Grant of a lease

Question 1

Advantages of a lease - tenant’s point of view

Answer 1

• no need to spend capital
• not permanent
• some premises only available as a leasehold

Question 2

Who are commercial landlord?

Answer 2

• 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.

Question 3

Asset management

Answer 3

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.

Question 4

Essential ingredients of a lease

Answer 4

1. exclusive possession
2. fixed term or periodic tenancy
3. formalities

Reversion

Question 5

Exclusive possession

Answer 5

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.

Question 6

Formalities

Answer 6

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.

Question 7

Fixed term or periodic tenancy

Answer 7

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)

Question 8

Reversion

Answer 8

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 is a lease?

Answer 9

A lease is the document that creates a leasehold interest.

Question 10

Landlord’s objectives in drafting a lease

Answer 10

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)

Question 11

Tenant’s objectives

Answer 11

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)

Question 12

Different perspectives

Answer 12

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

Question 12

When does a lease need to be created by deed?

Answer 12

A legal tenancy of over 3 years must be created by deed.

Question 13

What is a term commencement date?

Answer 13

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.

Question 13

Lease term

Answer 13

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.

Question 14

Calculating the expiry of the lease term

Answer 14

“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

Question 15

Break clauses

Answer 15

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.

Question 16

Long leases

Answer 16

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).

Question 17

Short lease

Answer 17

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

Question 18

Rent in a commercial full repairing and insuring (FRI) lease 1

Answer 18

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.

Question 19

Rent in a commercial full repairing and insuring (FRI) lease 2

Answer 19

• 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”

Question 20

Types of rent review

Answer 20

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

Question 21

Open market rent review

Answer 21

• 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

Question 22

Hypothetical lease

Answer 22

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)

Question 23

Common assumptions

Answer 23

1. Tenant has complied with all its covenants under the lease
   - this is fair, tenant should not be rewarded for letting premises fall into disrepair
2. 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
3. Terms of actual lease (other than rent)
   - yes this is fair, rent should reflect any onerous terms (or flexible ones!)
4. 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
5. 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

Question 24

Common disregards

Answer 24

1. 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
2. Goodwill attached to tenant’s business
   - if successful this makes the location more valuable to tenant and to other businesses
3. Tenant’s improvements
   - yes tenant should not be penalised for voluntarily improving the property

Question 25

What happens after a rent review

Answer 25

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)

Question 26

Rent review memorandum

Answer 26

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.

Question 27

Why does the code for leasing business premises exist?

Answer 27

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.

Question 28

Where does the code for leasing business premises come from and to whom does it apply?

Answer 28

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.

Question 29

What does the code contain?

Answer 29

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)

Question 30

Mandatory requirements under the Code for Leasing Business Premises

Answer 30

• 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

Question 31

Good practice: Code for leasing business premises

Answer 31

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

Question 32

Grant of lease procedure

Answer 32

Most leases are:
pre-completion
—– completion —–
post-completion

Sometimes there is pre-exchange and an exchange

Question 33

Agreement for lease

Answer 33

• 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

Question 34

Drafting the lease

Answer 34

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.

Question 35

Lease: investigations of title, searches and enquiries

Answer 35

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

Question 36

Exchange of an agreement for lease

Answer 36

• 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

Question 37

Landlord’s solicitor: pre-completion

Answer 37

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)

Question 38

Tenant’s solicitor: pre-completion

Answer 38

• 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)

Question 39

Preparing completion statement

Answer 39

• 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.

Question 40

What happens on completion?

Answer 40

• 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 41

Post completion

Answer 41

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

Question 42

SDLT: long lease

Answer 42

The calculation is similar to a freehold

Question 43

Registration of leases

Answer 43

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

Question 44

Procedure for registering a lease

Answer 44

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

Question 45

Repair - who is responsible?

Answer 45

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.

Question 46

Repairing covenant

Answer 46

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’.

Question 47

Full repairing obligation

Answer 47

• 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

Question 48

Qualified repairing obligation

Answer 48

“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

Question 49

Limits of the repairing obligation

Answer 49

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.

Question 50

Renewal

Answer 50

Renewal: needs to be rebuilt

Not covered in a a simple repairing obligation

Onerous and should be avoided

Question 51

Good repair and condition

Answer 51

More onerous.

Condition includes extra obligations:

e.g. condensation comes with condition but not repair

Question 52

Inherent and structural defects

Answer 52

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.

Question 53

Insurance

Answer 53

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”.

Question 54

Insured risks

Answer 54

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)

Question 55

What if a lease is silent on alterations?

Answer 55

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.

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.

Question 57

What is the doctrine of waste?

Answer 57

The the tenant cannot carry out alterations which reduce the value of the premises.

Question 58

Typical restrictions on alterations

Answer 58

• 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.

Question 59

Absolute covenant (alterations)

Answer 59

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.

Question 60

Qualified covenant (alterations)

Answer 60

A qualified covenant against alterations means that they are only permitted with the landlord’s consent.

Question 61

Fully qualified covenant (alterations)

Answer 61

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

Question 62

s19(2) LTA 1927

Answer 62

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.

Question 63

Licence for alterations

Answer 63

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

Question 64

Circumventing absolute covenant against alterations

Answer 64

• 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.

Question 65

What is user?

Answer 65

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

Question 66

What if the lease is silent on user?

Answer 66

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.

Question 67

User clause

Answer 67

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.

Question 68

Change of use and statute

Answer 68

• 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.

Question 69

Planning law and changes of use

Answer 69

• 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.

Question 70

Alterations and user: code for leasing business premises

Answer 70

• 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.