6 - Grant of a Lease, Structure & Content

Question 1

What are the different types of leases, and what are their key characteristics?

Answer 1

Long-term residential leases (e.g., 99 or 999 years):
- Typically, very low rent is payable (e.g., £150/year for newer properties or as low as £2.50/year for older houses).

Assured shorthold tenancies:
- Common for six- or twelve-month rentals of houses or flats.
- The tenant pays a market rent.
- These leases are more common in residential conveyancing.

Commercial leases:
- For a variety of uses, such as office blocks, factories, warehouses, or shops.
- Usually short-term (up to 15 years).
- A market rent is payable, similar to assured shorthold tenancies, but commercial leases differ in other significant ways.

Question 2

What are the advantages of leases from a tenant’s perspective?

Answer 2

Advantages of leases for tenants:
- No need to spend capital, particularly useful for new businesses.
- Flexibility to leave at the end of the lease or in certain circumstances if business needs change.
- Some premises (e.g., shops in large shopping centres) are only available as leasehold.

Question 3

Who are typical commercial landlords?

Answer 3

Private investors: Individuals or companies, like Derwent, which owns 5.5 million square feet of commercial property, often in central London.

Institutional investors: Financial institutions (e.g., pension funds, life assurance companies) view property as a safe investment, offering rent income and long-term capital growth, though this view may have been affected by the pandemic and a shift towards remote working.

Question 4

What are the key concerns of institutional investors in relation to commercial property?

Answer 4

Institutional investors focus on the income a property produces and therefore favour a full repairing and insuring (FRI) lease.

The key concerns are:
Full repairing and insuring (FRI) lease:
- Tenants cover the property-related costs (e.g., repairs, insurance).
- The landlord receives the clear rent without deductions for expenses.

Covenant strength:
- Institutional investors want tenants with the means to meet their lease obligations.
- They assess whether the tenant has assets that the landlord can recover against in the event of breaches.
- A long-established company generally has good covenant strength, while a new, “off-the-shelf” company may not.
- If the tenant lacks sufficient covenant strength, the landlord may require a guarantor (e.g., the company director) or a rent deposit.

Question 5

What is asset management in commercial property, and what are the typical legal tasks involved?

Answer 5

Asset management in commercial property refers to the ongoing management of legal work generated by a property asset. This is a common practice area for commercial property solicitors, particularly when acting for institutional landlords.

Typical tasks include:
- Granting a lease to a new tenant.
- Considering tenant applications during the lease, such as requests to alter the premises.
- Advising on breaches of the lease, such as:
Failure to pay rent, Allowing the premises to fall into disrepair.
- Dealing with lease-end issues, such as: When a tenant is leaving, If the tenant seeks a new lease.

Question 6

Provide a summary of the introduction to leasehold transactions.

Answer 6

· There are residential and commercial leases, which tend to be quite different. Commercial leases are the main focus of this course, but many of the principles are transferable.

· There are various advantages to a business of taking a lease instead of buying a freehold.

· Most commercial landlords will treat the property primarily as an investment.

· Institutional investors are financial institutions, such as pension funds and life assurance companies.

· Asset management involves assisting a commercial landlord (which may be an institutional investor) with the day to day management of the estate.

· This may involve granting new leases, considering applications for consent, advising on breaches of the lease, and dealing with the issues at the end of the lease.

Question 7

What is a lease and what does it include?

Answer 7

“The grant of a right to the exclusive possession of land for a determinate term less than that which the grantor has himself in the land”

If the owner has a freehold, their interest is in perpetuity, and therefore it doesn’t matter how long a fixed term is (10 years, 99 years, 999 years or even more), it will be less than their interest.

A lease itself is the document that creates a leasehold interest.

At its simplest it may just state the contractual term and rent payable. There are some common law and statutory principles that apply to a simple lease.

In practice, most leases will go into considerable detail about the respective obligations of the landlord and tenant.

Drafting and negotiating the terms of a lease is an important part of the work that the landlord’s and tenant’s solicitors undertake.

Question 8

What are the essential ingredients of a lease?

Answer 8

Exclusive Possession:
- This distinguishes a lease from a license. Without exclusive possession, it will be a license.
- The tenant must be able to exclude strangers and even the landlord (except where the landlord is exercising its right to enter the premises, e.g., to inspect it) from the premesis let.

Fixed Term or Periodic Tenancy:
- The lease must be for a fixed term (six months, 5 years etc.) or a periodic term (a weekly, monthly, yearly tenancy etc.)
- Generally speaking, it may not be for an indeterminate time (e.g., for as long as the tenant is an employee of the lanlord). There are exceptions.

Formalities:
- A legal lease must be created by deed if the term is over 3 years.
- A tenancy of 3 years or under may be created in writing, or even orally.

The Reversion:
- The reversion si the interest that the landlord holds subject to the lease. At the end of the lease term, the property reverts to the landlord.

Question 9

What are the landlord’s objectives under a lease?

Answer 9

In many cases, the landlord is in the dominant negotiating position.

Institutional landlords will insist on a full repairing and insuring (FRI) lease, meaning that any costs are met by the tenant, whether directly or indirectly. This means that rent paid by tenants is clear of deduction.

The landlord will want a lease that ensures the premises are:
- Insured
- Kept in repair
- Only used for the permitted purpose

The landlord will also want:
- To control whom may occupy of the premises (eg, if the tenant tries to pass the lease on)
- To have a say over how the premises are altered by the tenant
- To increase the rent in line with market rent over the contractual term of the lease (by way of rent review)

Examples:
20-year lease with no break clause: The landlord benefits from uninterrupted rent, enhancing the value of the reversion.
Rent reviewed every 5 years, upwards only: This ensures rent doesn’t decrease if the market dips.
No alterations to the property: The landlord may want to ensure the premises remain unaltered.

