Grant of a lease Flashcards
Advantages of a lease - tenant’s point of view
- no need to spend capital
- not permanent
- some premises only available as a leasehold
Who are commercial landlord?
- Private investors
- Institutional investors (pensions funds, life assurance companies)
+ FRI lease (expect a tenant to pay the cost of insuring the property and if appropriate a service charge)
+ Covenant strength - established companies are seen as more secure
Attractive investment: offers income, potential for capital growth and is seen as reasonably secure.
Asset management
Involves acting for an institutional landlord and dealing with legal work relating to this portfolio
- granting a lease to new tenant
- considering application by tenant
- advising on breaches of the lease
- dealing with issues that arise when the lease comes to an end.
Essential ingredients of a lease
- exclusive possession
- fixed term or periodic tenancy
- formalities
Reversion
Exclusive possession
Tenant must be able to exclude strangers and even the landlord (except where the landlord is exercising its right to enter the premises eg. inspect it) from the premises let.
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.
Fixed term or periodic tenancy
Lease must be for a fixed term (six months, 5 years) or a periodic term (weekly, monthly, yearly)
Generally, it may not be for an indeterminate time (e.g. for as long as then tenant is an employee of the landlord)
Reversion
The interest that the landlord holds subject to the lease. At the end of the lease term, the property reverts to the landlord.
What is a lease?
A lease is the document that creates a leasehold interest.
Landlord’s objectives in drafting a lease
Most cases, landlord is in the dominant negotiation position.
Institutional landlords will insist on full repairing and insuring (FRI) lease, meaning that any costs are met by the tenant whether directly or indirectly. Means rent paid is clear of deductions.
Landlord will want a lease that ensures premises are:
- insured
- kept in repair
- only used for the permitted purpose
Landlord will also want:
- to control whom may occupy remises
- 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 (rent review)
Tenant’s objectives
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
- provides some flexibility if circumstances change
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)
Different perspectives
20 year lease with no break clause
Landlord: Good for the value of the landlord’s reversion as the landlord can expect a long period of uninterrupted rent
Tenant: 20 years is a long commitment, tenant might ask for 10years with a break clause or a 5 year lease
Rent review every 5 years to higher market rent and current rent (upwards only)
Landlord: usual for full repairing and insuring lease (FRI) - landlord will not want the rent to go down
Tenant: might want the rent to go down if the market rent goes down but it is difficult to find a landlord that would accept this
No alterations:
Landlord: may want to ensure that the premises are returned unaltered
Tenant: unless there is good reason (e.g. listed building) the tenant will usually want to be able at least to alter the interior for their purposes
When does a lease need to be created by deed?
A legal tenancy of over 3 years must be created by deed.
What is a term commencement date?
The date on which the lease term starts.
May be the day of completion of the lease, but may also be before or after.
Common for it to be earlier than the lease is dated e.g. so all leases start at the same time (but tenant doesn’t pay rent for the period they haven’t used.
Sometimes dated after - common to use when parties what to extend the letting in advance of the expiry of the current lease.
Lease term
Lease term must be determinate meaning it is either a fixed term (6 months, 5 years, 999 years) 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 - business plans tend to be drafted in 5 or 10 year cycles.
Calculating the expiry of the lease term
“from and including” means lease will expire day before that day of the year in relevant year e.g. 10 years from and including 24 march 2019 expires on 23 march 2029.
“from” - term starts the day after that day, and so expires on that day of the year in the relevant year e.g. 10 years form 24 march 2019 will start on 25 march 2019 and expire on 24 march 2019
Break clauses
If the tenant is unsure about the commitment of a lease term and the landlord is unwilling to grant s shorter term - a break clause can offer a compromise.
Can be landlord break, tenant break or mutual break.
May specify a date or be a rolling date.
Difference between 10year lease with 5 year break and 5 year lease - tenant’s are generally less likely to leave.
Long leases
Residential leases are usually long leases. The first person to buy the property will pay a premium to the landlord for the grant of the lease.
Often used to impose a ground rent (e.g. £150), but since June 2022 they are restricted to peppercorn rent (nominal).
Short lease
Commercial leases are usually short leases (up to 15 or 20 years) with a market rent. A premium is not usually charged.
