What are restrictive covenants and how do they affect development?
A restrictive covenant is a legally binding obligation attached to land that restricts how the land can be used or developed. Restrictive covenants are created by deed, typically when a landowner sells part of their land and imposes conditions on the buyer to protect the value or character of the retained land. Once created, a restrictive covenant runs with the land, meaning it binds all future owners, not just the original buyer. For property developers, restrictive covenants can present a fundamental obstacle to development if the covenant prohibits or restricts the type of building work proposed.
Common restrictive covenants affecting development sites include covenants restricting the land to residential use only, prohibiting commercial or industrial use; covenants limiting the number of dwellings that can be built on the land; covenants specifying a maximum building height or minimum setback from boundaries; covenants requiring the approval of building plans by the original landowner or their successors; and covenants prohibiting the demolition of existing buildings. Each of these covenants can directly conflict with the developer's proposals and must be addressed before a development finance lender will complete the facility.
The impact of a restrictive covenant on a development finance application depends on the nature of the covenant and the extent to which it conflicts with the proposed scheme. A covenant restricting the number of dwellings to one on a site where the developer proposes to build twelve apartments is a fundamental issue. A covenant requiring building plans to be approved by a management company, where the management company no longer exists, is a technical issue that can usually be resolved through indemnity insurance. In our experience, approximately 30% of development sites in established residential areas have restrictive covenants that require attention during the finance application process.
How lenders assess restrictive covenant risk
Development finance lenders are concerned about restrictive covenants because a covenant that is enforced could prevent the development from being completed, reduce the value of the completed units, or result in the developer being required to demolish completed works. Each of these outcomes would impair the value of the lender's security and potentially prevent the repayment of the loan. The lender's solicitor will identify any restrictive covenants from the title register and report on their potential impact on the proposed development.
The lender's assessment focuses on three key questions. First, does the covenant conflict with the proposed development? If the covenant prohibits building above two storeys and the proposed development is two storeys, there is no conflict. Second, is the covenant enforceable? A covenant that was imposed over a hundred years ago by a landowner who has since sold all their land may not be enforceable because there is no identifiable person with the benefit of the covenant. Third, if the covenant is both conflicting and potentially enforceable, can the risk be adequately mitigated through insurance or legal mechanisms?
The lender's solicitor will typically provide an opinion on enforceability based on the age of the covenant, whether the person with the benefit can be identified, whether the covenant has been previously breached without enforcement, and the nature of the neighbourhood. A pre-war covenant restricting use to single dwelling houses in an area that is now predominantly apartment blocks may be assessed as low risk because the character of the area has fundamentally changed. However, a recent covenant imposed by a housing estate developer who retains neighbouring land is high risk because the person with the benefit is identifiable and has a clear interest in enforcement. We have seen covenant issues add £5,000 to £50,000 in costs depending on the complexity and the solution required.
Restrictive covenant indemnity insurance
The most common solution to restrictive covenant issues in development finance transactions is indemnity insurance. Restrictive covenant indemnity insurance is a one-off policy that covers the insured against financial loss arising from the enforcement of the covenant. If the person with the benefit of the covenant takes legal action to enforce it, the insurance policy covers the legal costs of defending the action, any damages or compensation payable, and potentially the cost of complying with an injunction if one is granted.
The cost of restrictive covenant indemnity insurance depends on the risk profile assessed by the insurer. For low-risk covenants, where the person with the benefit cannot be identified or where the covenant has been widely breached without enforcement, premiums are typically £200 to £1,000 for a one-off payment providing cover in perpetuity. For higher-risk covenants, where the beneficiary is identifiable and has a potential interest in enforcement, premiums can range from £2,000 to £10,000 or more. In extreme cases, where the risk is considered high, insurers may decline to provide cover at all.
There is an important limitation that developers must understand: indemnity insurance must be obtained before the person with the benefit of the covenant is approached or notified about the proposed development. If the beneficiary is put on notice of the breach, most insurers will refuse to provide cover because the risk of enforcement has materially increased. This means that the developer must not approach the neighbouring landowner to seek consent before investigating whether indemnity insurance is available. In our experience, the most effective approach is to instruct your solicitor to investigate the covenant, obtain quotes for indemnity insurance, and only approach the beneficiary if insurance is either unavailable or prohibitively expensive. The lender will typically accept indemnity insurance as adequate mitigation provided the level of cover is sufficient and the insurer is reputable.
For development schemes where the covenant is being clearly breached and the risk cannot be adequately insured, the developer's solicitor may recommend applying to the Upper Tribunal under Section 84 of the Law of Property Act 1925 to have the covenant modified or discharged. This process typically takes six to twelve months and costs £10,000 to £30,000 in legal fees and tribunal costs, but it provides a definitive resolution. Submit your deal and we can advise on the best approach for your specific circumstances.
