Why Is It Important To Understand And Review Your Business Leases?
A lease is essentially a contract between the landlord and the tenant that gives the tenant the exclusive right to occupy and use the landlord’s property for a period of time.
As with any other contract, the terms of the lease reflect the circumstances and the parties’ needs when the lease is granted. The terms of a short lease over a small dilapidated space should be appropriate to that type of property and will be significantly different from the terms of a long lease over high-quality premises. Long leases need to allow for circumstances and requirements to change over the lease term.
There are a number of reasons why a business tenant will want to review the leases that it holds. On the grant of a lease, the tenant’s solicitors will have explained the provisions. However, because the lease is a contract that governs the rights and obligations of both the landlord and the tenant during its term, the tenant will need to refer to the lease regularly to:
- Check that the business and the landlord are complying with their obligations.
- Check what rights the landlord and the business each have.
- Remind the business of the processes it needs to follow if there is a problem.
What Is A Business Lease?
A business lease is defined in the Landlord and Tenant Act 1954 (LTA 1954). Essentially, a business lease is a lease where the tenant occupies the premises for the purposes of its business.
If the lease is classed as a “business lease” under the LTA 1954, the tenant has certain rights to renew the lease at the end of the contractual term (although there are exceptions to this and these rights may be defeated by the landlord in certain circumstances) (see Contracting out of the LTA 1954).
The lease is granted for a period of time, referred to as the “term”.
Generally, a business lease is granted for a “fixed term”, that is, a fixed period starting and ending on fixed dates. For more information, see Practice note, Leases: “term” and “contractual term”.
It is important to be aware of when the fixed term will end, and whether it can be terminated earlier by either party. The right to terminate early is usually referred to as a “break right”
Tenant break rights are sometimes linked to rent reviews so that, if the rent is likely to be unacceptable to the tenant, it can terminate the lease, and limit its financial liabilities (see Rent and rent review).
If the lease is contracted out of the LTA 1954, it finishes at the end of the term and the property must be vacated. If the lease is not contracted out of the LTA 1954, it will continue until terminated under the Landlord and Tenant Act 1954 (see Contracting out of the LTA 1954).
Rent And Rent Review
The lease may have been granted for a substantial premium and a small, or nominal annual rent. Alternatively, the lease may have been granted without any initial premium, but for a more substantial rent.
The rent will generally be expressed to be an annual sum that has to be paid in four instalments in advance. It is common for the lease to require the rent to be paid on the “usual quarter days”, which are 25 March, 24 June, 29 September and 25 December.
The rent may increase during the term of the lease in a number of ways:
- There may be set dates for the rent to be reviewed. If the rent is to be reviewed to the “market rent”, the reviews will usually take place every three to five years. The rent may be reviewed by reference to the open market valuation, or by reference to an index (typically the Retail Price Index (RPI)), in which case, it is common for the review to take place more frequently than every five years.
- The lease may provide for the rent to be increased by pre-agreed increments, or “steps”, each year.
- The lease may have a set figure for rent and then require the tenant to pay an additional amount of rent linked to the tenant’s business profits (”turnover rent”).
In addition to the rent, the tenant may have to pay:
- VAT on the rent.
- Outgoings (such as rates, insurance premiums and utility bills).
- Service charges.
If the lease is of the whole of a building, the tenant is likely to be responsible for all the outgoings associated with the building. Where the lease is of a part of a building, it is generally easier for the landlord to pay the outgoings and then bill the tenant for the tenant’s share of those (the “service charge”).
It is important that the tenant knows what costs the landlord can include in the service charge. The landlord will want to pass the total cost of running the property to its tenants, so the service charge will usually include all costs, including the costs of repairs, maintenance, sometimes improvements and alterations, utility bills, insurance premiums and the cost of employing staff (such as caretakers, groundsmen, receptionists and cleaners).
The landlord may also want to collect a sum to put towards a major expense in the future (a “sinking fund” contribution).