Question 10

What are the tenant’s objectives under a lease?

Answer 10

The tenant will want a lease that:
- Allows the tenant to use the premises for its intended purpose
- Has a contractual term (say 10 years) that is satisfactory to the tenant (ie, not too short or too long for its business purposes)
- Provides some flexibility if circumstances change

The tenant will not want:
- Onerous restrictions that prevent the tenant from using the premises for its intended purpose or that make it difficult to pass the lease on to a third party
- Provisions that allow for a steep rise in rent
- Excessively unfair provisions (that favour the landlord over the tenant).

Examples:
20-year lease with no break clause: The tenant may prefer a shorter commitment, such as a 10-year lease with a 5-year break option.
Rent reviewed every 5 years, upwards only: The tenant may prefer rent to decrease if market rent declines, though it’s rare to find landlords offering this.
No alterations to the property: The tenant typically seeks the ability to alter the interior unless there are good reasons (e.g., the building is listed).

Question 11

Provide a summary on the essentials of a lease.

Answer 11

A lease grants exclusive possession, is for a determinate term, and if over 3 years, must be executed by deed

The landlord’s interest (subject to the lease) is the reversion

An institutional landlord will want an FRI lease

Most landlords will be in the dominant negotiating position

A landlord’s concern is to maximise their investment by ensuring a clear rental stream, and retaining control over the premises

A tenant’s concern is to be able to use the premises for their intended purpose, and have flexibility to, for example, pass the premises on if needed

Question 12

What are the key points regarding the lease term in commercial leases?

Answer 12

The lease term must be determinate, meaning that it is either a fixed term (6 months, 5 years, 999 years, etc) or a periodic tenancy (weekly, monthly, yearly, etc).

FRI leases are generally for a fixed term, as a lease where the tenant can give notice at any time is not as valuable.

Typical commercial lease terms are 3, 5, 10 or 15 years depending on the business sector.

Shorter and more flexible leases have become more popular in recent years. Reasons might include:
- Business plans are often drafted in 5 or 10 year cycles. Business tenants may not want to commit to a property longer than this.
- A tenant may pay less Stamp Duty Land Tax or Land Transaction Tax on a shorter tenancy.

Question 13

What is the term commencement date in a lease?

Answer 13

The term commencement date is the date on which the lease term (say 5 years) starts.

The term commencement date may be the date of completion of the lease (when it is dated and becomes legally binding), but may also be before or afterwards.

It is common for the term commencement date to be earlier than the lease is dated. A landlord may want all of the leases to start at the same time for simplicity. Note that if the term started in the past (whether a week ago or a year ago), the tenant is not generally expected to pay rent for the period they haven’t used.

The term may also start after the lease is dated. This is called a reversionary lease. These may, for example, be used when the parties want to extend the letting in advance of the expiry of the current lease.

Question 14

How is the expiry of a lease term calculated?

Answer 14

This will depend on how the term is defined in the lease:

If the term of the lease is “from and including” a certain day of the year, the term expires on the day before that day of the year in the relevant year (more common in practice).
For example, a lease with a term of 10 years from and including 24 March 2019 expires on 23 March 2029.

If the term of the lease is “from” a certain day of the year, the term starts the day after that day, and so expires on that day of the year in the relevant year (less common in practice).
For example, a lease with a term of 10 years from 24 March 2019 will start on 25 March 2019 and expire on 24 March 2029.

Question 15

What is a break clause in a lease?

Answer 15

If the tenant is unsure about the commitment of a lease term, and the landlord is unwilling to grant a shorter term, a break clause can offer a compromise solution.

Note that if the lease does not include a break clause, in general neither landlord nor tenant can bring the lease to an end before the end of the fixed term without the agreement of the other.

A break clause can be:
- A landlord break (only the landlord can exercise it),
- A tenant break (only the tenant can exercise it – the most common type),
- A mutual break (either party can exercise it).

The break clause may specify a date (e.g., the fifth anniversary of the term commencement date) or it may be a rolling break (e.g., any time after the fifth anniversary of the term commencement date).

Question 16

Why might a landlord accept a tenant’s break clause rather than a shorter lease term?

Answer 16

Landlords may hope that the tenant will not exercise the break clause, similar to how Internet-based companies offer a free first month hoping subscribers forget to cancel.

A 10-year lease with a 5th anniversary tenant’s break is more valuable to the landlord than a 5-year lease when valuing the landlord’s reversion.

Example: A tenant with a new business on a 5-year lease might seek out more suitable premises at the end of the term. However, on a 10-year lease with a 5-year break, the tenant is more likely to stay unless there are compelling reasons to move.

Question 17

What is rent in the context of commercial leases?

Answer 17

Most leases fall into one of two categories: either a short lease with a market rent; or a long lease with a ground rent.

Commercial leases are usually short leases (up to 15 or 20 years) with a market rent (also known as rack rent). A premium (lump sum) is not usually charged on the grant of a commercial lease.

For example, a commercial tenant may pay a rent of £20,000 per annum but will not pay a premium to the landlord on the grant of the lease.

Commercial long leases also exist, for example, land for electrical substations is sometimes leased in this way.

Question 18

Rent - residential leases

Answer 18

Residential leases may be long leases (say 99 or 999 years). The first person to buy the property will pay a premium (say £200,000) to the landlord for the grant of the lease.

Such leases often used to impose a ground rent (a low sum, say £150 per annum).

Since 30 June 2022, most new long residential leases have been restricted to imposing a peppercorn rent only (literally the payment of a rent, not usually paid in reality). Ground rents imposed before that date remain effective.

