Structure and Content of a Lease (Repair, Insurance + Alterations) Flashcards
What are the advantages and disadvantages of owning a leasehold property?
Advantages
- Positive covenants easily enforced against subsequent owners of leasehold
- Landlord retains the capital interest, which is an asset
- Leasing a property is a good income stream
- Greater flexibility for commercial tenants + no capital outlay
- Advantages outweigh disadvantages for a commercial tenant
Disadvantages
- Depreciating asset from date of grant, as there is no return on the rent
- Landlord retains control and can dictate what the tenant can and cannot do
- Tenant may be unreliable and not pay the rent, or may not take care of the premises
What are the three main types of tenancy?
1) A fixed term tenancy, which expires at the end, without either side needing to give notice
2) A periodic tenancy continues indefinitely from one period to the next, which runs until either party decides to terminate by giving notice
- Notice should be the length of one period of the lease (monthly period would be one month’s notice)
- Yearly tenancy can be terminated on six months’ notice (exception)
3) Tenancy at will is where a tenant occupies the property with the permission of the LL, on the terms that the tenancy may be terminated by either party at any time
- Indefinite, but uncertain as can be terminated with no notice
What are the three categories of leasehold covenants?
The landlord exercises control over the tenant by way of covenants
Three categories:
1) Absolute – T absolutely cannot carry out the stated action according to the lease
- The landlord may decide to allow it, either by way of a one-off consent or a permanent variation of the lease, but the landlord has total discretion on the matter
2) Qualified – T can carry out the stated action, provided they get LL’s consent first
3) Fully Qualified Covenant – T can carry out the stated action, provided they get LL’s consent first, which will not be able to be withheld unreasonably
What is meant by a ‘full repairing and insuring lease?’
Leasehold properties are investment products to obtain rental income in the meantime and a capital gain when it is sold
Tenants are a part of this investment, so leases are often full repairing and insuring, so LL doesn’t have to pay for repairs, maintenance and insurance contributions, as these are T’s obligations
As such, leases preserve the capital value of the building by ensuring that:
- the building is kept in good repair
- the lease reserves a market rent throughout the term (with the ability to increase the rent at regular intervals) to ensure a steady income
- the investment is readily sellable, if necessary, ie the lease must be acceptable to future buyers of the freehold
What are the differences between a tenant’s repairing obligations when they lease the whole or just part of a building?
Where T has the lease of the whole building, they will have a full repairing obligation for the whole building
Where T has the lease of a part of the building, LL has responsibility for the structural parts of the building and common areas + T has responsibility for non-structural parts of the premises
What are some of the major points in terms of defining what is meant by ‘repair’ and when the tenant’s repair obligations might be engaged?
- There must be disrepair before T can be in breach of the covenant to repair - Physical condition has deteriorated
- Property need not be kept in perfect repair – just in a ‘state of repair as renders it fit for the occupation of a reasonably minded tenant of the class likely to take it’
- Words of renewal or improvement of the whole go beyond repair – question of fact and degree
- The repair covenant can oblige the tenant to remedy an inherent defect in the design if that is the only way to effect the repair and damage arising from such a defect
- T might have to put the building into a better state of repair than when they entered the lease
- T should be aware of additional wording, such as to keep the property ‘in good condition.’ This is more burdensome as they might have to carry out works, even if there is no disrepair
- T doesn’t have to repair the property to the extent that any disrepair has been caused by an Insured risk, although the policy might be void if there was an act or omission by T leading to the disrepair
The landlord will take out insurance on the leasehold property, but who must pay the insurance?
Where T has lease of the whole building, T could be made solely responsible for insurance
More common for LL to take out the insurance, with cost being passed to T as a separate insurance rent
The insurance provisions in a typical lease of commercial property have various elements. Briefly list the elements
A LL’s covenant to insure the property against defined risks (the ‘insured risks’)
A covenant by T to pay for the insurance policy
A covenant by LL to reinstate the property
Rent suspension
Termination
Give details of what is meant by ‘insured risks.’
