Unit 5 Grant of a Lease and Underlease Flashcards
Advantages and disadvantages of owning a leasehold property
- Disadvantages of owning a lease from the tenant’s point of view:
- Lease will be a depreciating asset.
- As the tenant does not own the property, the landlord will probably retain control and therefore specify what the tenant can and cannot do. - There will probably be repairing obligations in the lease which will involve expenditure for the tenant.
- Disadvantages from landlords POV:
- The tenant may prove unreliable and not pay the rent.
- The tenant may not take care of the premises, which could result in a depreciation of the landlord’s investment.
- The income and capital are not guaranteed and are dependent on the state of the property market.
- Advantages for landlord:
- Positive covenants cannot be easily enforced against subsequent owners in freehold land.
- Landlord retains a capital interest in the freehold which, depending upon the market, will be an asset.
- The landlord can retain control of the management of the building to ensure that the capital value is preserved.
- If the lease is drafted properly, the landlord will be able to recover all expenditure, for example in relation to repairs and maintenance, by way of a service charge paid by the tenant.
- The landlord also gains a steady income by renting the property at a market rent.
- Advantages for tenants:
- Commercial tenants also have good business reasons for taking a lease. A lease is flexible: if it is a short- term lease, the tenant can move easily at the end of the term if they need smaller or larger premises. Tenants can often negotiate a break clause to enable them to terminate the lease before the end of the fixed term.
- Also, the tenant has no capital outlay. Although they may need to pay a capital sum (known as a premium) at the start of the lease, the capital of their business is not tied up in the premises.
Structure of a typical commercial lease
- Prescribed clauses: leases that are dated on or after 19 June 2006 which are granted out of registered land and are compulsorily registrable must contain a standard set of clauses (‘prescribed clauses’) at the beginning of the lease, or immediately after any front cover sheet and/ or front contents page.
- Commencement
- Interpretation: definitions
- Grant of the lease
- Ancillary rights: these give the tenant rights over other land to enable them to use the leased property more effectively.
- Rights excepted and reserved: these are rights in favour of the landlord over the leased property.
- Annual rent
- Rent review
- Tenant’s covenants
- Landlord’s covenants
- Re- entry and forfeiture
Options for the term of a lease
Fixed term.
Periodic tenancy = one which is not granted for a fixed period but continues indefinitely from one period to another. Is an initial period. The notice should be the length of one period of the lease. However, as an exception to the general rule, a yearly tenancy can be terminated on six months’ notice.
Tenancy at will = a tenant occupies the property with the permission of the landlord on the terms that the tenancy may be terminated by either party at any time.
Business tenants who satisfy certain criteria are able to extend the term and renew the lease under the Landlord and Tenant Act 1954.
Types of leasehold covenant
- Absolute Covenant
Tenant 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. - Qualified Covenant
Allows the tenant to carry out the stated action, but only if it obtains landlord’s consent first. - Fully Qualified Covenant
Allows the tenant to carry out the stated action if it obtains landlord’s consent first, but goes on to say that the landlord will not be able to withhold consent unreasonably.
The full repairing and insuring lease
= landlord gets a ‘clear’ rental stream (all profit) and does not have to dip into it to pay for repairs, maintenance and insurance contributions.
A lease which does not make the tenant pay for all this is often referred to as not being ‘investment quality’ or ‘institutionally acceptable’ to the investment institutions such as pension funds and insurance companies.
Important that the leases act to preserve the capital value of the property 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.
Repair
Lease of part = responsibility normally split.
The tenant will normally be responsible for the non- structural parts of the premises and the landlord will assume responsibility for the structural parts of the building and the common areas.
Usually contain provisions enabling the landlord to pass on the costs.
Case law:
- Must be disrepair first, before the tenant can be in breach of covenant to repair.
- Brand new - need not be kept in perfect repair just fit for occupation.
- Works of renewal or improvement go beyond repair.
- A repairing covenant does not oblige the tenant to give back to the landlord a property that is ‘wholly different’ from that leased to them.
A covenant to ‘keep’ a building in repair also means ‘put’ it into repair, even if that involves the tenant putting the building into a better state of repair than when they entered into the lease.
A covenant to ‘keep the property in good condition’ is more onerous than a plain covenant to keep it in repair. It can mean that the tenant is obliged to carry out some works, even though there is no actual disrepair.
Insurance - covenants
- Landlord’s covenant to insure the property against defined risks (the ‘insured risks’)
Inclusive list of the risks which the landlord must insure against.