Question 19

What is rent in a commercial FRI lease and how is it paid?

Answer 19

The rent is usually expressed as a yearly figure (e.g., £80,000 per annum) but payable quarterly.

The year is divided into approximate quarters, which may run from traditional quarter days:
- 25 December to 24 March
- 25 March to 23 June
- 24 June to 28 September
- 29 September to 24 December

Some leases now use modern quarter days: 1 January, 1 April, 1 July, and 1 October.

Rent is usually divided equally across the quarters, even though they vary slightly in length. For example, £80,000 per annum would mean £20,000 per quarter.

Rent is generally due in advance on the quarter day. For example, rent for 25 March would cover the period up to 23 June.

If the lease is silent on when rent is payable, rent is paid in arrears (more common in residential long leases).

If the lease starts partway through a quarter, the rent is apportioned accordingly.

The lease will outline how rent is paid (usually by standing order) and whether VAT is applicable.
Other payments like contributions to insurance premiums and service charges are often described as “rent”.

Question 20

What are the different types of rent review?

Answer 20

Stepped rent – the lease may set out, for example, a yearly rent of £25,000 for the first two years, a yearly rent of £30,000 for the next two years, and so on.

Turnover rent – the rent may be calculated based on the tenant’s turnover at the property. This is mostly commonly seen with retail leases (e.g., shops).

Index-linked rent – the rent is increased by reference to an agreed measure of inflation, such as the retail prices index.

Open market rent review – this is the most common type of rent review adopted by FRI leases, and involves ascertaining the rent based on comparable premises and certain principles.

Question 21

What is the process for open market rent review?

Answer 21

Open market rent review provisions can be complex and, as they affect the future rent payable, may be a particularly contentious area for negotiation.
- Commercial leases almost always have an “upwards only” rent review. This means that the rent can only increase. If market rents have fallen on the date of the rent review, the rent stays the same.
- Typically, the rent review clauses will give the landlord and tenant the opportunity to agree on the new rent between themselves. If they cannot agree, then the lease will set out a mechanism for a specialist valuer to be engaged to determine the new rent.

The valuer will consider:
- The rent payable for comparable premises (i.e., premises of similar size and location) plus
- The terms of the hypothetical lease – an imaginary lease based on the actual lease but assuming certain matters and disregarding others.

Question 22

What is the hypothetical lease in the context of an open market rent review?

Answer 22

Hypothetical lease: This is an imaginary lease used to help value the rent, based on the actual lease but assuming certain matters and disregarding others.

The hypothetical lease differs from the actual lease in key aspects.

Assumptions: Enable valuation to take place, such as assuming:
- The premises are vacant and available.
- There is a willing landlord and willing tenant.

Disregards: Generally, disregards what the tenant has voluntarily done (e.g., improvements), as the tenant should not be penalised with a higher rent for their actions.

Question 23

What are the basic assumptions considered in the hypothetical lease in the context of a rent review?

Answer 23

The tenant has complied with all its covenants under the lease. If the tenant, say, lets the premises fall into disrepair, it should not be rewarded with a lower rent.

The landlord has complied with all its covenants under the lease. Say that the lift in an office block never works. This would affect the rent that tenants would pay. From the tenant’s perspective, the assumption is unfair, as the landlord is not suffering the consequences of its inaction.

On the terms of the actual lease other than the rent payable. If the actual lease, for example, has clauses that are very restrictive on the tenant’s use of the property, the tenant is stuck with those and should not have to pay a higher rent as if those clauses do not exist.

The term of the hypothetical lease is the term remaining of the actual lease. This is a tricky point, and can depend on the particular market, and whether prospective tenants favour short or long lease terms. Say that 5 years are left at rent review, and prospective tenants want 5-year leases. This would work against the tenant who initially took a 10-year lease.

If damaged or destroyed, the premises have been repaired or rebuilt. This is because the lease will usually have detailed provisions for what happens in this instance (including suspending the rent). It would be unfair on the landlord if the tenant continues to pay a decreased rent as if the premises have been destroyed once they have been rebuilt!

Question 24

What are common disregards in the hypothetical lease in the context of a rent review?

Answer 24

The effect of the tenant’s occupation on the rent. The premises will be worth more to the tenant than a new prospective tenant, as the tenant has the convenience of not having to move.

Goodwill attached to the tenant’s business. Say the tenant is a restaurant business. If successful, the tenant will make that location more valuable to other restaurant businesses. It is unfair for the tenant to be penalised with a higher rent for this.

Tenant’s improvements (other than as obliged under the lease).. If the tenant voluntarily improves the property, then it is unfair to the tenant if this is used to increase the rent, and unfair to the landlord if it limits the rent.

Question 25

What happens after a rent review?

Answer 25

Once the parties have agreed the new rent, or failing that, the new rent has been determined by a valuer, the new rent is documented in a rent review memorandum:
- This is a short document (usually a single page) that records the new rent, is signed by the landlord and tenant and is kept with the lease for future reference.
- If the rent review is before the 5th anniversary of the term commencement date, the tenant may have to pay further Stamp Duty Land Tax or Land Transaction Tax (as this is calculated on the first five years’ rent).
- If the rent review is on or after the 5th anniversary of the term commencement date, the tenant will not have to pay further SDLT or LTT.
- If the new rent has only been agreed some time after the rent review date set out in the lease, the new rent is backdated to the rent review date. This means that the tenant will have to pay an additional sum plus interest at a rate set out in the lease (this should not be a punitive rate of interest).

Question 26

Provide a summary of the principal terms of a lease.

