The grant and the assignment of a commercial lease/underlease

Question 1

Who are commercial landlords?

Answer 1

Private investors
Institutional investors

Question 2

What can asset management involve?

Question 3

definition of a lease

Answer 3

‘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.

Question 4

What is a FRI lease?

Answer 4

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.

Question 5

What are the elements for a valid lease?

Answer 5

Exclusive possession
Fixed term or periodic tenancy
Formalities

Question 6

At the simplest, what is a lease?

Answer 6

A lease 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.
However, in practice, most leases will go
into considerable detail about the respective obligations of the landlord and tenant.

Question 7

What effect do the mandatory provisions of Royal Institution of Chartered Surveyors (RICS) Code for Leasing Business Premises (1st edition February 2020) have regarding leasehold transactions?

Answer 7

Letting agents and other property professionals who are RICS members or in a RICS regulated firm must comply with mandatory provisions, and non-compliance may be taken into account in regulatory or disciplinary proceedings.

Question 8

What is a break clause?

Question 9

What would be the best advice to give for the below:

In negotiations to take a commercial lease in England, the prospective tenant asks for a 5 year lease term as the tenant knows that it will not need the premises for longer. The landlord offers a 10 year lease with a 5 year mutual break clause, saying this is just as good.

Answer 9

Although the tenant can get out of the lease at 5 years, exercising a break is not straightforward, and there may be more Stamp Duty Land Tax payable on the longer term.

Question 10

What is an example of title guarantee the landlord cangive?

Answer 10

Full title guarantee the Property to the Tenant for the Contractual Term.

Question 11

Give an example of how rent can be defined in the lease? What is an example of where the tenant may have to pay anything other than rent?

Answer 11

Rent is defined as Annual Rent and Insurance Rent, the tenant must also pay:

the Service Charge and all VAT in respect of it;
all interest payable under this lease; and
all other sums due under this lease.

Question 12

Formalities of a legal lease:

Answer 12

-A legal lease must be made by deed.
-However, a legal lease may be created orally or in writing if it is for a term of three years or less and takes effect immediately, reserving the best rent reasonably obtainable (s54(2) LPA 1925).
-If not legal, the tenant will have an equitable interest provided the lease complies with s2 of the Law of Property Act 1989; namely, it is in writing, contains all the agreed terms and is signed by the parties.

• The tenant (or lessee) must hold a term that is shorter than that held by the landlord (or lessor). payment of rent is not an essential element of a lease.

The tenant must have exclusive possession; that is, the right to use the premises to the exclusion of all others, including the landlord (Street v Mountford [1985] 2 All ER 289).
If not, the agreement will not create a legal interest in land and be merely a licence.

A lease for a term of more than seven years is compulsorily registrable at the Land Registry. If such a lease is granted on or after 19 June 2006 it must contain prescribed clauses

Question 13

Can a legal lease be created orally/in writing?

Answer 13

A legal lease must be made by deed. However, a legal lease may be created orally or in writing if it is for a term of three years or less and takes effect immediately, reserving the best rent reasonably obtainable (s54(2) LPA 1925).

Question 14

Advantages of a lease - tenants point of view

Answer 14

• There is no need to spend capital which may be in short supply, especially with a newly
  established business, or which may be needed for other purposes.
• A leasehold is not a permanent investment. If the needs of the business change, the tenant
  may have the opportunity to leave the premises at the end of the lease, or in other certain instances. This gives the business flexibility to experiment with taking new or additional premises.
• Some premises will only be available as a leasehold. For example, if a retail chain want to open a shop in a large shopping centre, they have no choice but to take a lease.

Question 15

Types of commercial landlords

Answer 15

• Private investors (individuals or companies who make a business out of letting premises)
• Institutional investors (These are financial institutions, typically, pension funds and life
  assurance companies who invest in property just as they would in the stock market)

Question 16

What do institutional investors favour?

Answer 16

Because the institutional investor is concerned with the property in terms of the income it
produces, they favour a full repairing and insuring (FRI) lease.

This means that the tenants pick up the costs associated with the property, and the landlord receives the clear rent. We will look at this in more detail in the appropriate sections.

Question 17

What is an area to concern re institutional investors?

Answer 17

Covenant strength.
A landlord will want to know that the tenant has the means to comply with its obligations, and also that it has assets that the landlord can recover breaches against.

