Workshop 6

Question 1

Different types of lease (list)

Answer 1

Leases of houses and flats for long terms

Assured shorthold tenancies

Commercial leases

Question 2

Leases of houses and flats for long terms

Answer 2

Leases of houses and flats for long terms, such as 99 or 999 years. With this type of lease, a very low rent is usually payable. For a newer house or flat, it may be, say £150 a year. With older houses it is not uncommon to come across very low rents, such as £2.50 or £5 a year.

Question 3

Assured shorthold tenancies

Answer 3

Assured shorthold tenancies, are common for letting out houses and flats on a six or twelve month basis. The tenant will pay a market rent for the house or flat. Although residential conveyancers will become familiar with these types of leases, they are not the primary focus of this course.

Question 4

Commercial leases

Answer 4

Commercial leases are common and can be for all kinds of different uses. For example, a commercial lease might relate to an office block, a factory, a warehouse or a shop, whether on the high street or in a large shopping centre.

Unlike the residential long lease, a commercial leases is usually for a relatively short term (say, up to 15 years), and a market rent will be payable. In this respect it is similar to an assured shorthold tenancy, but in most other respects it is very different.

Question 5

Advantages of a lease – tenant’s point of view

Answer 5

• 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 6

Who are commercial landlords?

Answer 6

Private investors, whether individuals or companies, who make a business out of letting premises. For example, the company Derwent owns a portfolio of 5.5 million square feet of commercial real estate, most of which is in Central London. At the other end of the sale, an individual may just own one small shop premises and let it out.

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. Compared to the stock market, property has been traditionally seen as a safe and valuable investment, offering both income (through rent) and long-term capital growth (through the rise in property prices over time). It is possible that this view has been tempered by the effect of the pandemic. For example, the tendency towards increased working from home may translate to smaller demand for office space, and therefore a decrease in the rent it can command.

Question 7

Institutional investors

Answer 7

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 elements.

The other issue of concern to an institutional investor is 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 8

Asset management

Answer 8

Asset management or property management. 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, e.g. failure to pay 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 9

Lease definition

Answer 9

“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 10

Essential ingredients of a lease

Answer 10

Exclusive possession
* Fixed term or periodic tenancy
* The lease must be for a fixed term (six months, 5 years, etc) or a periodic term (a weekly tenancy, monthly tenancy, yearly tenancy etc).
* Generally speaking, it may not be for an indeterminate time (eg, for as long as the tenant is an employee of the landlord). There are exceptions.

Formalities
* 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.

The reversion
* 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 11

What is a lease?

Answer 11

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.
Drafting and negotiating the terms of a lease is an important part of the work that the landlord’s and tenant’s solicitors undertake.

Question 12

Landlord’s objectives

Answer 12

In many cases, the landlord is in the dominant negotiating position.
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.
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 13

Tenant’s objectives

Answer 13

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 14

The lease term

Answer 14

Generally, the lease term must be determinate, meaning that it is either a fixed term (6 months, 5 years, 999 years, etc) 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. Reasons might include:
- Business plans are often drafted in 5 or 10 year cycles. Business tenants may not want to commit to a property longer than this.
- A tenant may pay less Stamp Duty Land Tax or Land Transaction Tax on a shorter tenancy.

Question 15

The term commencement date

Answer 15

The term commencement date is the date on which the lease term (say 5 years) starts.
The term commencement date may be the date of completion of the lease (when it is dated and becomes legally binding) 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. Note that if the term started in the past (whether a week ago or a year ago), the tenant is not generally expected to pay rent for the period they haven’t used!
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 16

Calculating the expiry of a lease term

Answer 16

It is important to understand when the lease term expires. A 10 year term will expire 10 years after the term commencement date, but on what day?
This will depend on how the term is defined in the lease…
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 (more common in practice).

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 (less common in practice).

