Property (Leasehold) - Lease Covenants (2) Flashcards
What are the typical restrictive leasehold covenants of a commercial lease?
Types of Covenant: A restrictive leasehold covenant can be absolute, qualified, or fully qualified. Consent to breach will always require a written licence of consent.
(1) Absolute: Stated action is absolutely prohibited, and landlord can refuse outright. Tenants avoid such clauses.
Consent: Landlords always have discretion to consent or vary lease, but this is discretional.
(2) Qualified: Stated action requires consent of the landlord.
Consent: Landlord has absolute discretion to refuse consent.
(3) Fully Qualified: Stated action requires consent of the landlord.
Consent: Landlord cannot unreasonably withhold consent.
In Practice: Qualified covenants are often impliedly fully qualified by law (varies by covenant).
What is the ‘repair’ component of a Full Repair and Insuring covenant?
Repair: Commercial leases are typically ‘Full Repair and Insuring’ (FRI), meaning the costs of repair, maintenance, and insurance are passed onto the tenant.
(1) Full Repair and Insuring: FRI is a requirement to be an ‘investment quality’ lease, crucial for the purposes of mortgage lenders and sales of the freehold reversion.
(2) Meaning of Repair: Repair means tenants must fix ‘disrepair’, meaning physical deterioration to the property since the grant of lease (Post Office v Aquarius). This differs circumstantially:
New Build: New builds must be kept fit for occupation by a reasonably minded tenant (Proudfoot v Hart).
Inherent Defects: Tenants may be required to remedy inherent defects to oblige (Ravenseft v Davstone).
Restoration: Restoration is not required, merely repair (Lurcott v Wakely).
(3) Onerous Wording: The wording of a repair covenant may be onerous.
‘Keep in Repair’: This means to remedy all disrepair (even if it existed on grant).
‘Keep in Good Condition’: This means to put the property into a good state (even if it does not comprise disrepair) (Welsh v Greenwich).
(4) Insured Damage: Tenants are not required to remedy damage if properly insured against (below).
What is the ‘insurance’ component of a Full Repair and Insuring covenant?
Insurance: FRI leases require the landlord to take out insurance over the property, and offset the costs against the tenant.
Insurance Policy
Insurance Policy: The landlord covenants to insure the property against defined risks for full reinstatement value.
(1) Defined Risks: Generally risks such as fire, flood, burglary, provided occupier or owner is not responsible. >Tenants are typically responsible for damage caused by uninsured risks, under the repair covenant.
(2) Full Reinstatement Value: Full reinstatement value is the sum required to fully restore the property, up to and including full reconstruction and accounting for the sum of ordinary rent suspended during that period.
(3) Cost Offset: The landlord passes the cost to the tenant as a form of ‘insurance rent’ (this is easier to recover, as it can be sought as a debt).
Effect of Damage
Effect of Damage: If damage occurs through an insured risk, the following occurs:
(1) Full Reinstatement: Landlord should attempt to fully restore the property in the first instance.
>If this is impossible, the parties should divide the insurance proceeds between them as appropriate.
(2) Rent Suspension: The tenant’s annual rent can be suspended for up to 3 years, depending on the terms of the covenant. Forfeited annual rent is insured, and the tenant will continue to pay insurance rent in the meantime.
(3) Termination: If full restoration is impossible, the covenant may permit one or both parties to terminate the lease. This provision will be laid out in the terms of the covenant.
What is an alteration covenant?
Alteration: Tenants are typically restricted from making physical alterations to the property.
(1) Structural: Structural alterations are typically absolutely prohibited, such as removing a wall of the property.
(2) Non-Structural: Non-structural alterations are typically fully qualified, or unrestricted, and includes altering utilities (‘service media’), demountable partitioning, and interior design.
What is the effect of an absolute alteration covenant?
Absolute Covenant: Lease may absolutely restrict some or all alterations.
(1) Discretionary Consent: Landlord can but has no obligation to consent in respect of an absolute covenant.
>If they negotiate consent, i.e. for more rent, the tenant cannot seek the business improvement court order.