A long established company will generally have good covenant strength, an off-the-shelf new company will not.

If the tenant does not have good covenant strength, the landlord may require a guarantor (such as the director of the company) or a rent deposit

Question 18

What is asset management?

Answer 18

• common area of practice for commercial solicitors

This often involves acting for an institutional landlord, and dealing with the legal work generated by the property asset on an ongoing basis.

This may involve:
* Granting a lease to a new tenant
* Considering applications by the tenant during the lease; for example, to alter the premises
* Advising on breaches of the lease, such as failure to pay the rent or letting the premises fall into disrepair
* Or dealing with the issues that arise when a lease comes to an end and the tenant is leaving or wants a new lease.

Question 19

What is exclusive possession?

Answer 19

The tenant must be able to exclude strangers and even the landlord (except where the landlord is exercising its right to enter the premises, eg, to inspect it) from the premises let.

Question 20

Formalities of a lease?

Answer 20

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 21

What is the reversion?

Answer 21

The reversion is the interest that the landlord holds subject to the lease. At the end of the lease term, the property reverts to the landlord.

Question 22

Landlord’s objectives in a lease

Answer 22

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)

Question 23

Tenant’s objectives in a lease

Answer 23

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)

Question 24

The term commencement date

Answer 24

This is the date on which the lease term starts.
The term commencement date may be the date of completion of the lease 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.

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 25

How to work out the expiry of the lease term

Answer 25

• 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

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

Question 26

What is a break clause?

Answer 26

A break clause can be a landlord break (meaning only the landlord can exercise it),

a tenant break (meaning only the tenant can exercise it – the most common type), or a mutual break (either party can exercise it).

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

Question 27

What are the two common categories for renting a lease

Answer 27

either a short lease with a market rent; or a long lease with a ground rent.

Question 28

Rent in commercial leases

Answer 28

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.

Question 29

Rent in residential leases

Answer 29

Residential leases may be long leases (say 99 or 999 years) with a ground rent (that may be a low sum, say £150 per annum or even a peppercorn each year).

The first person to buy the property will pay a premium (say £200,000) to the landlord for the
grant of the lease.

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

Question 30

Rent in a commercial FRI lease

Answer 30

• The rent is usually expressed as a yearly figure (eg, £80,000 per annum) but payable
  quarterly.
• The year is divided into approximate quarters, which may run from the traditional quarter days (in bold), based on religious festivals, as follows:
  25 December to 24 March
  25 March to 23 June
  24 June to 28 September
  29 September to 24 December
• These are still commonly used, but some leases now adopt the modern quarter days being 1 January, 1 April, 1 July and 1 October.
• Rent is usually due in advance on the quarter day
• However, the lease needs to state if the rent is payable in advance (which an FRI lease will) - if the lease is silent, the rent is payable in arrears. This is more often seen in a residential long lease.
• The lease will set out how the rent is to be paid (usually by standing order) and whether VAT is payable on it.

Question 31

Types of rent review

Answer 31

There is no implied right for the landlord to be able to increase the rent

• 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 (eg, 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 32

What is the ‘Code for Leasing Business Premises’ mainly for? (‘the code’)

Answer 32

As it is recognised that landlords generally enjoy a stronger negotiating position than tenants, the Code for Leasing Business Premises (1st Edition February 2020) (‘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’

Question 33

Mandatory requirements in ‘the Code’

Answer 33

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

Question 34

What does ‘the Code’ specify MUST be covered in the heads of terms

Answer 34

• 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 35

Landlord’s solicitor, pre-exchange

Answer 35

• Takes 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

Question 36

Tenants solicitor, pre-exchange

Answer 36

• Takes 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 37

How does investigation of title, searches and enquiries work in leases

Answer 37

• The landlord’s solicitor will deduce their freehold title, and the tenant’s solicitor should investigate it.
• The tenant’s solicitor should ensure that the landlord has title to grant the lease, and will also need, for example, to consider any freehold covenants as they will also bind the tenant
• The tenant’s solicitor will raise CPSE1 enquiries (as does a buyer’s solicitor in a commercial freehold transaction) but will also raise CPSE3 enquiries which are specific to the grant of a lease.
• The tenant’s solicitor should raise the same searches as they would if they were buying the
  freehold.

