Chapter 7: Grant of a Relief Flashcards
(142 cards)
1
Q
1 Introduction to leasehold transactions
A
This section is an introduction to leasehold transactions, and will put them in their commercial context
2
Q
1.1 Different types of lease
A
There are different types of lease. For example, it is common to find 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.
3
Q
1.1 Different types of lease
A
There are also assured shorthold tenancies, which 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
4
Q
Commercial leases are common
A
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
5
Q
Relatively short-term
A
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
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Q
1.2 Advantages of a lease – tenant’s point of view
A
From a tenant’s point of view, there are various advantages to taking a lease over buying a
freehold:
* 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.
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Q
1.2 Advantages of a lease – tenant’s point of view
A
- 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.
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Q
1.2 Advantages of a lease – tenant’s point of view
A
- 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.
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Q
1.3 Who are commercial landlords?
A
- 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
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Q
1.3 Who are commercial landlords?
A
- 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).
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Q
1.4 Institutional investors
A
- 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.
12
Q
Covenant Strength
A
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.
13
Q
1.5 Asset management
A
A common area of practice for commercial property solicitors is 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:
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Q
1.5 Asset management
A
- 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.
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Q
1.6 Summary
A
- There are residential and commercial leases, which tend to be quite different. Commercial
leases are the main focus of this course, but many of the principles are transferable. - There are various advantages to a business of taking a lease instead of buying a freehold.
- Most commercial landlords will treat the property primarily as an investment.
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Q
1.6 Summary
A
- Institutional investors are financial institutions, such as pension funds and life assurance
companies. - Asset management involves assisting a commercial landlord (which may be an institutional
investor) with the day to day management of the estate. - This may involve granting new leases, considering applications for consent, advising on breaches of the lease, and dealing with the issues at the end of the lease.
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Q
2.1 Lease definition
A
Woodfall’s Law of Landlord and Tenant defines a lease as:
‘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.
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Q
2.2 Essential ingredients of a lease
2.2.1 Exclusive possession
A
Exclusive possession is an essential ingredient of a lease (distinguishing it from a licence). 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.
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Q
2.2.2 Fixed term or periodic tenancy
A
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.
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Q
2.2.3 Formalities
A
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.
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Q
2.2.3 Formalities
A
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.
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Q
2.3 What is a lease?
A
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
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Q
2.3 What is a lease?
A
Drafting and negotiating the terms of a lease is an important part of the work that the landlord’s and tenant’s solicitors undertake. We will look at the landlord’s and tenant’s (and therefore their solicitors’) objectives in negotiating
the terms of the lease.
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Q
2.4 Landlord’s objectives
A
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
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The landlord will want a lease that ensures the premises are:
* insured
* kept in repair
* only used for the permitted purpose
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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)
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2.5 Tenant’s objectives
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
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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)
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2.7 Summary
* A lease grants exclusive possession, is for a determinate term, and if over 3 years, must be
executed by deed
* The landlord’s interest (subject to the lease) is the reversion
* An institutional landlord will want an FRI lease
* Most landlords will be in the dominant negotiation
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2.7 Summary
* A landlord’s concern is to maximise their investment by ensuring a clear rental stream, and retaining control over the premises
* A tenant’s concern is to be able to use the premises for their intended purpose, and have
flexibility to, for example, pass the premises on if needed
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3 Term of a lease, break clauses, rent and rent review
3.1 The lease term
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.
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3.1 The lease term
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 (or even no) Stamp Duty Land Tax or Land Transaction Tax on a shorter
tenancy.
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3.2 The term commencement date
Term commencement date: This is the date on which the lease term starts.
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The term commencement date
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!
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Term may start after lease is dated
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.
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3.3 Calculating the expiry of a lease term
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…
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3.3.1 Meaning of ‘from and including’
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). For example, a lease with a term of 10 years from and including 24 March 2019 expires on 23 March 2029
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3.3.2 Meaning of ‘from’
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). For example, a lease with a term of 10 years from and including 24 March 2019 expires on 23
March 2029
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3.3.2 Meaning of ‘from’
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). For example, a lease with a term of 10 years from 24 March 2019 will start on 25 March 2019 and expire on 24 March 2019
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3.4 Break clauses
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 be a compromise. 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.
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3.4 Break clauses
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)
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Anniversary
Anniversary: This 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.
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3.4.1 What’s the difference?
You might wonder why the landlord would accept say, a five year tenant only break clause on a ten year lease, but not a five year term. In either case the tenant can bring the lease to an end at
five years, so what’s the difference?
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3.4.1 What’s the difference?
You will be familiar with Internet-based companies who offer a free first month in the hope that you subscribe and forget to cancel. Similarly, landlords will offer a longer lease with a break
clause hoping that the tenant will not use it. Like cancelling Internet subscriptions, exercising a break clause is not easy. A surveyor valuing the landlord’s reversion is likely to consider a 10 year lease with a 5th
anniversary tenant’s break more valuable than a 5 year lease.
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3.5 Rent
Most leases fall into one of two categories: either a short lease with a market rent; or a long lease with a ground rent.
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3.5.1 Rent in commercial leases
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.