Liability for any shortfall in the proceeds caused by expulsions imposed by insurer are passed on to the tenant in the repairing covenant.
The property should be insured to its ‘full reinstatement value’.
- A covenant by the tenant to pay for the insurance policy
Pay a sum reserved as rent (the ‘insurance rent’), which includes the premium for the buildings insurance policy and an associated policy covering the landlord for loss of the annual rent (ie the income stream). - A covenant by the landlord to reinstate the property
Use the insurance proceeds to reinstate the property (rather than an absolute obligation to reinstate even if the proceeds are insufficient).
There may also be a provision to deal with the situation where reinstatement is impossible e.g. proceeds split. - If risk not insured tenant liable under repairing covenant.
Insurance - rent suspension and termination
- Rent suspension
In the absence of an express term to the contrary, rent will continue to be payable even if the property is rendered unusable.
Landlord normally fine to contract out if insurance. Insurance normally limited to 3 years.
- Termination
Unless the lease states otherwise, if the building is totally destroyed, the doctrine of frustration will only apply in exceptional circumstances. Therefore, the lease will often give the landlord the right to terminate the lease should reinstatement prove impossible.
The tenant should try to ensure that they have the same right, particularly where the rent suspension is time- limited.
Alterations - Absolute covenants
Against all types of alterations, but it is more common for a lease to contain this type of covenant in relation to structural and exterior alterations.
- A tenant of business premises can use the provisions of s 3 Landlord and Tenant Act 1927 to enable it to carry out ‘improvements’ - serve a notice on the landlord detailing its proposals.
- The landlord has 3 months within which to object and if it does, the tenant has the right to apply to the court for authorisation to carry out the improvements.
- The court can authorise the improvements 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.
- Instead of objecting or consenting to the works, a landlord can offer to carry out the works itself in return for a reasonable increase in the rent. A tenant is under no obligation to accept an offer by the landlord to carry out the works and may withdraw its notice. If it does so, the landlord then has no right to carry out the works and increase the rent. However, if the tenant rejects the landlord’s offer, the court cannot give the tenant authority to do the works itself.
Alterations - Qualified and fully qualified covenants
Many landlords will allow tenants to make non- structural alterations and changes to service media, but with consent so that the landlord can retain control. The consent, and the conditions, will typically be imposed in a separate document called a licence to alter.
A qualified covenant against alterations prohibits alterations without the landlord’s prior consent.
Under s 19(2) of the Landlord and Tenant Act 1927, a term is implied into a qualified covenant against making ‘improvements’ that the landlord cannot unreasonably withhold its consent.
Case law has established that if the works in question will increase the value or usefulness of the property to the tenant, then they will constitute an improvement, even if they will result in the reduction in the value of the landlord’s reversionary interest.
In relation to improvements, therefore, the landlord will not be able to withhold their consent unreasonably.
However, a tenant would prefer a fully qualified covenant that makes it clear that the landlord cannot withhold their consent unreasonably to an alteration, whether or not it amounts to an improvement.
Since demountable partitioning usually has a minimal impact on the building, many landlords will allow this to be erected and removed without the need for consent at all.
Alterations - Compensation for improvements
A tenant which has obtained prior authorisation to make the improvements by using the s 3 statutory procedure is entitled to claim compensation for improvements at the end of the term that ‘add to the letting value of the holding’ under s 1 of the Landlord and Tenant Act 1927, provided the claim is made within certain statutory time limits.
User and planning
A landlord may choose to impose a tenant’s covenant which restricts the use of the property to a single purpose:
- Not to use the Premises other than as a restaurant.
- Not to use the Premises other than as a restaurant or such other use falling within Use Class E of the Town and Country Planning (Use Classes) Order 1987.
- Qualified covenant - there is no statutory implication that the landlord’s consent cannot be unreasonably withheld for user covenants, but the landlord cannot charge a fine or an increased rent as a condition of giving consent, provided no structural alteration is involved (s 19(3) of the Landlord and Tenant Act 1927).
- Fully qualified covenant.
Not to use the Premises other than as a restaurant or such other use falling within Use Class E of the Town and Country Planning (Use Classes) Order 1987 as the Landlord may approve in writing (such approval not to be unreasonably withheld).
It is not uncommon for the landlord to retain control of such issues by, for example, imposing a tenant’s covenant not to apply for planning consents without the landlord’s permission.
Alienation
= different ways of creating an interest in the property for the benefit of a third party.