Often, there is an inclusive list of the risks which the LL must insure against
- Examples like fire, explosion, storm, flood etc
Commonly concludes the list with ‘such other risks as the LL may reasonably require’
Property should be insured to ‘full reinstatement value’
Give details of the covenant of the tenant to pay the insurance policy
T often has to pay a sum reserved as ‘insurance rent’ which includes the premium for the buildings insurance policy
Also, includes an associated policy covering the landlord for loss of the annual rent (ie the income stream) during any period where the tenant is unable to use the building following the occurrence of an insured risk
Give details about the covenant of the landlord to reinstate the property
Often expressed as a covenant to use the insurance proceeds to reinstate the property
T would want this to include an obligation for LL to make good any shortfall in the insurance proceeds from its own resources, to return property to full reinstatement value
Give details around rent suspension in the context of the insurance covenant
Unless there is an express term to the contrary, rent will remain payable even if the property is rendered unusable
LL usually happy to agree a term for rent suspension, as they can insure against loss of rent in these circumstances, but this is usually time-limited to a max of 3 years
Where only a part of the building is damaged, it may only be a fair proportion of the rent that will cease to be payable
Give details about termination in relation to the insurance covenant
If the building is totally destroyed, the doctrine of frustration will only apply in exceptional circumstances, so the lease allows the LL the right to terminate if reinstatement proves impossible
T should seek the same right, particularly if rent-suspension is time-limited
- They should be able to terminate the lease if the property hasn’t been reinstated by the end of the rent suspension period
What is the interplay between LL’s insurance covenants and T’s repair covenant?
- If the LL has insured the property to its full reinstatement value, they can do so using the insurance proceeds
- LL will not receive rent while reinstatement takes place, but they will get an equivalent sum under the loss of rent insurance policy, paid for by T
- Where the damage is caused by something not covered by the insurance policy, T will be liable to repair the property under the repairing covenant
Give an overview of what is meant by an ‘alterations covenant.’
In the absence of an alterations covenant, T is able to make any changes they wish, so LL will restrict the extent to which T can make alterations
Different types of covenant exert different levels of control over different types of alterations
It is common for a lease to contain absolute covenants in relation to structural and exterior alterations.
In what circumstances can a tenant make alterations, even where there is an absolute covenant/prohibition? Explain the process.
1) T of business premises can carry out improvements, even if there is an absolute prohibition – s3 LTA statutory procedure
2) T serves notice on LL, detailing proposals
- LL has 3 months to object; if they do, T can go to court for authorisation to carry out improvements
- Court can authorise if they add to the letting value of the property, are reasonable and suitable to the character of the property and do not diminish the value of any other property of the landlord
3) LL can offer to carry out the works themselves for a reasonable increase in the rent
- If T rejects this, LL has no right to carry out the work and increase rent, but the court cannot give T authority to do it themselves
4) If LL doesn’t carry them out or object in 3 months, T can carry them out, even if there is an absolute covenant
5) Remember that exterior changes may also require planning permission
Explain how qualified and fully qualified alteration covenants work
T usually allowed to make non-structural alterations with consent from LL
Ordinarily, it is only fully qualified covenants where LL will not be able withhold consent unreasonably, however under the Landlord and Tenant Act, a term is implied into a qualified covenant against making improvements, that LL cannot unreasonably withhold consent
T would prefer a FQ covenant, as they must determine if it amounts to improvement first
What is meant by ‘improvements’ for the purposes of alteration covenants?
Improvements = works that increase the value or usefulness of property to T, even if it reduces LL’s reversionary interest
When can the tenant claim compensation for improvements?
T who obtained prior authorisation to make improvements by using the statutory procedure is entitled to claim compensation for improvements at the end of the term, only if they ‘add to the letting value of the holding’
Rare to be used, as T usually either gets consent from LL without the procedure or there is another covenant to remove all alterations and reinstate the premises at the end of the term
How might a landlord restrict the use of a property?
LL might impose a covenant which restricts the use of the property to a single purpose
They might impose a narrow user clause which allows T to switch the use within the same class (Class E for example) - this might depress the rent on any rent review
- LL cannot charge a fine or increased rent as a condition of giving consent
May be necessary for T to get planning permission depending on what they intend
What is the Royal Institute of Chartered Surveyors (RICS) Code for Leasing Business Premises?
1) All its members must observe the mandatory parts and need a justifiable good reason to depart from its other best practice statements
2) LLs aren’t bound by the RICS Code, nor are LL’s solicitors and non-RICS surveyors
3) Mandatory parts
(i) Lease negotiations must be approached in a constructive and collaborative manner
(ii) Any party not represented by an RICS member or other property professional must be advised of the existence of the code and must be recommended to obtain professional advice
(iii) Transaction terms must be recorded in writing, subject to contract and must summarise specified details as a minimum, such as:
- identity and extent of the premises, together with any special rights to be granted
- length of term including details of any renewal or break rights
- amount of rent, frequency of rent payments and frequency and basis of any rent review
- liability for payment of insurance premiums
- ability to assign, underlet, charge or share the premises
- repairing, permitted use and alterations obligations
