It is a common misconception amongst tenants of commercial space that there is an underlying legal framework to protect them from unfair terms, much like the regulatory protections afforded to residential tenants. Unfortunately, this is far from the reality.
It is crucial tenants are aware of the potentially disproportionate liabilities they could be signing up for, and that they enter into negotiations with their eyes open to the pitfalls, particularly given the relatively short-term interest they will be taking on with the premises.
Here are our top five considerations for tenants taking a commercial lease:
Investor landlords often push for full repair and insurance, or ‘FRI’ leases, to maximise their returns. The starting position is often a full tenant’s repair obligation, which can include putting premises into a state of repair where they were in disrepair at the date of grant.
This liability can be substantial, particularly where tenants are responsible for the structure of the building itself. This often comes as a surprise to tenants, and it seems unfair that they should be required to improve the state of premises where the underlying investment value remains with their landlord.
To afford tenants some protection, we recommend limiting repair liability to the condition at the start of the lease, as evidenced by a schedule of condition.
Tenants should be aware that, whilst a schedule of condition will go some way towards reducing their liability for disrepair, where the condition of the premises worsens as a result of pre-existing issues shown in a schedule, they will still be responsible for bringing the property up to the state of repair as at the lease start date.
Any failure to put the premises into the required state of repair at the end of the term can result in the tenant being served with a hefty terminal dilapidations claim.
2. Rights to Renew
Landlords usually insist on ‘contracting out’ of the Landlord and Tenant Act 1954, the statute which gives commercial tenants the right to renew their lease on similar terms when it expires. This can be a valuable right, especially where the tenant invests in building goodwill in a particular location. Having that ‘security of tenure’ may increase the rent cost, but may be a price worth paying. However, some landlords are reluctant to give up the flexibility to let to the highest bidder and tenants may find themselves with little choice.
Where there is no right to a new lease, if a deal has not been put in place by the end of the term, the tenant will need to vacate, or will otherwise be a trespasser liable to pay damages for the period the landlord is unable to let in the open market.
Tenants often fail to start negotiations far enough in advance of lease expiry, and can find themselves ransomed to landlords where they want to remain in occupation and need to ensure business continuity.
Tenants should consider at the heads of terms stage the most appropriate term length to suit their business needs, and the flexibility of break options or contractual rights to renew, but should also ensure that renewal discussions are raised well in advance of term end.
3. Break Options
Where it is agreed that the tenant will have an option to end its lease early, it is important that any conditions imposed upon such right are carefully scrutinised.
Break conditions are strictly construed, meaning that any uncertainty surrounding compliance with the same may enable a landlord to frustrate the tenant’s break option. In the worst case can leave a tenant paying rent on a property it no longer needs, even after it has moved out.
For this reason, an unconditional break is the ideal position for a tenant. Any conditions which are agreed should be definite, and obligations to give vacant possession, or to pay ‘all sums due’ (even if they haven’t been invoiced or might not be quantified), should be strongly resisted.
4. Assignment and subletting
Rights to underlet or assign a lease are crucial in order to give businesses options to streamline their property liabilities where circumstances change during the course of a lease (especially where a break clause is not on offer or the date has already passed).
Tenants should ensure that such dealings are permitted, but should be aware that they are unlikely to be off the hook in the event the rights are exercised. It is usually a requirement of the landlord permitting an assignment that the outgoing tenant gives a guarantee of performance of the covenants (including payment of rents and dilapidations sums) by the new tenant. The guarantee will remain in place until the assignee transfers the lease on again, or the end of the lease, whichever comes first.
5. Service Charge
Tenants are wary of responsibility for payment of unknown sums, and a landlord’s discretion to carry out maintenance, or even improvement works, under a lease and recharge the costs to tenants via the service charge is generally broad.
To ensure that they can budget for such expenditure, and are not hit with unexpectedly high service charge bills, tenants may want to negotiate an inclusive rental figure or service charge cap. This will be a particular issue where they have not carried out a survey to identify any pre-existing issues with structural parts or plant and machinery repaired by the landlord.
Carve-outs for items the tenant does not benefit from, and is not expecting to contribute towards, should also be considered.
Ultimately, the world of commercial leasing is a minefield of unexpected liabilities for unsuspecting tenants, who should seek professional legal and surveyors’ advice early in negotiations to protect the long-term interests of their business.
The content of this article is from the summer 2019 edition of Room with a View and is for general information only. For further information please contact Laura Jones or another member of the Birketts’ Commercial Property Team. Law covered as at July 2019.
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The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at July 2019.