The landlord will not know the amount of the total service charge in advance. Instead, the landlord’s managing agents will give an estimate, which the tenant is then required to pay in quarterly instalments (often at the same time as the rent). At the end of the service charge year, the tenant will be asked to pay the balance due. It is rare for a landlord to ask for too much up front, but if it does, the lease should provide that any overpayment is reimbursed to the tenant (or credited to the following service charge year).
The service charge year will not necessarily be the same as the lease term year. For example, the lease may be for ten years from 29 September 2012, but the service charge year may start at the beginning of each financial year.
The lease refers to the property that is given to the tenant as the “demise”. The extent of the demise is important because the tenant:
- Is only responsible for its demise.
- Does not have to repair or redecorate any property outside its demise, unless the lease specifically states otherwise (which would be rare).
- Has no rights over the landlord’s property that is not within the tenant’s demise, unless those rights are given in the lease (see Rights, exceptions and reservations).
- Cannot make alterations or additions to its property that fall outside the demise (for example, an extension).
Rights, Exceptions And Reservations
The lease will usually grant the tenant rights over the property that is outside the tenant’s demise, but still forms part of the landlord’s property. For example, if the tenant has a lease over a floor in an office, it will require rights to use the stairs, lifts and entrance hall so that it can get access to and from its office. It may also need rights to park vehicles and walk or drive over the landlord’s land if there is no direct access from the building to the public highway.
The lease will also usually grant rights to the landlord over the property demised to the tenant. Traditionally, these rights granted to the landlord are referred to as reservations because the rights are reserved out of the grant of the demise to the tenant. For example, the lease may give the landlord the right to go onto the tenant’s demised property to carry out repairs.
The lease will usually also exclude certain rights from the tenant. These are referred to as exceptions, and effectively limit the tenant’s rights. An example of an exception would be a right to light, which is often excluded so that the tenant cannot raise an objection if the landlord develops land in a way that obstructs light getting through the tenant’s windows.
Rights, exceptions and reservations are important. They can have implications for a landlord’s freedom to deal with, or develop, neighbouring land and with the tenant’s ability to use the property, and carry out its business.
The insurance clause needs to be read carefully and in conjunction with each party’s repairing obligations (see Repairs).
It is important that one party is obliged to insure the property so that problems of double insurance and no insurance are avoided.
If the tenant is to insure the property, it needs to check if the lease makes any specific requirements about the level of cover, the risks covered and the names of the insured parties.
If the landlord is to insure the property, the tenant might be required to pay a proportion of the premium covering the area demised by the lease to the tenant. In this case, the tenant needs to consider the following points:
- Is the insurance in the landlord’s sole name or the joint names of the landlord and the tenant? If the tenant has paid a premium for the lease, it will have a capital interest in the property and needs to make sure this is adequately protected by insurance. Noting the tenant’s interest on the landlord’s policy does not give the tenant any right to claim on the insurance.
- Is the level of cover appropriate for the property?
- Are the risks covered appropriate for the property and the tenant’s use of it? What are the excluded risks? Typically, this might be damage caused by terrorism, but may also be subsidence and flooding.
- Will the tenant be liable to pay any excess on a claim?
- What are the terms of the insurance policy? If the tenant does not comply with these, the insurance policy might be invalidated and the landlord could have a claim against the tenant for a breach of an obligation in the lease not to invalidate any insurance cover.
- Typically, the tenant will have to disclose certain information about itself, its business and what is kept at the property.
- What happens if the property is damaged so that it cannot be occupied? Is the rent suspended and, if so, for how long? What will happen if the landlord cannot rebuild the property? Typically, there will be a rent cesser period during which the tenant will not have to pay rent. This period should be the same as the period that the landlord insures for loss of rent and there should usually be a right to terminate the lease at the end of the rent cesser period if the property is still not fit for occupation and use.
- What other insurance cover does the tenant need? For example, business interruption insurance to cover a move to temporary premises because the demised property has been damaged and cannot be occupied.