Answer 26

• Commercial leases are usually for a fixed term. Landlords will tend to prefer longer terms, whereas tenants’ preferences will depend on their business requirements.
• A tenant’s break clause can offer a compromise where a landlord wants a longer term and tenant wants the ability to end the lease early.
• Commercial leases are usually granted at a market rent, expressed as a yearly rent but payable quarterly.
• For terms longer than 5 years, there will usually be rent review provisions. For an FRI lease the rent review will be upwards only.
• There are different options for rent review: stepped rent, index-linked rent, turnover rent and open market rent.
• Open market rent review is complex and depends on a hypothetical lease with assumptions and disregards which may lead to a fairer result (but can be contentious).

Question 27

What is the purpose of the Code for Leasing Business Premises?

Answer 27

As it is recognised that landlord generally enjoy a stronger negotiating position than tenants, the code exists to:
“Improve the quality and fairness of negotiations on lease terms” and
“promote the issue of comprehensive heads of terms that should make the legal drafting process more efficient”

Previous codes existed, but were entirely voluntary, and their influence over landlord and tenant negotiations was limited. The 2020 Code, however, does have stronger powers.

Question 28

Where does the Code for Leasing Business Premises come from, and to who does it apply?

Answer 28

The Code is written by the Royal Institution of Chartered Surveyors (RICS) and applies to members of the RICS and RICS regulated firms. Many property professionals, whether property firms or in-house property specialists who deal with the letting of commercial property, will be RICS regulated.

Example: A commercial landlord employs a letting agent to find tenants and negotiate heads of terms. The letting agent is an RICS regulated firm. The letting agent will be professionally obliged to take account of the Code in negotiations. Note that neither the landlord nor the landlord’s solicitor are obliged to do so, however, unless they are members of the RICS or RICS regulated firms in their own right.

The Code applies to most commercial lettings but there are exceptions (eg, tenancies of 6 months or less)

Question 29

What does the Code for Leasing Business Premises contain?

Answer 29

The Code concerns itself with negotiations and heads of terms, and is divided into mandatory requirements and good practice.
- Mandatory requirements are indicated by the word “must”. RICS members and regulated firms must follow them.
- Good practice is indicated by the word “should”. RICS members and regulated firms must follow them unless there are exceptional circumstances (and they may need to be justified to the RICS).

Although the Code’s introduction states that it is concerned with the process rather than the outcome, the section on good practice does concern itself with what lease provisions should and should not be included in the lease.

Question 30

What are mandatory requirements under the Code for Leasing Business Premises?

Answer 30

The mandatory requirements must be followed, and include the following:
- Lease negotiations must be approached in a constructive and collaborative manner
- An unrepresented party must be advised about the existence of the Code and recommended to seek professional advice
- The landlord (or its letting agent) is responsible for ensuring that heads of terms compliant with the Code are agreed before the draft lease is circulated

Example: An RICS regulated property agent is negotiating a lease for an institutional landlord. The prospective tenant is a new business which does not have a property agent or solicitor. The landlord’s property agent must advise the tenant about the Code and recommend that the tenant seeks legal advice.

It is also mandatory to prepare written heads of terms, stating that it is subject to contract. The Code specifies certain areas which must be covered in the heads of terms. These include:
- Extent of the premises
- Length of term and break rights
- Rent and rent review (including basis for rent review)
- Repairing obligation
- Rights to assign (transfer to a new tenant) or underlet the lease
- Permitted use of the property (and whether tenant can change it)
- Rights to alter the property and any obligations to put the property back in its original state

Question 31

What constitutes good practice according to the Code for RICS members and regulated firms?

Answer 31

RICS members and regulated firms should follow good practice unless there are exceptional circumstances, which may need to be justified to the RICS.

It is likely that the provisions of the Code will become standard in time.

Specific areas of concern include:
Premises: The heads of terms should clearly define the demise, provide a lease plan, and refer to all the rights that the tenant will need for its use of the premises (e.g., the right of access to the premises, water and electricity, etc.).

Length of term, renewal rights and break rights: The heads of terms should clearly specify the length of term and any break rights. The Code sets out basic conditions for exercising the break that are acceptable, and others may be included but must be specified in the heads of terms.

Rent and rent review: The heads of terms should clearly state the initial rent, frequency of payment (e.g., quarterly), whether VAT will be charged, and if there is a rent-free period.

Landlord’s title: The landlord should be responsible for obtaining any consent needed to grant the lease (such as from a superior landlord, mortgagee, or any other third party).

Repairs: The tenant’s repairing obligation should be appropriate to the length of the term and the condition of the premises.

Insurance and damage: The lease should suspend the rent if the premises are damaged by an insured risk (unless the damage is due to something the tenant has done or not done).

Question 32

Provide a summary of the Code for Leasing Business Premises.

Answer 32

· The Code aims to make commercial lease negotiations fairer and more transparent

· The Code applies to RICS members and RICS regulated firms

· The Code does not apply to clients, property professionals or legal advisers who are not regulated by the RICS

· Solicitors, however, should be familiar with the Code as landlord clients or their agents may be bound by it

· The mandatory requirements must be followed by RICS members and concern themselves with the manner of negotiation and the content of the heads of terms

· The statements of good practice must be followed by RICS members unless there are strong reasons not to, and go into more detail on what should be specified in the heads of terms, and what are acceptable lease terms

Question 33

What are the main stages of the procedure to grant a lease?

Answer 33

Like freehold transactions, some grant of lease transactions can be divided into three main stages, divided by exchange and completion.

1. Pre-exchange - exchange occurs between this and the next stage.
2. Pre-completion - completion occurs during this and the next stage.
3. Post-completion.

However, grant of lease transactions commonly do not need an exchange, and there are then just two stages:
1. Pre-completion - completion happens between this and the next stage.
2. Post-completion.