Question 17

Break clauses

Answer 17

If the tenant is unsure about the commitment of a lease term, and the landlord is unwilling to grant a shorter term, a break clause can offer a compromise solution.
Note that if the lease does not include a break clause, in general neither landlord nor tenant can bring the lease to an end before the end of the fixed term without the agreement of the other.
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 (e.g., the fifth anniversary of the term commencement date) or it may be a rolling break (e.g., any time after the fifth anniversary of the term commencement date).
Anniversary is used in leases to mean the same day of the year. For example, the fifth anniversary of 8 September 2030 would be 8 September 2035.

Question 18

leases - rent

Answer 18

Most leases fall into one of two categories: either a short lease with a market rent; or a long lease with a ground rent.

Question 19

Commercial leases

Answer 19

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 20

Residential leases

Answer 20

Residential leases may be long leases (say 99 or 999 years). The first person to buy the property will pay a premium (say £200,000) to the landlord for the grant of the lease.
Such leases often used to impose a ground rent (a low sum, say £150 per annum).
Since 30 June 2022, most new long residential leases have been restricted to imposing a peppercorn rent only (literally the payment of a rent, not usually paid in reality). Ground rents imposed before that date remain effective.
Commercial long leases also exist; for example, land for electrical substations is sometimes leased in this way.

Question 21

Rent in a commercial FRI lease

Answer 21

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.
Although the quarters under neither system are the exact same length, the rent is usually divided equally (so if the rent is £80,000 per annum, £20,000 would be payable for each quarter)

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.
* Earlier in the element, we saw that the parties may complete the lease part way through the term. If this is part-way through a quarter, then the quarter will be apportioned, so the tenant will only pay the appropriate portion of the rent (for example, if the tenant’s lease starts one month into the quarter, they will pay approximately two thirds of that quarter’s rent).
* The lease will set out how the rent is to be paid (usually by standing order) and whether VAT is payable on it.
* The lease will usually describe other payments such as contributions to the insurance premium and service charge as “rent”. The reason for this is covered in the element on termination of leases. The rent proper is often referred to as the “annual rent” or “yearly rent”.

Question 22

Types of rent review

Answer 22

There is no implied right for the landlord to be able to increase the rent. An FRI lease of 10 years or more will usually contain a rent review clause as an institutional investor will want to ensure that their rents are keeping up with the market.

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 23

Open market rent review

Answer 23

Open market rent review provisions can be complex and, as they affect the future rent payable, may be a particularly contentious area for negotiation.
Commercial leases almost always have an “upwards only” rent review. This means that the rent can only increase. If market rents have fallen on the date of the rent review, the rent stays the same.
Typically the rent review clauses will give the landlord and tenant the opportunity to agree the new rent between themselves. If they cannot agree, then the lease will set out a mechanism for a specialist valuer to be engaged to determine the new rent.
The valuer will consider:
- The rent payable for comparable premises (ie, premises of similar size and location) plus
- The terms of the hypothetical lease – an imaginary lease based on the actual lease but assuming certain matters and disregarding others

Question 24

The hypothetical lease

Answer 24

From the starting point of the actual lease (and premises), the rent review provision instructs the valuers on assumptions (matters to assume) and disregards (matters to be disregarded). The hypothetical lease differs therefore from the actual lease (and premises).

Basic assumptions
The basic assumptions enable valuation to take place:
- the premises are vacant and available (as otherwise a prospective tenant would not be interested!)
- there is a willing landlord and a willing tenant

Common disregards
- Disregards generally operate to ignore what the tenant has done voluntarily, and not as an obligation of the lease.
- The rationale is that the tenant should not be penalised with a higher rent if, for example, the tenant has improved the premises for its own use.

Question 25

What happens after rent review?

Answer 25

Once the parties have agreed the new rent, or failing that, the new rent has been determined by a valuer, the new rent is documented in a rent review memorandum. This is a short document (usually a single page) that records the new rent, is signed by the landlord and tenant and is kept with the lease for future reference.
If the rent review is before the 5th anniversary of the term commencement date, the tenant may have to pay further Stamp Duty Land Tax or Land Transaction Tax (as this is calculated on the first five years’ rent).
If the rent review is on or after the 5th anniversary of the term commencement date, the tenant will not have to pay further SDLT or LTT.
If the new rent has only been agreed some time after the rent review date set out in the lease, the new rent is backdated to the rent review date. This means that the tenant will have to pay an additional sum plus interest at a rate set out in the lease (this should not be a punitive rate of interest).

