Originally published June 2023.
Is anyone else uncomfortable with the recent legal judgement that says the Ministry of Defence (MOD) can enfranchise 8 “test properties” from the portfolio that it “sold” to Annington over 25 years ago?
The 1996 deal attracted much opprobrium for its apparent failure to provide value for money for the UK tax-payer. For those readers of lesser years than your Undercover Investor, allow me to briefly rehearse the facts here.
The MOD sold the so-called Married Quarters Estate in 1996. Mr. Hands, now of Terra Firma but working for Nomura back then, proved the most astute of all the bidders (there were many, and full disclosure, I was one) and Annington, Nomura’s vehicle, won the auction. Consensus had it that Nomura had invested far more in the due diligence than anyone else, so understood the cash-flows rather better than others, and certainly the MOD who, after a brief period of celebration, have regretted the deal ever since. Hats off to Mr. Hands I say.
The purchase has done well for Annington and less well for the vendor, partly because the latter has allegedly failed their side of the bargain over the years both by not giving back, nor refurbishing properties that they should have done during that time. That probably makes the deal look even worse for the MOD than it could have done had they simply done what they said they would do, but that is not the cause of my reflective mood.
There was apparently sufficient friction between the parties at the 2021 rent review (the first of the 25-year rent reviews in what I recall is a c. 200-year agreement) that the MOD have, it seems, decided to try to deconstruct the original deal. The mechanism that it proposes to use to do that, residential leasehold enfranchisement, is interesting for several reasons.
Whilst one can enfranchise a long leasehold residential property today, one cannot enfranchise a business lease, nor an annuity, and the enfranchisement process does not necessarily offer full recompense to the superior owner being enfranchised against. (The price at which an enfranchisement occurs is artificial and can produce perverse results). In this instance, the superior owner is the business Mr Hands created to own and run the estate which purchased it fair and square in 1996.
The MOD apparently agreed the December 2021 rent review and virtually the next day, to the surprise of everyone, including Annington, served enfranchisement notices on the test properties. No surprise then that this came in front of a judge.
The learned judge in question found in favour of the MOD on all six counts before him which is something of a surprise to me. Losing 6:0 in the first leg of any match is not ideal, and many might count Annington out of any chance of a second leg victory, but I personally rather doubt that we are done in the Courts just yet.
The decision challenges a number of my commercial, moral and societal senses, notwithstanding that the judge has provided a 152-page reasoning. I am neither a lawyer, nor clever enough to follow all the legal arguments, but I do know what I was involved in bidding for all those years ago.
Back then, the MOD needed professional management of the estate and wanted to transfer that responsibility to a third party. Some would call it privatisation. The MOD therefore offered the right to create, own and manage a business that collected rent from the Married Quarters Estate and to develop those properties that were returned as unwanted; all in return for an upfront premium, and a discount on the rent for the first 25 years of the arrangement. (The MOD had considered setting up their own business to do that but ultimately, decided that they would be better off (by many hundreds of £ millions) if they sold the whole business opportunity). They banked even more than they had hoped from the hard-fought auction.
Following the transfer of close on £1.7 billion (a huge sum of money back then) the MOD rent was further discounted to recognise their retained maintenance responsibilities and their ability to hand back surplus to requirements properties as they became free. The deal therefore created a long-dated government backed annuity, with some property risk thrown in for good measure but the main value in the deal was in the annuity. Lots of judgements needed to be made back then, and it was that relatively complicated construct that Mr Hands judged better than everyone else at the time. It was a classic corporate finance deal. Whilst some 57,000 individual properties were involved initially, it was far away from a straight-forward residential property purchase.
The purchase transferred much (though not all) of the risk to the buyer, which seems to have been forgotten by everyone. The mechanism by which the transfer was “papered” was as a series of head-leasehold property transactions. To the best of my knowledge, 57,000 separate residential units were never subject to individual sale and purchase but rather, the individual properties were grouped under various headleases.
I for one then am quite surprised that the MOD has got this far suggesting that they can enfranchise the properties individually under the 1967 Residential Housing Act (as amended). Enfranchisement law was brought in to protect Welsh miners from being thrown out of their properties by unscrupulous landlords in the 1950’s and 60’s. We are a very long way from that here. Whilst the legislation has evolved an awful lot since then, it feels an uncomfortable stretch to use such legislation in this case. Too much of a stretch for my comfort.
Furthermore, Annington has significant global investors who acquired the business from Nomura in 2012. They will have been hoping to refinance their investment having held it for over ten years, so this legal development likely delays them. Quite possibly by years. I cannot imagine that they will be pleased.