Includes:
* assignment
* underletting (also known as subletting)
* charging (also known as mortgaging)
* sharing occupation (allowing a third party in while continuing to occupy, perhaps under a licence or concession arrangement)
* parting with possession (a catch- all term which covers assignment and underletting but also includes informal arrangements which may be difficult to classify).
Most leases contain an absolute covenant against all types of alienation, but then go on to permit certain types of alienation on controlled terms.
Alienation - Assignment
= transfer lease to someone else.
A commercial lease will usually allow assignment of the whole property, but not of part.
- Section 19(1)(a) Landlord and Tenant Act 1927:
Qualified covenant (not to assign without the landlord’s consent) is converted into a fully qualified covenant - consent cannot be unreasonably withheld. - Section 19(1A) Landlord and Tenant Act 1927: this allows for the landlord and the tenant to agree in advance conditions and circumstances in which it would not be unreasonable for the landlord to refuse consent.
Circumstances can include that the assignor is up- to- date with the rent and/or that the assignee is of sufficient financial strength to enable it to comply with the tenant’s covenants in the lease.
- Section 1 Landlord and Tenant Act 1988: this means that where there is a qualified covenant on assignment (whether the proviso that consent is not to be unreasonably withheld is express or implied by statute) and the tenant has made a written application for consent, the landlord must within a reasonable time:
a) give consent, except in a case where it is reasonable not to give consent
b) serve on the tenant written notice of its decision whether or not to give consent specifying in addition:
i) if the consent is given subject to conditions, those conditions,
ii) if the consent is withheld, the reasons for withholding it.
Alienation - Assignment - reasonable examples
Examples of situations where consent has been held to have been reasonably withheld:
* where the proposed assignee’s references were unsatisfactory
* where there was a long- standing and extensive breach of the repairing covenant by the assignor and the landlord could not be reasonably satisfied that the assignee would be in a position to remedy the breach
* where the assignee would be in a position to compete with the landlord’s business
* where the assignment would reduce the value of the landlord’s reversion (although this will not be a reasonable ground for withholding consent if the landlord has no intention of selling the reversion)
* where the proposed assignee intends to carry on a use detrimental to the premises, or a use inconsistent with the landlord’s ‘tenant mix’ policy
* where the assignee would, unlike the assignor, acquire protection under Part II of the Landlord and Tenant Act 1954
The following are examples of situations where consent has been held to have been unreasonably withheld:
* where the landlord has refused consent in an attempt to obtain some advantage for itself
* where there are minor breaches of the repairing covenant
* where premises had been on the market for 18 months, the rent was significant and the slight harm to the landlord would be outweighed by prejudice to the tenant.
It is unnecessary for the landlord to prove that the conclusions which led it to refuse to consent were justified, if they were conclusions which might be reached by a reasonable person in the circumstances.
Underletting
= a lease created by someone who is already a tenant. When a tenant grants an underlease, there are two leases in existence in relation to the same property, a headlease and an underlease.
Has to be for shorter term.
Give AGA?
Landlord will be concerned about the prospect of an underletting for 2 main reasons:
1. It is possible that the landlord might end up with the undertenant as their direct tenant. This can occur if the headtenant’s lease is forfeited and the undertenant, whose underlease would normally come to an end at the same time, successfully applies to court for relief from forfeiture.
Also if the headtenant’s lease is surrendered, or disclaimed by the headtenant’s liquidator, or if both leases expire and the undertenant exercises their statutory right to stay on in the property and apply for a new lease under the Landlord and Tenant Act 1954, but the headtenant does not.
- Although legally the headtenant will remain liable to the landlord for the performance of the tenant’s covenants under the lease, in reality it is the undertenant who will be in occupation and who will have physical control of the property.
The landlord will have very limited day- to- day control over what is happening at the property as the rights reserved to the landlord, such as inspection and serving notices to repair, will be exercisable by the headtenant and the landlord will have to go through the headtenant to get anything done.
Underletting - statutory provisions and conditons
Need to get landlords consent.
Statutory provisions apply:
* Section 19(1)(a) Landlord and Tenant Act 1927:
Qualified covenant (not to assign without the landlord’s consent) is covered into a fully qualified covenant - consent cannot be unreasonably withheld.
* Section 1 Landlord and Tenant Act 1988: this means that where there is a fully qualified covenant on underletting (whether the proviso that consent is not to be unreasonably withheld is express or implied by statute) and the tenant has made a written application for consent, the landlord must within a reasonable time:
(a) give consent, except in a case where it is reasonable not to give consent
(b) serve on the tenant written notice of its decision whether or not to give consent specifying in addition:
(i) if the consent is given subject to conditions, those conditions,
(ii) if the consent is withheld, the reasons for withholding it.