Question 26

Code for Leasing Business Premises

Answer 26

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 27

Where does the Code come from, and to whom does it apply?

Answer 27

The Code is written by the Royal Institution of Chartered Surveyors (RICS) and applies to members of the RICS and RICS regulated firms. Many property professionals, whether property firms or in-house property specialists who deal with the letting of commercial property, will be RICS regulated.
The Code applies to most commercial lettings but there are exceptions (eg, tenancies of 6 months or less)

Question 28

What does the Code contain?

Answer 28

The Code concerns itself with negotiations and heads of terms, and is divided into mandatory requirements and good practice.
* Mandatory requirements are indicated by the word “must”. RICS members and regulated firms must follow them.
* Good practice is indicated by the word “should”. RICS members and regulated firms must follow them unless there are exceptional circumstances (and they may need to be justified to the RICS).
Although the Code’s introduction states that it is concerned with the process rather than the outcome, the section on good practice does concern itself with what lease provisions should and should not be included in the lease.

Question 29

Mandatory requirements

Answer 29

The mandatory requirements 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

It is also mandatory to prepare written heads of terms, stating that it is subject to contract. The Code specifies certain areas which must be covered in the heads of terms. These include:
* 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 30

Engross meaning

Answer 30

Engross simply means to print a copy for signature (eg, on good quality paper and bound). The original of a lease or an agreement for lease is executed by the landlord; the counterpart is executed by the tenant.

Question 31

Pre-exchange – drafting the lease

Answer 31

The landlord’s solicitor will draft the lease based on the heads of terms. The solicitor may use a generic precedent lease (eg, Practial Law or Encyclopaedia of Forms & Precedents). Alternatively, if there have been past lettings on the landlord’s estate, the solicitor may have a part-completed lease which just needs to be tailored to the individual letting.

Question 32

Pre-exchange – agreement for lease

Answer 32

An agreement for lease will often not be needed, in which case 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.
However, an agreement for lease is needed where the parties want to commit to completing the lease, but either are not yet ready, or there are conditions that need to be satisfied.

Question 33

Pre-exchange – investigation of title, searches and enquiries

Answer 33

• 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 (even if the lease states something different).
• The tenant’s solicitor will raise CPSE1 enquiries (as does a buyer’s solicitor in a commercial freehold transaction) but will also raise CPSE3enquiries 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.
• In general the tenant’s solicitor should ideally exercise the same care over their investigations with a leasehold transaction. In practice, the tenant may agree with their solicitor that the cost of full investigations are not justified for a very short lease with limited repair and other obligations. In this case, the tenant’s solicitor should ensure that the tenant is advised of the risks.

Question 34

Exchange

Answer 34

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 35

Pre-completion - Landlord’s solicitor’s tasks

Answer 35

· 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 36

Pre-completion - Tenant’s solicitor’s tasks

Answer 36

· Arrange for tenant to sign counterpart lease
· Obtain funds from client needed to complete as per completion statement
· Raise pre-completion searches

Question 37

Pre-completion steps

Answer 37

The landlord’s solicitor prepares a completion statement. This can be a tricky calculation, as the 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.
Usually, the yearly rent will be paid quarterly. Although both the traditional and modern quarters are not exact quarters of the year, generally the rent is split as if they are. Therefore, for a rent of £80,000 plus VAT, a sum of £20,000 plus VAT will be paid each quarter.
Apportionment 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, whichis found by dividing the yearly rent by 365 (or 366 in a leap year).
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 38

Completion

Answer 38

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 39

Post-completion

Answer 39

Landlord’s solicitor’s tasks
Send summary of main provisions of lease to client

Tenant’s solicitor’s tasks
· Arrange to submit SDLT or LTT return and pay appropriate SDLT or LTT if necessary
· Register lease if necessary

Question 40

Repair – who is responsible?