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3.5.2 Rent in residential leases
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.
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3.6 Rent in a commercial FRI lease
* 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
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3.6 Rent in a commercial FRI lease
* 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)
* Rent is usually due in advance on the quarter day – for example, on 25 March for the whole
period up to and including 23 June
* 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.
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3.6 Rent in a commercial FRI lease
* Earlier in this section, 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.
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3.6 Rent in a commercial FRI lease
* 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 chapter on termination of leases. The rent proper is often referred to as the ‘annual rent’ or ‘yearly rent’.
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3.6.1 Types of rent review
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.
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3.6.2 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…
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3.6.3 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).
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3.6.4 Index-linked rent
The rent is increased by reference to an agreed measure of inflation, such as the retail prices index
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3.6.5 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.
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3.7 Open market rent review
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.
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3.7 Open market rent review
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:
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3.8 The hypothetical lease
From the starting point of the actual lease (and premises), the rent review provisions instruct the valuer on assumptions (matters to assume) and disregards (matters to be disregarded). The hypothetical lease differs therefore from the actual lease (and premises).
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3.8.1 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
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3.8.2 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.
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3.9 Assumptions
The tenant has complied with all its covenants under the lease.
Yes. If the tenant, say, lets the premises fall into disrepair, it should not be rewarded with a lower rent
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The landlord has complied with all its
covenants under the lease
No. Say that the lift in an office block never works. This would affect the rent that tenants would pay. From the tenant’s perspective, the assumption is unfair, as the landlord is not suffering the consequences of its inaction.
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On the terms of the actual lease other than the rent payable
Yes. If the actual lease, for example, has
clauses that are very restrictive on the
tenant’s use of the property, the tenant is stuck with those and should not have to pay a higher rent as if those clauses do not exist.
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The term of the hypothetical lease is the term remaining of the actual lease.
Maybe! This is a tricky point, and can depend on the particular market, and whether prospective tenants favour short or long lease terms. Say that 5 years are left at rent review, and prospective tenants want 5 year leases.
This would work against the tenant who
initially took a 10 year lease.
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If damaged or destroyed, the premises have been repaired or rebuilt.
Yes. This is because the lease will usually have detailed provisions for what happens in this instance (including suspending the rent). It would be unfair on the landlord if the tenant continues to pay a decreased rent as if the
premises have been destroyed once they have been rebuilt!
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3.10 Disregards
This table looks at disregards in more detail
The effect of the tenant’s occupation on the rent.
Yes. The premises will be worth more to the tenant than a new prospective tenant, as the tenant has the convenience of not having to move.
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Goodwill attached to the tenant’s business.
Yes. Say the tenant is a restaurant business. If successful, the tenant will make that location more valuable to other restaurant businesses. It is unfair for the tenant to be penalised with a higher rent for this.
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Tenant’s improvements (other than as obliged under the lease)
Yes. If the tenant voluntarily improves the
property, then it is unfair to the tenant if this is used to increase the rent, and unfair to the landlord if it limits the rent.
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3.11 What happens after rent review?
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.
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3.11 What happens after rent review?
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
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3.11 What happens after rent review?
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)
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3.12 Summary
* Commercial leases are usually for a fixed term. Landlords will tend to prefer longer terms, whereas tenants’ preferences will depend on their business requirements.
* A tenant’s break clause can offer a compromise where a landlord wants a longer term and tenant wants the ability to end the lease early.
* Commercial leases are usually granted at a market rent, expressed as a yearly rent but payable quarterly
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3.12 Summary
* For terms longer than 5 years, there will usually be rent review provisions. For an FRI lease the rent review will be upwards only.
* There are different options for rent review: stepped rent, index-linked rent, turnover rent and open market rent.
* Open market rent review is complex and depends on a hypothetical lease with assumptions and disregards which may lead to a fairer result (but can be contentious).
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4 Code for Leasing Business Premises
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
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4 Code for Leasing Business Premises
Previous codes existed, but were entirely voluntary, and their influence over landlord and tenant negotiations was limited. The 2020 Code, however, does have stronger powers as this section will explore.
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4.1 Where does the Code come from, and to whom does it apply?
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.
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Example
A commercial landlord employs a letting agent to find tenants and negotiate heads of terms. The letting agent is an RICS regulated firm. The letting agent will be professionally obliged to take account of the Code in negotiations. Note that neither the landlord nor the landlord’s solicitor are
obliged to do so, however, unless they are members of the RICS or RICS regulated firms in their own right.
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4.2 What does the Code contain?
The Code concerns itself with negotiations and heads of terms, and is divided into mandatory requirements and good practice.
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4.2.1 Mandatory requirements
Mandatory requirements are indicated by the word ‘must’. RICS members and regulated firms must follow them.
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4.2.2 Good practice
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.
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4.3 Mandatory requirements
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
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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
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4.4 Good practice
The rest of the Code (which is much more detailed) indicates good practice. As RICS members and regulated firms are obliged to follow good practice unless there is justification not to, it is likely that the provisions of the Code will become standard in time.