Usually, there will be repairing obligations on the tenant. There may also be repairing obligations on the landlord, depending on the situation.
If the tenant is required to “keep” the property in repair, it must put the property into a good state of repair, even if it was not in a good state of repair at the date of the grant of the lease.
The tenant may be required to repair the property according to a schedule of condition attached to the lease. Particular points to look out for include:
- If the property demised to the tenant is part of a larger property, the tenant needs to make sure that the landlord is obliged to repair the parts that are not demised to the tenant.
- The repairing obligation should be read in conjunction with the insurance obligations. If the landlord insures, the lease should only require the tenant to repair where the damage will not be covered by the landlord’s insurance policy.
- What happens if the property is not capable of repair or if the landlord decides not to repair? Can the tenant terminate the lease?
Alterations And Improvements
The lease may impose restrictions on what alterations and improvements the tenant can make. This is to protect the landlord from alterations that might damage the landlord’s investment interest in the property. There will usually be a requirement to reinstate the property to its original configuration before the end of the term.
The restrictions should be appropriate to the type of property and length of the term. If the lease:
- Is of the whole property and for a long term, there may be few restrictions.
- Is of only part of a larger property or for a short term, the lease may prohibit absolutely structural alterations, but may allow internal alterations, either without the landlord’s consent or with the landlord’s consent (which the landlord cannot withhold unreasonably). Putting up or moving internal partitioning will generally be treated as an internal alteration unless the lease provides otherwise. Therefore, the tenant needs to remember to get the landlord’s consent.
Assignment And Underletting
If the tenant wants to sell its interest in the lease, the sale is referred to as an “assignment”. If the tenant wants to keep its interest in the lease, but allow someone else to use the demised property or part of it, the tenant could grant an underlease (also called a sublease). The tenant should look out for the following points:
- There are likely to be a number of restrictions associated with assignment and underletting (known as “alienation”) and these should be considered carefully.
- Generally, the tenant will require the landlord’s consent to the grant of an assignment or an underlease. The landlord is sometimes subject to statutory duties when considering these applications.
- Failure to obtain consent will put the tenant in breach of its lease and may lead to forfeiture proceedings by the landlord or a claim for damages. If the lease is a “new” tenancy for the purposes of the Landlord and Tenant (Covenants) Act 1995, the unauthorised assignment will be an “excluded” assignment. The seller will not be released from its liabilities under the tenant covenants in the lease until the next authorised assignment of the lease has taken place.
The lease will generally stipulate how the demised property may be used.
The restriction may be expressed positively or negatively:
- ”The tenant shall use the property for [the permitted use]”.
- ”The tenant shall not use the premises otherwise than for [the permitted use])”.
In particular, the tenant should look out for the following points:
- Whatever the permitted use under the lease, there must be planning permission for the actual use. Planning permission is required for a change of use as well as for the construction of new buildings and alterations to existing buildings.
- If the tenant needs to change the use, it might need the landlord’s consent under the lease as well as planning permission. The lease may require the tenant to get the landlord’s consent before applying for a change of use. This is because the authorised use of the property may affect the landlord’s investment in the property and its rental value, and so affect rent review.
Contracting Out Of The LTA 1954
If the lease is a “business lease” under the LTA 1954, the tenant has certain rights to renew the lease at the end of the contractual term (although there are exceptions to this and the right may be defeated by the landlord in certain circumstances).
The tenant may agree to forego these rights. If so, this has to be effectively authorised and recorded in the lease.
If the lease contains a clause confirming that sections 24 to 28 of the LTA 1954 have been excluded, the tenant will have no right to renew the lease, it finishes at the end of the term and the property must be vacated.
If the lease is not contracted out of the LTA 1954, it will continue until the lease has been properly terminated under the LTA 1954 or renewed and, until then, the tenant will have the right to remain in the property. This “state of limbo” is commonly referred to as the tenant “holding over”.