The lease is the principal document setting out the contractual relationship between the owner of a property (the landlord) and the occupier (the tenant). The content of the lease will vary depending on the property type, its physical condition, the relationship between the landlord and the tenant (their relative bargaining powers) and the state of the property market.
Key areas covered by commercial leases
The key areas are the length of the lease, rent and other payments to be made by the tenant, service charge, repairs and decoration, alterations, use and dealing with the tenant’s interest in the lease.
Buying an existing lease
If you are acquiring an existing lease, its terms are not normally open to negotiation. The lease terms should be carefully reviewed as the value of a property can be adversely affected by unusual or restrictive terms. There is a possibility of negotiating with an existing tenant to take up a new lease prior to their existing lease maturing. For example a landlord may be willing to accept a rent reduction for the removal of an upcoming break clause or for extending the term of the lease. It may be beneficial to both parties, the landlord and the tenant.
Negotiating a new lease
Where a new lease is being granted, the contractual terms can usually be negotiated.
Length of leases
The period of time for which a commercial lease is granted (called the “term”) will vary depending upon the nature of the letting and the requirements of the landlord and the tenant. They are rarely granted for more than 25 years. In recent years, the trend has been for considerably shorter leases and the average length is now around eight years.
Break clause
A break clause is an option for either the landlord or the tenant (or both) to end the lease before the end of the term, usually on a specified date by giving notice. Break clauses are frequently included in commercial/business leases.
Break clauses can significantly affect the investment value of a property. If exercised, the income from the property will stop until the property is re-let. For this reason, when valuing property, it is normal to assume that a tenant’s break will be exercised. As a result, tenants often need to pay a higher rent for the flexibility of a break clause.
Extending a commercial lease
Subject to satisfying certain criteria, business tenants have a statutory right under the Landlord and Tenant Act 1954 to extend the contractual term of their lease. At the end of the lease, the tenant can ask the landlord for a new lease.
The landlord has some limited grounds to resist the tenant’s request (the most common being that the landlord needs the property for its own occupation or wants to redevelop it). Even then compensation may be payable to the tenant.
However, it is possible for the parties to agree (prior to the grant of the lease) that the tenant will not have these renewal rights. A specified procedure involving the service of statutory notices and the swearing of a declaration needs to be followed to ‘exclude’ the lease from the 1954 Act. The right to renew a business lease is a valuable tenant right and you should think carefully before agreeing to the lease being excluded from the 1954 Act.
Rent reviews
Leases over five years normally include provisions to review (change) the rent at specified intervals during the term. These lease provisions are called ‘rent review’ provisions. Rent reviews are commonly negotiated between the landlord and the tenant by referring to the rents achieved in the open market.
Commercial leases in England and Wales have traditionally provided for ‘upwards only’ reviews, where the new rent negotiated cannot fall below the rent the tenant was paying before the rent review, even if market rents have fallen.
The Code for Leasing Business Premises has encouraged alternative forms of rent review mechanisms and it is becoming more common for rents to be reviewed in line with specified indices such as the Retail Prices Index (RPI).
Tenants legal responsibilities under a commercial lease
This depends upon when the lease was granted. For leases granted before 1996, the original tenant remains legally responsible for the rent and the other lease commitments for the duration of the term (even after it has sold its interest).
For leases granted after 1996, the position is different. The tenant ceases to be liable to the landlord for future breaches once it has sold (assigned) the lease. However, landlords can legally require the selling tenant to guarantee the new tenant’s lease obligations using a guarantee document known as an Authorised Guarantee Agreement or AGA. It is important, therefore, when selling leasehold property, that you are happy with ‘covenant’ strength of your buyer.
The law in this area is complex and still developing and it is important that you get legal advice regarding your on-going liabilities when selling (assigning) a lease.
Repairing and maintaining the property
In most cases, the tenant will be responsible for keeping the property in good repair. Landlords expect the property to be regularly re-decorated and they may require carpets to be renewed and plant and equipment to be replaced.
Schedule of dilapidations
If the tenant does not comply with its repair/decorating obligations, the landlord can serve a ‘schedule of dilapidations’ on the tenant. This requires the tenant to put the property back into a satisfactory state of repair. If the tenant does not carry out the work, the landlord can pursue a legal claim against the tenant for breach of the lease.
Disagreements over dilapidations claims are frequent and the law is complex so expert advice is recommended.
Service charges
In multi-occupied buildings with common areas, the landlord will normally repair and maintain the structure and common areas of the property (eg entrance halls, service yards, stairs etc). However, the landlord will expect to recover the full cost of such repair/maintenance from the tenant by way of a service charge. If the landlord provides services to the tenant (eg heating and lighting a reception area, providing a lift service etc) these costs will also be recovered from the tenant via a service charge.
Ability of a tenant to sell or sub-let their lease.
Commercial leases normally restrict the tenants’ ability to deal with the lease. Often a tenant will not be able to sell (assign), sub-let, share occupation or grant security over the lease unless the landlord’s consent to the transaction is obtained. Landlords also impose conditions which have to be met before such consent will be granted.
Careful drafting and negotiation is required to ensure that these lease provisions (known as alienation covenants) are not too restrictive and allow the tenant enough flexibility to deal with the lease should their business requirements change.