It is important to bear in mind that any pre-exchange steps can be merged into the pre-completion stage if there is no exchange.

Question 34

What are the landlord’s solicitors steps at pre-exchange?

Answer 34

• Take instructions
• Prepare draft lease and, if relevant, agreement for lease (ie, if there is to be an exchange)
• Deduce title (and check that lender will consent to letting) and respond to any queries on title
• Answer pre-contract enquiries
• Once agreed, engross the agreement for lease, obtain landlord’s signature, and send counterpart to tenant’s solicitor.

Engross - Means to print a copy for signature (eg, on good quality paper and bound). The original of a lease or an agreement for lease is executed by the landlord; the counterpart is executed by the tenant.

Question 35

What are the tenant’s solicitors steps at pre-exchange?

Answer 35

• Take instructions
• Review draft lease and agreement for lease and amend as required
• Investigate title and raise any queries on title
• Raise pre-contract enquiries and searches
• Arrange for tenant to sign counterpart lease

Question 36

Who will draft the lease?

Answer 36

The landlord’s solicitor will draft the lease based on the heads of terms. The solicitor may use a generic precedent lease. Alternatively, if there have been past lettings on the landlord’s estate, the solicitor may have a part-completed lease which just needs to be tailored to the individual letting.

The tenant’s solicitor will go through the lease and amend anything that is onerous or unfair to the tenant, or simply to try to balance it more in favour of the tenant.

Example: An institutional landlord has an industrial estate with ten warehouses on it. Eight of the warehouses have been let already, and heads of terms have been agreed for the ninth. The landlord’s solicitor uses a precedent specific to the estate. It will already be part-completed with the details that do not change from unit to unit, such as the landlord’s freehold title, description of the estate, and rights that are granted to all of the tenants.

Question 37

Is an agreement for the lease needed between the landlord and the tenant?

Answer 37

An agreement for lease will often not be needed, in which case the parties’ solicitors will simply complete once the tenant’s solicitor is happy with their title investigations and the form of the lease is agreed.

However, an agreement for lease is needed where the parties want to commit to completing the lease, but either are not yet ready, or there are conditions that need to be satisfied.

Similarly with the draft lease, the tenant’s solicitor will review the agreement for lease and amend any provision they feel appropriate in favour of the tenant.

Example: A developer builds a shopping centre which is due to be completed in two years’ time. The developer has found various retailers who are interested in taking units. Rather than wait for completion of the centre, and risk losing interested parties, the developer will sign each retailer up to an agreement for lease providing for completion following practical completion of the shopping centre.

Question 38

What are the pre-exchange tasks for the landlord’s and tenant’s solicitors in relation to investigation of title, searches, and enquiries for a lease?

Answer 38

The pre-exchange tasks for investigation of title, searches, and enquiries include:

The landlord’s solicitor will deduce their freehold title, and the tenant’s solicitor should investigate it. The tenant’s solicitor must ensure that the landlord has title to grant the lease and consider any freehold covenants as they will also bind the tenant (even if the lease states something different).

The tenant’s solicitor will raise CPSE1 enquiries (as a buyer’s solicitor would in a commercial freehold transaction) and also raise CPSE3 enquiries specific to the grant of a lease.

The tenant’s solicitor should raise the same searches as if they were buying the freehold.

Generally, the tenant’s solicitor should exercise the same care over their investigations as they would in a freehold transaction. However, for very short leases with limited repair and obligations, the tenant may agree that full investigations are not justified. In such cases, the tenant’s solicitor should ensure the tenant is advised of the risks.

Question 39

What happens on exchange of an agreement for lease?

Answer 39

On exchange of an agreement for lease:
- The landlord’s solicitor and tenant’s solicitor exchange in similar manner as for a freehold contract (usually adopting Law Society B)
- No deposit is usually payable
- The agreement for lease may set a fixed completion date, but more likely will set out what conditions need to be satisfied and by when for completion to take place
- The agreement for lease will usually have a draft of the agreed form of lease annexed to it, so it can only be exchanged once the terms of the lease have been agreed

Question 40

What are the landlord’s solicitor’s pre-completion steps?

Answer 40

• Prepare original and counterpart lease, obtain landlord’s signature to original and send counterpart to tenant’s signature
• Prepare and send completion statement, detailing the money due on completion (eg, any apportioned annual rent, service charge and insurance rent)

The completion statement can be a difficult calculation as the solicitor must apportion the yearly rent, insurance rent (ie, contribution to the insurance premium), and service charge (for a lease of part) on a daily basis.

Apportionment involves counting the number of days for which the tenant is going to occupy in the current quarter and calculating an appropriate proportion of the yearly rent (and other sums treated as rent). One method is to multiply the number of days by the daily rate, whichis found by dividing the yearly rent by 365 (or 366 in a leap year).

Question 41

What are the tenant’s solicitor’s pre-completion steps?

Answer 41

• Arrange for tenant to sign counterpart lease
• Obtain funds from client needed to complete as per completion statement
• Raise pre-completion searches

The appropriate pre-completion search is an OS1 search with a lease of whole or an OS2 search with a lease of part. If the lease is not registrable and priority is therefore not needed, then an OS3 search could be used. This does not confer priority but will check that the landlord is free (or not) to grant the lease.

Question 42

What happens on completion of the lease?

Answer 42

On completion of the lease
- The tenant’s solicitor sends the landlord’s solicitor the completion monies
- The landlord’s solicitor and tenant’s solicitor agree over the telephone to complete and date the executed leases that they are holding
- The landlord’s solicitor and tenant’s solicitor send the completed original and counterpart to each other

Question 43

What are the landlord’s solicitors and the tenant’s solicitors steps post-completion?