Resolving covenants through consent or modification
Where the person with the benefit of the covenant can be identified and is willing to negotiate, the simplest solution is to obtain their formal consent to the proposed development. Consent should be documented in a deed of release or deed of variation, which is registered at the Land Registry to provide certainty for the developer, the lender, and future purchasers of the completed units. The cost of obtaining consent varies enormously depending on the beneficiary's expectations. We have seen cases where consent was obtained for a nominal payment of £1, and cases where the beneficiary demanded £250,000 for consent to develop six units.
The price of consent often reflects the beneficiary's bargaining position. If the covenant is clearly enforceable and the proposed development would cause demonstrable harm to the beneficiary's property, the beneficiary is in a strong position and may demand a substantial payment. If the covenant is of doubtful enforceability and the proposed development would have minimal impact on the beneficiary, the bargaining position is weaker. Experienced solicitors can negotiate these arrangements effectively, and the cost of consent should be weighed against the cost of indemnity insurance or a Tribunal application.
The Upper Tribunal can modify or discharge a restrictive covenant under Section 84 of the Law of Property Act 1925 on several grounds. The most commonly used grounds are that the covenant is obsolete due to changes in the character of the neighbourhood, that the covenant impedes a reasonable use of the land and either does not secure practical benefits of substantial value to the beneficiary or is contrary to the public interest. A successful application results in the covenant being formally modified or discharged, providing certainty for the developer and the lender. The Tribunal can also award compensation to the beneficiary for any loss caused by the modification or discharge. While the Tribunal route is slower and more expensive than insurance, it may be the only option for high-value developments where the covenant risk is too great for insurance and the beneficiary will not negotiate.
Restrictive covenants and the buyer's perspective
It is important to consider how restrictive covenants affect the end purchasers of the completed development, because this directly impacts the developer's exit strategy and the lender's recovery. When a buyer purchases a completed unit, their solicitor will conduct title due diligence and will identify any restrictive covenants affecting the land. If the covenant has been breached by the development and has not been formally released, modified, or insured, the buyer's solicitor may raise this as a requirement before completing the purchase.
Buyers' mortgage lenders are also concerned about restrictive covenant risk. A mortgage lender will not lend against a property where there is a material risk that the property could be subject to an enforcement action. If the restrictive covenant issue has been addressed by indemnity insurance, the buyer's solicitor and mortgage lender will want to see that the policy covers successors in title, meaning it protects the buyer as well as the developer. Most restrictive covenant indemnity policies provide cover in perpetuity and extend to successors, but this should be confirmed before the policy is purchased.
In our experience, addressing restrictive covenant issues thoroughly during the development phase avoids sales delays later. A developer who can provide buyers with either a deed of release, a Tribunal order, or a comprehensive indemnity policy provides clean title that enables smooth sales. A developer who has not addressed the covenant issue may find that buyers' solicitors raise additional enquiries, request additional insurance, or advise their clients to proceed with caution, any of which can delay sales and extend the period over which development finance interest is accruing. The upfront cost of addressing the covenant is almost always less than the cost of delayed sales on a scheme with a £2,000,000 to £5,000,000 facility charging 8-10% per annum.
Practical steps for managing restrictive covenants
The first step in managing restrictive covenants is identification. Obtain official copies of the title register from the Land Registry and review the entries in the property register and charges register carefully. Restrictive covenants are usually set out in a transfer or conveyance that is referred to in the register, and the full text of the covenant may need to be obtained from the Land Registry or from the original deed. Do not rely solely on the summary in the register; always read the full covenant to understand its scope and the identity of the beneficiary.
Once identified, assess whether the covenant conflicts with your proposed development. If there is no conflict, note this in your legal pack and move on. If there is a conflict, instruct your solicitor to advise on enforceability and to obtain quotes for indemnity insurance before taking any other action. Do not approach the beneficiary at this stage, as this will typically prevent insurance being obtained. If insurance is available at a reasonable cost, purchase the policy and provide it to the lender's solicitor as part of the conditions precedent to drawdown.
If insurance is not available or the premium is prohibitive, consider whether consent from the beneficiary or an application to the Upper Tribunal is the appropriate route. Discuss the options with your solicitor and your broker, as the cost and timeline of each option will affect the overall viability and programme of the development. We always recommend addressing restrictive covenant issues as early as possible in the project lifecycle, ideally before exchanging contracts to purchase the site. Including a covenant resolution strategy in your finance application demonstrates thorough preparation and gives the lender confidence that you have identified and are managing this common risk.