Top 5 points to consider when negotiating a Lease (acting for a Tenant)

6 Feb 2018

The commercial terms for a new lease are a matter of negotiation between the Landlord and the Tenant. Whilst commercial factors will to a large extent determine the headline terms (such as the term length and annual rent payable), significant concessions can be won as a result of the Tenant receiving good and timely professional advice from both a letting surveyor instructed to negotiate the Heads of Terms and from the solicitor subsequently instructed to negotiate the Lease and any supplemental documents.

Whilst by no means an exhaustive list, I set out below 5 key sections of a commercial lease where we can typically help the Tenant and add value:

Alienation

“Alienation” is the term which describes the extent to which the Tenant can part with possession of the Lease. Typically, a Tenant will be permitted to assign or sublet the whole (but not part) of the Lease, in both cases subject to obtaining the Landlord’s prior written consent (not to be unreasonably withheld or delayed) and to share occupation with group companies without having to obtain Landlord consent, provided no landlord/tenant relationship is created.

The assignment provisions in the Lease usually expressly specify both the conditions which must be satisfied for the Landlord to grant consent and the circumstances which would justify the Landlord withholding consent. From the Tenant’s perspective, the conditions and circumstances should be as few and easy to meet as possible, thereby making it more likely that they will be able to part with their interest in the Lease in a timely manner. To take just a couple of examples, where we can help achieve this:

i) A typical assignment condition is that the outgoing tenant should enter into an Authorised Guarantee Agreement (AGA) with the Landlord. This is a guarantee that the incoming tenant will comply with the Lease. Whilst a Landlord will want this irrespective of the financial strength of the proposed incoming tenant and/or the other collateral security offered by the incoming tenant (a rent deposit and/or a Guarantee), the outgoing tenant should always try to persuade the Landlord that those factors are relevant to whether an Authorised Guarantee Agreement should be required and that the Landlord’s entitlement in the Lease should be qualified and only be insisted upon where it is a reasonable requirement. By not having to give an AGA, the outgoing tenant can walk away with no contingent future liability for the Lease. It is therefore a point well worth fighting for.

ii) A key negotiation point on underletting is whether the Landlord can insist on the annual rent in the underlease being the higher of the passing rent in the Lease and the prevailing open market rent or whether the underlease rent should simply be the prevailing open market rent at the time the underlease is granted. The Landlord would prefer the former to apply, as it would ensure both that its immediate Tenant will have the funds to pay the annual rent payable under the Lease and that there is no risk of adverse rental evidence being created by the underlease. From the Tenant’s perspective, such a provision in the Lease would be detrimental as it would make it far harder to underlet in a recessionary market, at a time when the Lease could be overrented and therefore at precisely the time when assignment is not viable and underletting is therefore the most attractive option to the Tenant. An argument that will often help us to persuade a Landlord to permit underletting at the prevailing open market rent is that there is case law which supports the view that where the Lease imposes a restriction on underletting allowing it only at the higher of the passing rent in the Lease and the prevailing open market rent, it is viewed by the Courts as an onerous term and one which would enable a Tenant to discount the annual rent payable pursuant to any open market rent review in the Lease.

Break Clause

A break clause is a valuable right enabling a Tenant to bring the Lease to an end earlier than the expiry of the Lease term. It is often (but does not have to be) linked to a rent review date in the Lease, to enable the Tenant to walk away from the Lease if it expects the annual rent to increase on review to a level it cannot afford.

The key area to negotiate for the Tenant is whether or the extent to which there are any conditions which it must satisfy to enable it to validly exercise the break. The Landlord will typically require conditions that all the rents have been paid, that all tenant obligations in the Lease have been complied with and that the Premises are yielded up and handed back to the Landlord with vacant possession. On the face of it, these conditions do not sound unreasonable or difficult to discharge. However, the last recession presented numerous examples of landlords exploiting the existence of such conditions to frustrate and prevent tenants from exercising their break, as in a downturn it is still better for a landlord to retain a defaulting tenant who remains liable for business rates rather than take back possession. Case law has shown that the Courts are reluctant to interfere with the bargain reached by the landlord and the tenant and will construe any conditions in a lease strictly.