Can be long but rare e.g. land for electrical substations
Rent in a commercial full repairing and insuring (FRI) lease 1
Rent is usually expressed as a yearly figure but payable quarterly
Year is divided into approximate quarters which are either
- 25 December - 24 March
- 25 March - 23 June
- 24 June - 28 September
- 29 September - 24 December
or modern quarters: 1 January, 1 April, 1 July and 1 October
Rent is divided equally between the quarters.
Rent in a commercial full repairing and insuring (FRI) lease 2
- Rent is usually due in advance on the quarter day e.g. 25 March for the whole period up to and including 23 June
- Lease needs to state if rend is payable in advance, if silent payable in arrears
- If lease is completed part way through the term then the quarter will be apportioned so the tenant will only pay the appropriate portion of the rent.
- lease will set out how the rent is to be paid and whether VAT is payable on it
- Lease will usually describe other payments such as contributions to the insurance premium and service charge as “rent”. Rent proper is referred to as “annual rent” or “yearly rent”
Types of rent review
Stepped rent:
lease may set out a yearly rent of 25,000 for first two years, then 30,000 for next two and so on
Index-linked rent:
rent is increased by reference to an agreed measure of inflation such as the retail price index
Turnover rent:
rent may be calculated based on the tenant’s turnover at the property. Most commonly seen with retail leases
Open market rent review:
most common type of rent review adopted by FRI leases and involves ascertaining the rent based on comparable premises and certain principles
Open market rent review
- usually upwards only
- gives landlord and tenant opportunity to agree the rent themselves
- If can’t agree: lease will set out a mechanism for a specialist valuer to be engaged to determine the new rent
Valuer considers:
- rent payable for comparable premises
AND
- terms of the hypothetical lease: imaginary lease based on the actual lease but assuming certain matters and disregarding others
Hypothetical lease
Basic assumptions:
- premises are vacant
- there is a willing landlord and tenant
Common disregards:
- Generally ignore what the tenant has done voluntarily (rationale is that tenant should not be penalised with a higher rent if the tenant has improved the premises for its own use)
Common assumptions
- Tenant has complied with all its covenants under the lease
- this is fair, tenant should not be rewarded for letting premises fall into disrepair - Landlord complied with all its covenants
- may not be fair to tenants if landlord has not - as they will be penalised for landlord’s inaction - Terms of actual lease (other than rent)
- yes this is fair, rent should reflect any onerous terms (or flexible ones!) - Term of hypothetical lease is term remaining
- may work against tenant if say there are 5 years left and 5 year leases are popular but it was originally a 10 year lease - If damaged or destroyed, premises have been repaired or rebuilt
- Yes because the lease will usually have detailed provisions for what happens in this instance
Common disregards
- effect of tenant’s occupation on the rent
- yes premises will be worth more to the tenant than a new one bc of convenience of not having to move - Goodwill attached to tenant’s business
- if successful this makes the location more valuable to tenant and to other businesses - Tenant’s improvements
- yes tenant should not be penalised for voluntarily improving the property
What happens after a rent review
Once the new rent has been determined by a valuer, the new rent is documented in a rent review memorandum.
This is a short document that records the new rent, is signed by the landlord and tenant and is kept with the lease for future reference.
If rent review is before the 5th anniversary - may have to pay further SDLT
If new rent has been agreed only after the rent review date, the new rent is backdated (so tenant may have to pay more)
Rent review memorandum
This is a short document that records the new rent, is signed by the landlord and tenant and is kept with the lease for future reference.
Why does the code for leasing business premises exist?
Exists to:
- improve the quality and fairness of negotiations on lease terms
- promote the issue of comprehensive heads of terms that should make the legal drafting process more efficient
It recognised that landlords generally have a stronger negotiating position than tenants.
Where does the code for leasing business premises come from and to whom does it apply?
Code is written by the Royal Institution of Chartered Surveyors (RICS)
Many property professions, firms or in-house specialists will be RICS regulated. If RICS regulated they are professionally obliged to take account of the code. If they are not, then they are not obliged.
Note: code does not apply to commercial lettings which are 6 months or less.
What does the code contain?
Code concerns itself with negotiations and heads of terms. It is divided into mandatory requirements and good practice.