(2) Court Order: Business tenants can seek court order to break an absolute alteration covenant (s3 LTA).
Notice of Intent: Tenant must serve notice of intent on the landlord, who has 3 months to object.
Letting Value Improvement: If objected, court must be satisfied alteration will improve the letting value of the lease, is reasonable and suitable to the property, and will not diminish the freehold reversion value.
Compensation: Tenant is entitled to landlord compensation for a court ordered improvement on termination of lease, unless the lease requires reversion to original state, as is typical (s1 LTA).
What is the effect of an (fully) qualified alteration covenant?
(Fully) Qualified Covenant: Lease may contain a qualified or fully qualified covenant on alteration. By lawful implication, all qualified covenants against alteration are converted to fully qualified covenants (s19(2) LTA).
(1) Application: Tenant must provide written notice of intent to landlord.
(2) Response: Landlord must respond in writing in a reasonable time, confirming consent or setting out reasonable grounds of objection.
What are user and planning covenants?
User and Planning: Tenants may be restricted in their use of the property. Planning permission does not overrule this covenant, nor vice versa.
(1) Absolute: Tenant may be absolutely prohibited from changing use, or restricted to a range of uses.
(2) Qualified: Tenant can be restricted subject to consent, which can be unreasonably withheld.
(3) Fully Qualified: Tenant can be restricted subject to consent, which is not to be unreasonably withheld (if expressed as such in the terms of the lease).
(4) Fines and Premiums: Landlords cannot impose fines or premiums as a condition of consent other than for changes of use that involve structural alterations (s19(3) LTA).
What are alienation covenants?
Alienation: Tenants are typically restricted in their ability to alienate the lease, meaning to part possession in some way.
(1) Types: Alienation includes:
Charging: Taking a charge over the lease, such as a mortgage.
Sharing: Sharing possession.
Parting: Informally assigning or underletting.
Assigning: Formally selling the remainder of the lease.
Underletting: Creating a ‘sublease’ over the current lease (a lease of a lease).
(2) Absolute: Typically, the lease will absolutely prohibit alienation, subject to a fully qualified covenant on assignment and underletting of the whole.
What is a covenant against assignment?
Assignment: Assignment is the process of selling the remainder of the lease to a new tenant (see assignment of lease).
(1) Consent: Consent to assign whole is usually permitted by consent, which by implication cannot be unreasonably refused (s19(1)(a) LTA). Consent to assign part is usually absolutely prohibited.
(2) Licence to Assign: Tenants must write for permission, and landlords must respond in writing with reasons within a reasonable time. On assignment, the parties enter a formal deed known as a ‘licence to assign’.
AGA: In new leases, assigning tenants tend to enter into an AGA, indemnifying the landlord for breaches of the new tenant for the length of their interest. The new tenant will indemnify them as such.
>An AGA will be ‘reasonable’ for any reason stated in the lease itself, or if otherwise reasonable on the fact (below).
Old Leases: Under old leases, the new tenant tends to enter a direct covenant with the landlord, meaning they will be liable even after they leave possession. They will also indemnify the original tenant.
(3) Reasonable Refusal: Reasonable refusal includes: a) poor references; b) assignee’s persistent breach of repair covenant; c) competition to landlord’s business; d) risk to freehold reversion value; e) anticipated detrimental use of property; f) inconsistent with other tenants; g) statutory protection; h) anticipated breach of lease terms.
>Personal gain, minor breaches, low risk of harm, and discrimination are not reasonable grounds.
What is a covenant against underletting?
Underlet: Underletting is the process of creating a sublease over the current lease (meaning it must be shorter than current lease). Tenants becomes ‘head tenant’ of the ‘undertenant’, but remain tenants to the ‘head landlord’ (see grant of underlease).
(1) Consent: The right to underlet is usually permitted with consent, which by implication cannot be unreasonably refused (s19(1)(a) LTA).
(2) Reasonable Grounds: Reasonable grounds are the same as above.