Answer 43

Landlord’s solicitor’s tasks
Send summary of main provisions of lease to client

Tenant’s solicitor’s tasks
Arrange to submit SDLT or LTT return and pay appropriate SDLT or LTT if necessary
Register lease if necessary

Question 44

Provide a summary of the grant of lease procedure.

Answer 44

· A grant of lease transaction may follow the same steps as a freehold transaction, ie, pre-exchange, exchange, pre-completion, completion, post completion.

· Exchange is not always necessary, but may be if the parties have conditions to satisfy before completing the lease. If exchange takes place, the contract is referred to as an agreement for lease.

· Pre-exchange is similar to a freehold transaction (title investigation, searches and enquiries) but additionally the lease (and, if appropriate, agreement for lease) must be drafted and agreed.

· Exchange is similar, but a deposit is not usually paid.

· Pre-completion involves circulation of a completion statement and the tenant’s solicitor will carry out pre-completion searches.

· Completion is straightforward, and simply involves payment of the completion monies and dating of the executed leases.

· Post-completion will involve payment of SDLT and registration of the lease, if appropriate.

Question 45

What type of leases need to be registered?

Answer 45

Unlike freeholds, not all leases need to be registered. Leases are treated differently depending upon the length of term granted.

Term of lease up to 3 years – does not need to be registered. Cannot be noted against the landlord’s title.

Term of lease more than 3 years up to 7 years - does not need to be registered. Can be noted against the landlord’s title (it will appear in the schedule of leases to the landlord’s freehold title).

Term of lease more than 7 years - must be registered at the Land Registry (and will be given its own title number). Will be noted against the landlord’s title (it will appear in the schedule of leases to the landlord’s freehold title).

Question 46

What is the procedure for registering a lease?

Answer 46

If a lease is registrable, then an OS1 (lease of whole) or OS2 (lease of part) search should have been carried out before completion to give priority.

The tenant applies to register the lease using form AP1 (if the landlord’s title is registered) or FR1 (if the landlord’s title is unregistered).

A certified copy of the lease may be scanned and submitted electronically.

If the landlord’s freehold title is charged, then a letter of consent from the lender will also be needed.

On completion of the application, the tenant’s solicitor will receive two official copies (the new leasehold title and the updated landlord’s title)

Note that if the tenant is a company, then usually the lease will not be charged, and so there is no need to register the transaction at Companies House.

Question 47

Provide a summary for post-completion on a grant of lease.

Answer 47

• Calculating SDLT and LTT on a long residential lease is similar to calculating it on the freehold.
• Lease of 3 years and under are not registrable and cannot be noted against the landlord’s title.
• Leases of over 3 years up to 7 years are not registrable but can be noted against the landlord’s title.
• Leases of over 7 years are registrable and will be noted against the landlord’s title.
• On registering a new lease, the tenant’s solicitor will receive official copies for the new leasehold title and the landlord’s updated title.

Question 48

In a lease of whole, who is responsible for repair?

Answer 48

A commercial tenant is almost always responsible for repairing their demise (the premises let to them).

In a lease of whole, such as an office block, the definition of “Premises” will refer to the entire title and postal address of the building.

The tenant is responsible for interior, exterior, and structural repair.

The repairing responsibility is solely the tenant’s.

Question 49

In a lease of part, who is responsible for repair?

Answer 49

In a lease of part, the tenant is responsible for interior repair, while the landlord is responsible for the repair of common parts:
- In a lease of part, the definition of “Premises” will specify, for example, the fifth floor of an office block and provide detailed coverage of the interior demise.
- The tenant is responsible only for interior repair,including floor and ceiling coverings, but not the structure or exterior of the building.
- Other tenants are responsible for their respective demises.
- The landlord is responsible for repairing common parts (e.g. hallways, lifts, staircases, and communal car parks), but will recover the cost from tenants through service charge payments.
- An FRI lease includes clauses outlining the services provided and how they are charged.

Example: Three businesses occupy a lease block under FRI leases. Business A occupies two floors, while businesses B and C occupy one floor each. If the lift needs replacing at a cost of £20,000, the landlord will charge £10,000 to A, and £5,000 to each of B and C via the service charge.

Question 50

What are the types of reparing covenant?

Answer 50

Full repairing obligation:
The tenant is required to “keep the Premises in good repair.”
This means that if the premises are not in good repair, the tenant must put them into good repair.
This type of obligation is essential in an FRI (Full Repairing and Insuring) lease.
A tenant with this obligation should obtain a survey to identify any major repair issues before entering the lease.

Qualified repairing obligation:
The tenant must “keep the Premises in good repair but not to put the Premises in any better state of repair than it was in at the date of this lease as evidenced by the Schedule of Condition.”
The Schedule of Condition contains photographs documenting the state of the premises at the start of the lease.
This is not an FRI lease covenant and is only accepted by institutional lenders in exceptional circumstances (e.g., short-term lettings or difficult market conditions).

Question 51

What are the limits of the reparing obligation?

Answer 51

Unless the lease states otherwise, the tenant may generally choose whether to repair or replace an item of disrepair.

If the lease does state that damaged items must be replaced, then the tenant will want this obligation only to apply if the item is beyond economic repair.

If the premises are damaged beyond repair; for example, if subsidence has caused the premises to be so damaged that they need to be rebuilt, this is renewal, not repair and the tenant is not responsible for doing this under a simple repairing obligation. A tenant may be asked to covenant to renew the premises, but this is onerous and should be avoided.

If the lease refers to keeping the premises in good repair and condition, this is more onerous to the tenant (for example, condensation comes within condition, but not repair).

Example: A tenant has a lease of whole, and the roof is dilapidated. The tenant may choose to replace the roof entirely, but if it is possible to do so, does not have to, and may instead repair it.