Mandatory: must
Good practice: should (means must follow then unless exceptional circumstances which need to be justified)
Mandatory requirements under the Code for Leasing Business Premises
- 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
Certain areas Must be covered in heads of terms:
- extent of premises
- length of term and break rights
- rent and rent review (including basis for rent review)
- repairing obligations
- rights to assign (transfer to a new tenant) or underlet the lease
- permitted use of the property (and whether the tenant can change it)
- rights to alter the property and any obligations to put the property back in its original state
Good practice: Code for leasing business premises
Premises: heads of terms should clearly define the demise, provide plan and refer to rights needed to use the premises
Length of term: heads of terms should clearly specify the length of term and any break rights
Rent and rent review: initial rent, frequency of payment, VAT. Should also state whether there is a rent free period. Should explain how rent review is going to work
Landlord’s title: Landlord should be responsible for obtaining any consent needed to grant the lease
Repairs: repairing obligation should be appropriate to the length of term and the condition of the premises. If qualified - there should be a schedule of conditions.
Insurance and damage: lease should suspend the rent if the premises are damaged by an insured risk or an uninsured risk
Grant of lease procedure
Most leases are:
pre-completion
—– completion —–
post-completion
Sometimes there is pre-exchange and an exchange
Agreement for lease
- often this is not needed
- 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.
- An agreement for lease is needed where the parties want to commit to completing the lease but either are not ready yet or there are conditions that need to be satisfied
Drafting the lease
Landlord’s solicitors will draft the lease based on the heads of terms.
Tenant’s solicitor will go through the lease and amend anything that is onerous or unfair to the tenant or try to balance it more in favour of the tenant.
Lease: investigations of title, searches and enquiries
Landlord’s solicitor will deduce their freehold title and tenant’s solicitor should investigate it.
Enquiries: CPSE1 and also raise CPSE3: enquiries specific to grant of a lease
Tenant’s solicitor should also raise the same searches as if they were buying the freehold
Exchange of an agreement for lease
- landlord’s solicitor and tenant’s solicitor exchange in similar manner as for a freehold contract (Law Society B)
- No deposit is usually payable
- 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 draft of the agreed form of lease annexed to it
Landlord’s solicitor: pre-completion
Prepare original 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 (e.g. apportioned rent, service charge and insurance rent)
Tenant’s solicitor: pre-completion
- Arrange for tenant to sign counterpart lease
- Obtain funds from client needed to complete as per completion statement
- Raise pre-completion searches
+ Lease of a whole: OS1
+ Lease of part: OS2
+ not registrable: OS3 (no priority is given with this search)
Preparing completion statement
- Can be tricky; 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
Divide yearly rent by 365 and multiply that figure by the number of days in the quarter. - Usually the yearly rent will be paid quarterly. So even though the time is not exact quarters, the rent and VAT are split as if they are.
What happens on completion?
- 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
Post completion
Landlord:
- send summary of main provisions of lease to the client
Tenant:
- arrange to submit SDLT or LTT return and pay
- register lease if necessary
SDLT: long lease
The calculation is similar to a freehold
Registration of leases
Up to 3 years:
- does not need to be registered
- cannot be noted against the landlord’s title
More than 3 up to 7:
- does not need to be registered
- can be noted against the landlord’s title (it will appear in schedule to freehold)
More than 7:
- must be registered at the Land Registry (and will be given its own title number
- Will be noted against the landlord’s title
Procedure for registering a lease
If the 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 (freehold registered) or FR1 (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
Repair - who is responsible?
In a lease of whole, the repairing responsibility is solely the tenant’s.
In a lease of part: common parts are the responsibility of the landlord (hallways, lifts and staircases, communal car parking etc)
Although the landlord will bear responsibility for repairing the common parts, the landlord will recover costs of doing so collectively from the tenants by way of service charge payments.
An FRI lease typically contains extensive clauses setting out the services and how they are charged.
Repairing covenant
Repairing obligation is set out as a tenant’s covenant in the lease. Without this, the tenant’s implied responsibilities as to the repair of the premises would be minimal so the obligation is essential to a commercial landlord.
Should make sure to look at the definition of ‘Premises’.
Full repairing obligation
- common in full repairing leases
“keep premises in good repair”
- means that if the premises are not in good repair the tenant must PUT them in good repair
- good idea to advise a client to obtain a survey so they are aware of any major items of repair
Qualified repairing obligation
“keep 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 evidence by the schedule of condition”
- schedule of condition will contain photographs recording the state of the premises
Limits of the repairing obligation
Unless the lease states otherwise, the tenant may generally choose whether to repair or replace an item of disrepair.