Likely conditions in the alienation covenant.
E.g.
* terms of the underlease mirror the terms of the headlease.
* that the annual rent reserved by the underlease is at least as high as the annual rent reserved by the headlease
* must be reviewed at the same time and on the same terms as the annual rent
* that any underletting must exclude s 24– 28 in Part II of the Landlord and Tenant Act 1954,
* that the undertenant enters into a ‘direct covenant’ with the landlord to perform the tenant’s covenants in the underlease and the headlease.
Only the obligation to pay the annual rent payable under the headlease is excluded from the direct covenant.
* that no further underletting of the property is permitted.
Code for Leasing Business Premises
RICS Code for leasing business premises came into operation on 1 September 2020.
Members must observe those parts which are mandatory and need a justifiable good reason to depart from its other best practice statements.
Surveyor could be subject to negligence claim.
Landlords not bound.
Mandatory requirements in the RICS Code are:
1. Lease negotiations must be approached in a constructive and collaborative manner.
2. 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.
3. Transaction terms must be recorded in writing, subject to contract and must summarise specified details as a minimum. The specified details relevant to the terms and conditions considered in this chapter are:
∘ 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.
Drafting the lease
The landlord’s solicitor will draft the lease and submit it to the tenant’s solicitor for approval.
The tenant’s solicitor will probably make amendments. The draft lease will go backwards and forwards until it is finally agreed.
Where the lease is an underlease, the scope for negotiating the document will be much more restricted as it is likely that the headlease requires that the terms of the underlease mirrors the terms of the headlease.
Purpose of an agreement for lease
Useful where there is going to be a delay between agreeing the lease/ underlease and actually granting it but one (or both) of the parties requires the other to be bound into the transaction.
E.g. refurbishing, need planning permission etc.
Drafted by landlords solicitors.
Standard Condition 8.2 (SCPC 11.2.3) provides for the lease/ underlease to be in the form annexed to the draft contract, and for the landlord to engross the lease/ underlease and supply the tenant with the engrossment at least 5 working days before the completion date.
Deduction and investigation of title
Tenant will want the landlord to deduce title to the freehold interest.
Tenant is not entitled to call for deduction of the freehold title unless the transaction is the grant of a lease for a term of more than seven years.
Where this is the case and there is to be an agreement for lease, SC 8.2.4 (SCPC 11.2.4) requires the landlord to deduce such title as would enable the tenant to obtain registration with an absolute title at the Land Registry.
If the landlord’s title is registered, the tenant will be able to check the landlord’s title under the Open Register rules in any event.
If the headlease is registered with absolute leasehold title, there will be no need to see the title to the freehold, although the headlease itself and the official copies for the headlease title must be reviewed.
Where the headlease is unregistered:
* the general law entitles the undertenant to call for the headlease and all subsequent assignments under which the headlease has been held for the last 15 years
* under the general law, the undertenant is only entitled to call for deduction of the freehold title where the transaction is the grant of a lease for a term of more than seven years.
Can exclude requirement via special condition.
Pre- contract enquiries and searches
The landlord’s solicitor should provide the tenant’s solicitor with:
(a) draft agreement for lease (if applicable);
(b) draft lease/ underlease;
(c) evidence of the freehold/ headlease title;
(d) copies of any relevant planning consents; and
(e) evidence of the lender’s consent to the grant of the lease/ underlease (where relevant).
Licence to underlet
= formal consent to the underletting.
Entered in to by the head- landlord, headtenant and undertenant.
The landlord’s consent must be given by or on completion of the underletting, otherwise the headtenant is likely to be in breach of the alienation covenant in the lease.
Usual condition is for under tenant to enter into direct covenant with head landlord to perform covenants in headless and underage (excludes headlease covenant to pay rent).
Pre- completion formalities
Normally lease and counterpart. The lease is executed by the landlord and the counterpart by the tenant. On completion, these are exchanged so that each party has a copy of the lease signed by the other in case of subsequent dispute.
The landlord will sign the lease itself in readiness for completion and the counterpart should be sent to the tenant’s solicitor for execution by the tenant (at least five working days before contractual completion date if SC 8.2.5 or SCPC 11.2.5 apply).
Most leases provide that rent is payable in advance, not in arrears. Unless completion takes place on a day when rent under the lease/ underlease falls due, a proportionate amount of rent calculated from the date of completion until the next rent payment day will be payable by the tenant on completion and this should be agreed in advance.