Question 52

Who has the responsibility for reparing inherent structural defects?

Answer 52

If the property is newly constructed, it may have inherent or structural defects that only come to light over time.

The tenant is not responsible for them, and the landlord should have warranties from the contractors (the builder, structural engineer, architect, etc) that the landlord can rely on.

A tenant taking a lease of a newly constructed property should ensure that inherent and structural defects are therefore excluded from the tenant’s repairing obligation and service charge contributions.

Example: A tenant takes a lease of a floor of a newly constructed office block. Due to a structural design fault, the walls along one side of the office develop cracks. If the tenant has excluded structural and inherent defects from the repairing obligation and service charge, the landlord cannot require the tenant to be responsible either directly for the repair, or indirectly through the service charge.

Question 53

Who will be responsible for obtaining insurance for the building?

Answer 53

A commercial landlord will almost always be responsible for the insurance of the building (even where it is a lease of whole). In keeping with the principles of an FRI lease, the cost of insuring will be recovered from the tenant under the lease.

In a lease of whole, the landlord will insure the whole, and the sole tenant will refund the landlord the whole of the insurance premium.

In a lease of part, the landlord will insure the whole, and each tenant will refund the landlord a proportionate part of the insurance premium.

The money that the tenant or tenants pay to the landlord will usually be referred to as “insurance rent”.

Question 54

What are insured risks?

Answer 54

A typical definition of insured risks in a lease might look like the following:
- Fire, explosion, lightning, earthquake, tempest, storm, flood, bursting and overflowing of water tanks, apparatus or pipes, damage to underground water, oil or gas pipes or electricity wires or cables, impact by aircraft and aerial devices and articles dropped from them, impact by vehicles, subsidence, ground slip, heave, riot, civil commotion, strikes, labour or political disturbances, malicious damage

These are the risks that will be covered by the insurance policy taken out by the landlord. The definition may allow for the landlord to add other risks to the list from time to time.

They will also be excluded from the tenant’s repairing obligation, except in certain instances (eg, if the tenant’s negligence means that the insurance is not paid out).

Question 55

Provide a summary of repair and insurance in leasehold transactions.

Answer 55

• In a lease of whole, the tenant is responsible for repairing the whole building. The landlord insures the building, and recovers the whole cost from the tenant.
• In a lease of part, the tenant is responsible for repairing the demise. The landlord insures the building and maintains the common areas and recovers a proportionate part of the cost from each tenant.
• A full repairing obligation is typically expressed as an obligation to keep the premises in repair, but extends to putting the premises into repair if they are not.
• A qualified repairing obligation limits the tenant’s repairing obligation to keeping the premises in the same state of repair as at the beginning of the lease term.
• By definition, an FRI lease will contain a full repairing obligation, not a qualified repairing obligation.
• The tenant is not responsible for damage by insured risks, except in limited circumstances.
• A lease will contain provisions to protect the tenant if the premises become unusable.

Question 56

What are alterations?

Answer 56

Alterations are changes to the premises, such as reconfiguring the internal walls, opening up new windows, adding a mezzanine floor, etc.

If the lease is silent on alterations, then the tenant is free to carry out alterations. The only restriction imposed by law is the doctrine of “waste” which means that the tenant cannot carry out alterations which reduce the value of the premises.

In practice, an institutional landlord will want to control tenant’s alterations to avoid issues such as the premises being less appealing to other future tenants.

Example: A tenant with a warehouse might want to install a gantry crane if they deal in heavy engineering parts. If the next prospective tenant deals in soft furnishings, the crane is likely to be an unnecessary hindrance.

Question 57

What are the restrictions on alterations typical in an FRI lease?

Answer 57

Typical provisions in an FRI lease:

• The type of alterations permitted (external or internal, structural or non-structural?)
• If they are permitted, whether landlord’s consent needed
• Whether they must be reinstated (ie, the premises returned to its original state) at the end of the lease term

The degree of control will likely depend on the type of alteration. For example, in an office lease, it is common to allow internal non-structural partitions to be altered to provide a different office configuration.

Question 58

What is an absolute covenant against alterations?

Answer 58

An absolute covenant against alterations means that they are not permitted.

If the tenant wants to make an alteration covered by an absolute covenant, they can ask the landlord, but the landlord has no obligation even to consider such a request.

Question 59

What is a qualified and fully qualified covenant against alterations?

Answer 59

A qualified covenant against alterations means that they are only permitted with landlord’s consent. The landlord does not have to give consent.

A fully qualified covenant is similar to a qualified covenant, but in this case, the landlord must act reasonably in deciding to withhold consent.

The qualified covenant is upgraded if the alteration is an improvement from the tenant’s point of view.

Question 60

Can a lease have a mixture of absolute, qualified, and fully qualified covenants?

Answer 60

The same lease may have a mixture of absolute, qualified and fully qualified covenants for different matters. For example, it might have an absolute covenant against external and structural alterations, a qualified covenant against internal non-structural alterations, and no covenant against alterations to internal partitioning.

This terminology is not restricted to alterations – you will see it in relation to other covenants.

Question 61

How does s19(2) of the Landlord and Tenant Act 1927 affect qualified covenants against alterations in a lease when the tenant proposes improvements?

Answer 61

Improvements

If the lease contains a qualified covenant against alterations, s19(2) LTA1927 converts it to a fully qualified covenant insofar as the tenant’s proposed alterations are improvements from the point of view of the tenant.

Example: A tenant applies for consent under a qualified covenant to modernise the air conditioning system. As it is an improvement for the tenant, the landlord must act reasonably in its decision to give/withhold consent.