That there are global investors that are potentially disadvantaged by the MOD’s actions reinforces my disquiet. It also raises the question why the MOD should have rushed to serve the enfranchisement notices on Annington immediately after the rent review (and before a rumoured sale or refinancing) lest they found that the new owners were pension funds or other long-term capital (or heaven forbid, major UK investors?).
It is intriguing to wonder what the MOD hopes to achieve strategically. Do they really plan to serve enfranchisement notices on every single one of the remaining properties in the 1996 deal? That would surely require £ billions from the public purse and would be a highly questionable use of government funds, not least as 20% of the estate is apparently vacant. It would also mean that the MOD would have to manage the properties, or sell them again, simply re-creating the position that they were in in 1996. What are they hoping to achieve? It does not make any sense to enfranchise just a few properties, which are neither here or there to either the MOD or to Annington, so one has to presume their ambitions are rather greater, or is this simply a desire to scupper Annington’s onward sale of the asset?
There is also the valuation question; interest rates were a lot lower in December 2021 than they are today. Buying back cheaply and selling on again would make a lot of sense to me… if I wasn’t the government, and if I didn’t have to deconstruct a 25-year-old deal, and if I wasn’t enfranchising against global investors.
How long this case lasts will probably depend upon how Annington has valued their interests and whether they anticipated this action. If their interest has been valued conservatively over the years, then the action of enfranchisement will merely turn to cash what is currently valued. No big deal, but not the exit anticipated.
If, however, and perhaps more likely, Annington has valued their government annuity using the low interest rates of recent years, then it is possible that this action will cause the value to fall. If the existing case (if appealed) does not take years, then the valuation challenge that this case would bring is quite likely to do so. All of which means that there could be a long way to go from here in my humble opinion.
Right now, I feel rather uncomfortable with what is going on here, and all the more so when I read vitriolic articles in national newspapers from commentators suggesting that the MOD has somehow outsmarted Annington and that this is a jolly good thing. I am rather more circumspect. I am afraid we have to remember that this is the same government that has served these notices that admitted that its plan to “reinterpret” the special Brexit arrangements for Northern Ireland would break international law. I wasn’t too sure about that either.
I very much hope that this is not just an opportunistic or thinly veiled vendetta against one of the smartest finance professionals of his time, aided and abetted by a National Audit Office report. Right now, the learned judges reasoning does nothing to dissuade me of that. £millions must have been spent on advisers so far and there would likely be £ millions to come if this goes to appeal. One presumes that the prize for the MOD is significant if they are using public money like this. I wonder if there should be questions in Parliament?
The intention of the parties in 1996 was to sell a rent collection and property refurbishment business; it was simply structured as a series of property headlease transactions. The MOD retained significant responsibilities, hence the big rental discount, so the transaction was quite unlike a traditional residential long leasehold that one might normally enfranchise today. In my book, that makes it a business lease, not a residential one. Enfranchisement of the underlying properties under that contract might be a way of potentially breaking that over-arching contract, but it is not to my taste. If the MOD has restructured their interest to pull a legal “fast one” on Mr Hands, I for one feel pretty uncomfortable. The legal opinion though seems to say that this is ok. Am I just being old fashioned to feel that a deal done should be honoured? It is not as if Annington have reneged on their side of the deal from what I can ascertain, though Annington might possibly now be able to argue that the opposite is true.
The 1996 contract is still in place for the time being, so we shall see where this goes. The technicalities of leasehold enfranchisement will ensure this will not hit the desk of the man on the Clapham Omnibus but in the court of public opinion, which includes the global investor markets, this doesn’t look too good to me. Notwithstanding 152 pages of learned legal discourse, I am still not sure I understand what is really going on here.
Whatever the legal rights and wrongs, whatever clever lawyers can bring to an argument; the facts were plain to me at the time. I believe that this was a business deal papered through a series of head leasehold property agreements, and the terms agreed were a long way away from the terms that one would agree on purchase of an individual long leasehold residential property. That does not make for an enfranchisement opportunity now.
The National Audit Office have argued that the deal should not have been done in 1996 but that is not a justification for it being undone today. The principle that “bad” deals can be undone later is the stuff of other jurisdictions; not ours. Where could that end, I ask you?
If this judgement stands, as it might well do because this is government we are talking about, I fear it will ultimately prove a disaster for them. Even if MOD were to withdraw or agree not to enfranchise any more properties, I wonder if the damage might already have been done? More than one potential future global investor will wonder if the UK is investible now, and whether the UK government can be trusted not to “reinterpret” the rules on them and their money. Twice is a pattern. As sure as anything, they will now increase even further the risk premium for doing business in the UK. At a time when we desperately need inward investment to balance the books, this would all be rather bad news for you and me.
That is why I am uncomfortable.