Question 38

What happens at exchange of a lease

Answer 38

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 39

Landlord’s solicitor, pre-completion - lease

Answer 39

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)

Question 40

Tenant’s solicitor, pre-completion - lease

Answer 40

Arrange for tenant to sign counterpart lease

Obtain funds from client needed to complete
as per completion statement

Raise pre-completion searches

Question 41

What is apportionment - completion statement of a lease

Answer 41

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, which is found by dividing the yearly rent by 365 (or 366 in a leap year).

Question 42

What pre-completion searches are carried out in leases

Answer 42

As with a freehold transaction, pre-completion searches are carried out.

The appropriate search is an OS1 search with a lease of whole, an OS2 search with a lease of part.

If the lease is not registrable, 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 43

Completion - lease

Answer 43

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 44

Post completion lease - landlord’s solicitor

Answer 44

Send summary of main provisions of lease to
client

Question 45

Post completion lease - Tenant’s solicitor

Answer 45

Arrange to submit SDLT or LTT return and pay
appropriate SDLT or LTT if necessary

Register lease if necessary

Question 46

What is net present value (NPV)

Answer 46

With a freehold or long leasehold (say 999 years) where a premium is paid, it is quite simple to take that premium as the basis of the SDLT or LTT calculation.
It is a little more complex with a short lease with market rent payable.

The first step is to calculate a lump sum equivalent of the rent over the years it is payable, called the Net Present Value (NPV).

Question 47

What do you need to calculate NPV?

Answer 47

• You will need the start date of the lease, and the lease term (eg, 10 years)
• You will also need the rent payable for each of the first five years
  For calculating the NPV and therefore the SDLT or LTT, you must include the rent plus VAT

Question 48

Example of an NPV calculation

Answer 48

A tenant takes a ten year lease of an office at a rent of £200,000 per year plus VAT, with a rent
review on the fifth anniversary. Using the online calculator, you would enter £240,000 for each of the first five years. The NPV is £1,995,985.

Question 49

Stamp duty land tax (SDLT) on leases

Answer 49

grant of a residential long lease, the calculation is similar to that for purchasing
a freehold.

SDLT is assessed on the NPV, and different percentage rates apply to the slices of the total
purchase price.
* Up to £150,000, there is no SDLT payable.
* Over £150,000 up to £5 million, SDLT of 1% is payable
* Over £5 million, SDLT of 2% is payable
SDLT is rounded to the nearest pound.

Question 50

Example of SDLT on leases

Answer 50

A lease of 10 years with £200,000 plus VAT, rent review at 5 years gives an NPV of £1,995,985.

The first £150,000 is free of SDLT, so it is the remaining £1,995,985 less £150,000 = £1,845,985 that is charged at 1%.
The SDLT payable is £18,459.

Question 51

Land Transaction Tax (LTT) on leases

Answer 51

LTT is also assessed on the NPV, and different percentage rates apply to the slices of the total
purchase price. The rates are currently different from SDLT:
* Up to £225,000, there is no LTT payable.
* Over £225,000 up to £2 million, LTT of 1% is payable
* Over £2 million, LTT of 2% is payable

Unlike SDLT, LTT is not rounded to the nearest pound.

Question 52

LTT example

Answer 52

A lease of 10 years with £200,000 plus VAT, rent review at 5 years gives an NPV of £1,995,985.
The first £225,000 is free of LTT, so it is the remaining £1,995,985 less £225,000 = £1,770,985 that is charged at 1%.
The SDLT payable is £17,709.85.

Question 53

Lease of up to 3 years - registration purposes

Answer 53

Does not need to be registered.
Cannot be noted against the landlord’s title

Question 54

Lease of more than 3 years up to 7 years - registration purposes

Answer 54

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).

Question 55

Lease of more than 7 years - registration purposes

Answer 55

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 56

Procedure for registering a lease

Answer 56

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 57

What is an assignment?

Answer 57

The grant of a lease creates a leasehold interest. Just as a freehold interest may be sold or transferred to a new owner, so a leasehold interest may be sold or transferred.

We speak of the lease being assigned by the existing tenant (assignor) to the new tenant
(assignee).
As with a freehold, the assignee may pay for the leasehold interest, or the consideration may simply be the assignee agreeing to pay the rent and perform the other obligations of a tenant under the lease.

Assignment is a form of alienation.

Question 58

What is alienation?

Answer 58

This simply means a disposal of all or part of the tenant’s interest in the lease.