If lease states that damages items must be replaced the the tenant will want this obligation to only apply if the item is beyond economic repair
Note: if premises are so damaged they need to be rebuilt this is a RENEWAL not a repair. Should avoid tenant being liable for this.
Renewal
Renewal: needs to be rebuilt
Not covered in a a simple repairing obligation
Onerous and should be avoided
Good repair and condition
More onerous.
Condition includes extra obligations:
e.g. condensation comes with condition but not repair
Inherent and structural defects
If newly constructed, property may have structural defects which come to light over time. May cause issues that the tenant would be obliged to repair under its repairing obligation.
Unfair as the tenant is not responsible for them and landlord should have warranties from contractors.
Important to make sure structural and inherent defects are excluded from the tenant’s repairing obligation and service charge contributions.
Insurance
A commercial landlord will almost always be responsible for the insurance of the building (even where this is a lease of whole). In keeping with principles of an FRI lease, cost of insuring will be recovered from the tenant under the lease.
Money is referred to as “insurance rent”.
Insured risks
Typically will list out the insured risks covered by the policy taken out by the landlord.
These risks are usually excluded from the tenant’s repairing obligation (unless for some reason the insurance will not cover it e.g. negligence)
What if a lease is silent on alterations?
Tenant is free to carry out alterations. The only restriction imposed by law is the doctrine of waste.
In practice a landlord will want to control tenant’s alterations to avoid issues such as the premises being less appealing to other future tenants.
What are alterations?
Alterations are changes to the premises such as reconfiguring the internal walls, opening up new windows, adding a mezzanine floor etc.
What is the doctrine of waste?
The the tenant cannot carry out alterations which reduce the value of the premises.
Typical restrictions on alterations
- Type of alteration permitted (external, structural, non-structural)
- If they are permitted, whether the landlord’s consent is needed
- whether they must be reinstated at the end of the lease term
Degree of control will likely depend on the type of alteration. e/g/ in an office lease, it is common to allow internal non-structural partitions to be altered to provide a different office configuration.
Absolute covenant (alterations)
Absolute covenant against alteration 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 to even consider the request.
Qualified covenant (alterations)
A qualified covenant against alterations means that they are only permitted with the landlord’s consent.
Fully qualified covenant (alterations)
A fully qualified covenant is similar to a qualified covenant but in this case, the landlord must act reasonably in deciding to withhold consent.
s19(2) LTA 1927
A qualified covenant against alterations is automatically upgraded to a fully qualified covenant.
This means that where the tenant proposes an alterations which is an improvement (which they almost always are) - the landlord must act REASONABLY in it’s decision to give/withhold consent.
Licence for alterations
If the landlord consents to alterations under a qualified covenant, then the consent will usually be documented in a licence for alterations.
Will contain:
- details of the work consented to
- time limits for carrying out the work
- any requirements to carry out the work (e.g. quality of materials, standard of workmanship)
- obtain necessary consents: permission is subject to the tenant getting planning permission and building regulation approval
- reinstate the premises at end of term (maybe?)
- pay the landlord’s costs in dealing with the application: solicitor, surveyor
Circumventing absolute covenant against alterations
- under s3 LTA 1927, 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:
+ add to the letting value of the property
+ are reasonable and suitable to the character of the property
+ will not diminish the value of any other property belonging to the landlord - If the landlord does not object within three months, 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. BUT then they are unable to apply to the court.
What is user?
User refers to what the lease allows the tenant to use the premises for.
What if the lease is 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 use clause.
User clause
User may be very specific (tailor shop) or more general (retail premises) or refer to an appropriate user class.
Generally the tenant will want 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.
Change of use and statute
- absolute, qualified or fully qualified.
There is no statutory upgrade from qualified to fully qualified.
However if the landlord does give consent to change of sue, the landlord may NOT:
- charge a lump sum or
- increase rent
for giving consent UNLESS the change of use also requires structural alterations.
Planning law and changes of use
- Change of use may take the property outside the use class for which it has planning permission.
Lease will usually contain a clause requiring that the tenant complies with relevant laws.
Alterations and user: code for leasing business premises
- lease should only restrict alterations and change of use insofar as necessary to protect the value of the premises and any neighbouring premises
- Code requires landlords to at lease 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 requires alterations to be reinstated at the end of the lease, this should be clear in the heads of terms. Otherwise, the lease may only require this if it is reasonable.