Answer 40

A commercial tenant will almost always be responsible for the repair of their demise, i.e. the extent of the premises let to them. The first step is to look at the definition of “Premises”, “Demised Premises”, “Property” or similar in the lease.

Lease of whole - the landlord’s title such as an office block, the definition of “Premises” will refer simply to the title and postal address of the office block. The tenant is responsible for the interior, exterior and structural repair.

Lease of part - the definition of “Premises” will specify, for example, the fifth floor of the office block. But it will also go into much more detail of the demise, such as including the floor and ceiling coverings, but not the structure nor exterior of the building. The tenant is only responsible for interior repair.

Question 41

Repair – who is responsible?

Answer 41

Lease of whole - the repairing responsibility is solely the tenant’s.

Lease of part - other demises are the responsibility of their respective tenants. Areas of the building or estate used commonly by all tenants (“common parts”), such as hallways, lifts and staircases, communal car parking, etc, are the responsibility of the landlord.

Although the landlord will bear responsibility for repairing the common parts, the landlord will recover the cost 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 42

Types of repairing covenant

Answer 42

The 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.

Full repairing obligation
A covenant containing a full repairing obligation (which is required for an FRI lease) might say:
“to keep the Premises in good repair”
Don’t be misled by the word keep, as this obligation means that if the premises are not in good repair, the tenant must put the premises in good repair.
A tenant taking on a full repairing obligation should obtain a survey so they are aware of any major items of repair.

Qualified repairing obligation
A covenant containing a qualified repairing obligation might say:
“to keep the 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 evidenced by the Schedule of Condition”
The schedule of condition will contain photographs recording the state of the premises.

By definition, this is not an FRI lease repair covenant, and only likely to be accepted by an institutional lender in exceptional circumstances (eg, a short letting or a difficult market).

Question 43

Limits of the repairing obligation

Answer 43

Unless the lease states otherwise, the tenant may generally choose whether to repair or replace an item of disrepair.

Note that if the premises are damaged beyond repair; for example, if subsidence has caused the premises to be so damaged that they need to be rebuilt, this is renewal, not repair and the tenant is not responsible for doing this under a simple repairing obligation. A tenant may be asked to covenant to renew the premises, but this is onerous and should be avoided.
If the lease refers to keeping the premises in good repair and condition, this is more onerous to the tenant (for example, condensation comes within condition, but not repair).

Question 44

Inherent and structural defects

Answer 44

If the property is newly constructed, it may have inherent or structural defects that only come to light over time. These may cause issues that the tenant would be obliged to repair under its repairing obligation.
This is unfair, as the tenant is not responsible for them, and the landlord should have warranties from the contractors (the builder, structural engineer, architect, etc) that the landlord can rely on.
A tenant taking a lease of a newly constructed property should ensure that inherent and structural defects are therefore excluded from the tenant’s repairing obligation and service charge contributions.

Question 45

Insurance

Answer 45

A commercial landlord will almost always be responsible for the insurance of the building (even where it is a lease of whole). In keeping with the principles of an FRI lease, the cost of insuring will be recovered from the tenant under the lease.
In a lease of whole, the landlord will insure the whole, and the sole tenant will refund the landlord the whole of the insurance premium.
In a lease of part, the landlord will insure the whole, and each tenant will refund the landlord a proportionate part of the insurance premium.
The money that the tenant or tenants pay to the landlord will usually be referred to as “insurance rent”.

Question 46

Insured risks

Answer 46

A typical definition of insured risks in a lease might look like the following:
fire, explosion, lightning, earthquake, tempest, storm, flood, bursting and overflowing of water tanks, apparatus or pipes, damage to underground water, oil or gas pipes or electricity wires or cables, impact by aircraft and aerial devices and articles dropped from them, impact by vehicles, subsidence, ground slip, heave, riot, civil commotion, strikes, labour or political disturbances, malicious damage

These are the risks that will be covered by the insurance policy taken out by the landlord. The definition may allow for the landlord to add other risks to the list from time to time.
They will also be excluded from the tenant’s repairing obligation, except in certain instances (eg, if the tenant’s negligence means that the insurance is not paid out).