame for these fees at the feet of landlords is unfair and will not help resolve legitimate issues facing the sector.
The vast majority of landlords are considerate and conscious of their legal duties to their tenants and act in accordance with the law and often in accordance with the higher requirements of regulatory bodies such as RICS. Landlords should not become scapegoats for the complex problems with the way insurance and other service provisions are managed; nor should landlords be blamed for the actions of these bad apples who, as in any market, seek to exploit the system for their own gain.