Following assignment, the landlord becomes the landlord of the assignee.

The new tenant is now entitled to exclusive possession of the premises and is obliged to pay the rent and perform the other tenant covenants.

The assignor is no longer entitled to use the premises, and generally need not pay the rent or perform the other tenant covenants.

However, the assignor may still have liability for them, as we will see.

Question 59

How can a tenant’s covenant against assignment be drafted?

Answer 59

may be drafted as absolute, qualified or fully qualified.

An absolute covenant means that assignment is not allowed.

A commercial lease will usually contain an absolute covenant against assignment of part of the premises.

Question 60

How do qualified covenants against assignment work?

Answer 60

A tenant’s covenant against assignment of whole may be qualified, meaning that assignment is only allowed with the landlord’s consent.
s19(1)(a) of the Landlord and Tenant Act 1927 converts a qualified covenant into a fully qualified covenant = the landlord must act reasonably if deciding to withhold consent AND that it must give it’s decision within a reasonable time

This restricts the landlord’s discretion.

Question 61

What does caselaw suggest is ‘reasonable time’ in giving consent on assignment

Answer 61

dependent upon circumstances but should be measured in days or weeks rather than months

Question 62

What if the landlord does not act reasonably in withholding or delaying consent on assignment?

Answer 62

then the tenant may be able to claim damages (including costs for agents and solicitors).
The landlord will, however, have various concerns regarding assignment. A commercial lease, therefore, will contain:
* circumstances that the parties agree will be reasonable grounds for withholding consent and
* conditions that may be imposed on assignment.
Both conditions and circumstances are recognised by s19(1A) Landlord and Tenant Act 1927. If valid, they provide the landlord with specific grounds on which consent may be reasonably withheld.

Question 63

What is the difference between privity of contract and privity of estate?

Answer 63

Privity of contract: At common law, privity of contract is the ability of the original parties to a contract to enforce the obligations against each other, even after the contract has been assigned.

Privity of estate: By contrast, privity of estate is the ability of the landlord and tenant for the time to enforce the provisions of a lease against each other. However, not all obligations are enforceable under privity of estate.

Question 64

What is the rule for old leases + assignment?

Answer 64

The common law position for old leases was that, despite assignment, the original tenant
remained liable to the landlord to pay the rent and perform the other obligations under privity of contract.
By contrast, there were only limited obligations that automatically passed to the new tenant under privity of estate, and the new tenant would have to covenant directly with the landlord to observe all the tenant’s covenants in the lease.

Question 65

What is the rule for new leases + assignment?

Answer 65

The Landlord and Tenant (Covenants) Act 1995 changed the liability of the assignor and assignee to reflect better the commercial reality of the situation. The Act applies to leases granted on or after 1 January 1996, which are referred to as new leases.

When a new lease is assigned, the original tenant is released from liability, and all of the tenant covenants are passed to the new tenant.

Question 66

What is an authorised guarantee agreement? (AGA)

Answer 66

the statute provides a mechanism whereby the original tenant can agree to guarantee
the obligations of the incoming tenant.
This is done by a document called an authorised guarantee agreement (often abbreviated to AGA).

If there is a subsequent assignment, then the outgoing tenant’s liability under the AGA ends.

Question 67

Example of an AGA

Answer 67

A Ltd, the tenant of a new lease, assigns the lease to B Ltd, and A Ltd gives X Ltd, the landlord, an authorised guarantee agreement.

If B Ltd falls behind with the rent, X Ltd can pursue B Ltd as tenant but can also rely on the
authorised guarantee agreement, and pursue A Ltd even though A Ltd is no longer in occupation.

B Ltd subsequently assigns the lease to C Ltd, and B Ltd gives X Ltd an authorised guarantee
agreement.

If C Ltd falls behind with the rent, X Ltd can pursue C Ltd as tenant and B Ltd under B Ltd’s
authorised guarantee agreement.

However, X Ltd cannot pursue A Ltd, as A Ltd’s liability under its AGA has ended.

Question 68

Pre-completion searches: registered lease

Answer 68

An official search of the registers of the leasehold title (OS1) for any new entries and to gain priority

Question 69

Pre-completion searches: unregistered lease

Answer 69

Another land charges search should be made against the name of the assignor to check that no adverse entries have been made since the pre-exchange land charges search on all the previous estate owners was made and to ensure that the priority period of 15 working days covers completion of the assignment