(3) Risk of Underlet: Two major risks are posed by underletting: a) if original tenant forfeits, undertenant may be direct tenant of landlord through court relief; and b) landlord lacks direct control over the undertenant.
(4) Conditions of Consent: Reasonable conditions which may be required by the landlord to consent include:
Mirror Terms: Underlease must match terms of head lease, including rent and rent review.
Contracting Out: Underlease must contract out of statutory protection.
Direct Covenant: Undertenant must directly covenant with landlord, to allow landlord to enforce terms of underlease (other than rent).
Alienation Prohibition: Further alienation may be absolutely prohibited.
What are annual rent covenants?
Annual Rent: Tenants invariably covenant to pay annual rent.
(1) Payment Dates: Rent is historically due on four historic quarter days (25 Mar/24 Jun/29 Sep/25 Dec).
(2) Advance/Arrears: Rent is paid in arrears by default, but in advance in practice.
(3) Apportionment: Apportionment is the proportion of rent due on the grant of lease, specified at a daily rate.
>I.e. Lease begins 1 April, rent is due from 1 April to 24 June (the next quarter day).
(4) Payment Method: Rent is usually paid electronically or by direct debit.
(5) VAT: Leases will state whether the rent is subject to VAT.
>Commercial lease rent is exempt with the option to tax.
(6) Rent Review: The clause also will ordinarily set out whether rent is subject to rent review (below).
What is a rent review clause?
Rent Review: Rent review is a standard clause used to increase rent on set intervals, usually every 3 to 5 years. A number of rent review methods exist:
(1) Fixed Increase: Rent increases by fixed sum or percentage at set intervals.
(2) Index Linked: Rent increases at set intervals based on a price index (i.e. RPI).
>Often ‘capped and collared’ at a minimum and maximum increase to protect from downturn in market.
(3) Tenant Receipts: Rent changes based on the profitability of the tenant’s business.
>May also be capped and collared.
(4) Open Market: Most commonly, rent is increased based on the hypothetical open market value of the lease.
>Also commonly capped and collared (often just collared).
How does open market rent review work?
Open Market Rent Review: Rent is reviewed according to what a ‘hypothetical tenant’ would pay for the lease on the open market on the review date. It involves assumptions and disregards, to avoid subjectivities manipulating the hypothetical rent.
(1) Procedure: The lease will set out when review is to occur, and whether the procedure will be formal or informal.
Formal: Parties serve formal offers and counteroffers with specific time limits. Late reply is deemed as acceptance, which can prejudice tenants. This is less typical today.
Informal: Parties negotiate through specialist valuers, and time is not of the essence. The new rent is backdated to the rent review date with interest. This is typical today.
Independent Valuation: If an agreement cannot be met, the clause will typically refer parties to an independent valuer of the Royal Institute of Chartered Surveyors to determine the new rent.
(2) Assumptions: The following assumptions are applied to the hypothetical lease:
Willing Parties: Both landlord and tenant are willing to contract.
Vacant: Lease is vacant (meaning rent is not decreased by virtue of tenant’s occupation).
Mirror Terms: Lease is offered on the existing terms, including the rent review clause (but not rent).
Lease Compliance: Tenant has fully complied with covenants (cannot benefit from own disrepair).
Fully Restored: Lease is fully restored (tenant cannot benefit from any damage - rent would be suspended for any insured damage in any case).
Term of Lease: Parties must assume the length of the hypothetical term, which may differ.
Original: The lease may assume the original term. However, if the original term is 15 years and only 1 year remains, this would unfairly distort rent.
Unexpired: The lease may assume the unexpired residue of the term. However, if this is particularly short, such as 2 months, this could also distort the rent.
(3) Disregards: The following disregards are made of the hypothetical lease:
Relocation: Rent cannot be increased due to the inconvenience otherwise caused in having to relocate.
Goodwill: Goodwill attached to the property cannot increase rent.
Voluntary Improvement: Voluntary improvements by the tenant (with consent) cannot increase the rent.
Current Rent: The current rent is disregarded.