The conversion from qualified to fully qualified covenant:
- It will be rare that a tenant will propose alterations that do not constitute an improvement from their point of view (otherwise why would they want them?).
- Note that you will come across other areas where there is interplay between the drafting of a lease and statute.
- Unfortunately, it is not consistent, and you need to know different rules for different provisions.

Question 62

When is a license for alterations used and what does it allow for?

Answer 62

If the landlord consents to alterations under a qualified covenant, then the consent will usually be documented in a licence for alterations.

As well as details of the works consented to, and any time limit for carrying them out, it will contain various tenant’s covenants as below:
- Carry out the works in compliance with the landlord’s requirements, typically with good quality materials and a high standard of workmanship
- Pay the landlord’s costs in dealing with the tenant’s application for a licence for alterations (these will usually be the surveyor’s and solicitor’s costs)
- Obtain all necessary consents, which could include planning permissions and building regulations approval
- Reinstate the premises at the end of the lease term (ie, put them back in their original state without the alterations and put right any damage caused)

Question 63

What are a tenant’s statutory rights to carry out improvements?

Answer 63

If the tenant’s proposed alterations are improvements, then even if the lease contains an absolute covenant against alterations, the tenant may be able to circumvent this.

Under s3, LTA1927, the tenant serves notice on the landlord of its intention to carry out improvements.

If the landlord objects, the tenant can apply for the court’s permission to carry out the improvements. The court will give permission if the improvements:
* Add to the letting value of the property;
* Are reasonable and suitable to the character of the property; and
* Will not diminish the value of any other property belonging to the landlord.

If the landlord does not object within three months, the tenant may go ahead and carry out the improvements.

The landlord may offer to carry out the works itself and increase the rent, but the tenant does not have to agree to this. However, the tenant can then not ask the court for permission.

Question 64

What does ‘user’ refer to?

Answer 64

User refers to what the lease allows the tenant to use the premises for.

If the lease were to be silent on user, then the tenant is free to use the premises for anything they like. The lease will therefore control the use of the premises with a user clause.

The user may be very specific (“as a tailor’s shop”) or more general (“as retail premises”) or may be by reference to the appropriate use class (“as a use within Class E(a) of the Town and Country Planning (Use Classes) Order 1987”).

Generally, the tenant will want a more general use to allow them flexibility, and to make the lease more appealing if they want to pass the lease on.

Conversely, the landlord may wish to keep the user very narrow. However this can backfire on the landlord, as it limits the appeal of the premises. This could limit the market rent on rent review.

Question 65

What are the different types of covenants related to changes of use in a lease, and how does section 19(3) of the Landlord and Tenant Act 1927 impact these covenants?

Answer 65

Leases may include:
- Absolute covenant: Prohibits any changes of use.
- Qualified covenant: Allows changes of use with landlord’s consent.
- Fully qualified covenant: Allows changes of use with consent that cannot be unreasonably withheld.

Unlike alterations, there is no statutory provision converting a qualified user clause to a fully qualified user clause.

Section 19(3) LTA 1927 states:
- If the landlord gives consent to a change of use, they may not charge a lump sum or increase the rent for that consent unless the change of use requires structural alterations.
- In the case of structural alterations, the landlord may charge a lump sum or increase the rent for giving consent.

It is important to understand how statute affects different types of qualified covenants, noting that the rules are less generous for changes of use compared to alterations. Statutory references do not need to be memorised.

Question 66

What are the key considerations for tenants regarding planning law when making alterations or changes of use, particularly in relation to compliance with lease obligations?

Answer 66

Alterations and Changes of Use:
- Alterations may involve building works.
- A change of use may take the property outside its designated use class for which it has planning permission.

Lease Compliance:
- Leases typically include a clause requiring tenants to comply with relevant laws.
- This obligation is often reiterated in the licence for alterations or the licence to change use.

Obtaining Relevant Consents:

Tenants must ensure they obtain the necessary consents to comply with the lease and avoid enforcement action.

Example: If a landlord consents to convert a clothes shop (use class E(a)) in a shopping centre to a betting shop (sui generis use), this change requires:
- Planning permission.
- A betting premises licence.

Understanding the necessity of obtaining relevant consents is crucial, even if specific details of examples are not required.

Question 67

What is the Code for Leasing Business Premises and what does it set out?

Answer 67

The Code sets out some points of good practice on alterations and change of use such as the following:

• The lease should only restrict alterations and change of use insofar as necessary to protect the value of the premises and any adjoining or neighbouring premises of the landlord.
• The Code (subject to certain exceptions) requires a landlord to at least give the tenant a fully qualified covenant for internal non-structural alterations in a lease of part, and the tenant the ability to carry out internal non-structural alterations without consent in a lease of whole.
• If the landlord will require any alterations to be reinstated at the end of the lease, this should be made clear in the heads of terms. Otherwise, the lease may only require this if it is reasonable.

Question 68

Provide a summary of alterations, user, and planning.

Answer 68

• FRI leases will control what alterations the tenant may carry out, and may distinguish between external/internal and structural/non-structural alterations.
• A covenant against alterations (and various other matters) may be absolute (not allowed), qualified (allowed with landlord’s consent) or fully qualified (allowed with landlord’s consent not to be unreasonably withheld).
• A qualified covenant will be converted to a fully qualified covenant regarding tenant’s improvements (and there is a statutory procedure for allowing the tenant to carry out improvements even where there is an absolute covenant).
• If the landlord consents, this and the tenant’s obligations will be documented in a licence for alterations.
• FRI leases will control the use of the premises, and again, changes may be subject to an absolute, qualified or fully qualified covenant. Statute does not upgrade a qualified covenant to fully qualified, but does have some restrictions.
• The lease will usually require the tenant to comply with relevant laws, such as planning.