When acting for a tenant, there are a number of arguments to deploy to persuade the landlord to drop or at least dilute the number and extent of these conditions. They include; (i) pointing out that the value to the tenant of the break is usually reflected in the tenant having to pay a higher annual rent. As the Landlord has an unqualified right to receive that annual rent, it is only fair that the Tenant should have a unqualified expectation that it can successfully exercise the break; (ii) even if there are arrears or other tenant breaches at the date of the break, the determination of the Lease following exercise of the break will not extinguish the Landlord’s right to pursue its former tenant for those arrears or any losses it has suffered or incurred as a result of the breach; and (iii) as long ago as 2007, the voluntary Business Lease Code recommended that the conditions are restricted to there being no arrears of the principal annual rent and returning the premises free of any subsisting underleases and occupiers.

Service Charge

In a multi-let building or development, the Landlord typically remains liable for performing certain services which benefit the tenants generally, the cost of which it recovers from those tenants via the service charge mechanism. Key areas to negotiate include:

i) Imposing an annual cap on the Tenant’s liability. The obvious commercial benefit to the Tenant is that a cap provides budgetary certainty and ensures that it will not be stung for any unanticipated exceptional expenditure which the Landlord may incur. If agreed by the Landlord, it is usually subject to RPI annual review (upwards only) to ensure that the cap increases annually in line with inflation. A tenant has more chance of succeeding with a cap argument when the service charge regime is either new or based on ad-hoc expenditure of the Landlord, as in both cases the Landlord will be unable to provide previous service charge accounts to evidence the likely future liability of the Tenant.

ii) Excluding certain heads of expenditure from the Tenant’s service charge liability. The justification will be specific to the Property. For example, if the Property is a lock-up ground floor commercial unit with no rights to use any services on other floors in the building, then it should not be required to contribute towards maintenance/repair costs of the lifts.

'54 Act

If the Lease will be a business lease, to be granted to a business tenant with exclusive possession for the purpose of their business, then it will automatically enjoy the statutory protection of the Landlord and Tenant Act 1954. The main benefit to the Tenant is that the Act confers a statutory right for the Tenant to renew the Lease on the same terms (other than rent) when the contractual term expires. The Landlord can only bring a ’54 Act protected Lease to an end in accordance with certain notice provisions prescribed by the Act and has to financially compensate the Tenant in accordance with a prescribed statutory formula if it refuses to grant a new lease on grounds which are not related to the Tenant having defaulted on its obligations in the Lease. It is therefore a valuable commercial benefit for the Tenant to have a Lease which is inside the ’54 Act.

The parties to a business lease that would otherwise enjoy the protection of the ’54 Act can decide to exclude it. This is achieved by complying with a procedure prescribed by the Act and known as “contracting out”, which takes place before the Lease is entered into.

In practice, most business leases are contracted out. This is because the tendency is for business leases to be increasingly short and landlords are reluctant to agree to be bound by the inflexibility and possible compensation liability inherent with a ’54 Act protected lease. Ultimately, supply and demand is such that landlords will only rarely have to concede this point.

Having said that, there are circumstances when we can and have helped our tenant client to persuade the landlord to grant a lease inside the ’54 Act. This will typically be where the lease term is unusually long, where the tenant is to invest a significant amount of capital expenditure in fitting out and/or where the circumstances result in the prospective tenant having particular leverage.

Rent Review

For all but the shortest lease terms, the Landlord will want to review the open market rent at pre-agreed date(s) to ensure that any increase in the rental market since the lease was granted or the previous review is reflected in the Tenant’s rental liability to the Landlord.

Although there have been Industry led attempts to persuade landlords to move away from upwards only open market reviews in favour of upwards/downwards reviews to properly reflect prevailing rental market conditions on the review date, it is still the case that almost without exception an open market review will be upwards only.

Whilst our input will not therefore change that, we can ensure that the drafting of the rent review section in the Lease contains the appropriate assumptions and disregards and other terms for the correct valuation of the hypothetical lease at the review date and try to amend the timing requirements for the payment of any backdated uplift in the annual rent so that the Tenant has longer to make the payment.

Whilst every lease is different and specific to the property in question, the common theme is that the initial draft is prepared by the Landlord and will therefore inevitably be weighted in its favour. Some are undoubtedly more biased than others. However, without exception, we will always be able to re-address that balance by amending the draft Lease and negotiating with the Landlord’s solicitor to ensure that our tenant client ends up with a fairer contract that better protects their position.

Please do feel free to contact me once draft commercial terms have been agreed with the landlord. At that point, I will be happy to let you have my comments on those terms and will provide a fee estimate to act on your behalf.

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