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Premises
The heads of terms should clearly define the demise, provide a lease plan and refer to all the rights that the tenant will need for its use of the premises (eg, the right of access to the premises, water and electricity, etc).
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Length of term, renewal rights and break
rights
The heads of terms should clearly specify the length of term and any break rights.
The Code sets out basic conditions to
exercising the break that are acceptable;
others may be included but must be specified in the heads of terms. (This is an area where landlord-weighted drafting of the lease can make it very difficult for a tenant to exercise the break.)
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Rent and rent review
The heads of terms should clearly state the initial rent, frequency of payment (eg, quarterly) and whether VAT will be charged. They should also state whether there is a rentfree period (for example, the tenant may not have to pay rent for the first three months while they are fitting out the premises for their purposes).
If the landlord intends to review the rent, then the tenant should be advised how (eg, market rent, turnover, etc) and how often (eg, every fifth year).
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Landlord’s title
The landlord should be responsible for obtaining any consent needed to grant the
lease (such as from a superior landlord, mortgagee or any other third party).
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Repairs
The tenant’s repairing obligation should be
appropriate to the length of the term and the condition of the premises. (An extreme example might be that it would be unfair to ask a tenant on a 6 month tenancy to take a full repairing obligation of premises that are badly dilapidated!)
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Repairs
If the tenant gives a qualified repairing obligation (ie, limited to the initial state of the
premises), a schedule of condition should be required.
Where the premises are newly built, the tenant should be given appropriate protection
against inherent construction defects
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Insurance and damage
The lease should suspend the rent if the premises are damaged by an insured risk
(unless the damage is due to something the tenant has done or not done) or an uninsured risk.
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4.5 Summary
* The Code aims to make commercial lease negotiations fairer and more transparent
* The Code applies to RICS members and RICS regulated firms
* The Code does not apply to clients, property professionals or legal advisers who are not
regulated by the RICS
* Solicitors, however, should be familiar with the Code as landlord clients or their agents may be bound by it
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4.5 Summary
* The mandatory requirements must be followed by RICS members and concern themselves with
the manner of negotiation and the content of the heads of terms
* The statements of good practice must be followed by RICS members unless there are strong reasons not to, and go into more detail on what should be specified in the heads of terms, and what are acceptable lease terms
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5 Grant of a lease procedure
Like freehold transactions, some grant of lease transactions can be divided into three main stages, divided by exchange and completion. For ease of comparison with freehold transactions, a three stage transaction will be examined.
However, grant of lease transactions commonly do not require an exchange, in which case there are only two stages - pre-completion and post-completion.
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5 Grant of a lease procedure
Like freehold transactions, some grant of lease transactions can be divided into three main stages, divided by exchange and completion. For ease of comparison with freehold transactions, a three stage transaction will be examined.
However, grant of lease transactions commonly do not require an exchange, in which case there are only two stages - pre-completion and post completion
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5.1 Pre-exchange
Landlord's solicitors /
Tenant's Solicitors
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Take instructions
Take instructions
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Prepare draft lease and, if relevant, agreement for lease (ie, if there is to be an exchange)
Review draft lease and agreement for lease and amend as required
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Deduce title (and check that lender will consent to letting) and respond to any queries on title
Investigate title and raise any queries on title
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Answer pre-contract enquiries
Raise pre-contract enquiries and searches
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Once agreed, engross the agreement for lease, obtain landlord’s signature, and send counterpart to tenant’s solicitor
Arrange for tenant to sign counterpart lease
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5.1 Pre-exchange
Engross: This means to prepare a final copy for signature (eg, on good quality paper and bound. This copy is referred to as an engrossment. Original: This is the engrossment of a lease that is executed by the landlord. Counterpart: This is the engrossment of a lease that is executed by the tenant
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5.1.1 Drafting the lease
The landlord’s solicitor will draft the lease based on the heads of terms. The solicitor may use a generic precedent lease (eg, Practical 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.
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Example
An institutional landlord has an industrial estate with ten warehouses on it. Eight of the
warehouses have been let already, and heads of terms have been agreed for the ninth. The landlord’s solicitor uses a precedent specific to the estate. It will already be part-completed with the details that do not change from unit to unit, such as the landlord’s freehold title, description of the estate, and rights that are granted to all of the tenants.
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5.1.2 Agreement for lease
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
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Example
A developer builds a shopping centre which is due to be completed in two years’ time. The developer has found various retailers who are interested in taking units.
Rather than wait for completion of the centre, and risk losing interested parties, the developer will sign each retailer up to an agreement for lease providing for completion following practical completion of the shopping
centre.
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Tenant's solicitor will review the agreement
Similarly with the draft lease, the tenant’s solicitor will review the agreement for lease and amend any provision they feel appropriate in favour of the tenant.
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5.1.3 Investigation of title, searches and enquiries
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).
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5.1.3 Investigation of title, searches and enquiries
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
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5.1.3 Investigation of title, searches and enquiries
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.
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5.2 Exchange
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
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5.2 Exchange
* 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
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5.3 Pre-completion
Landlord’s solicitor
Tenant’s solicitor
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Prepare original and counterpart lease, obtain
landlord’s signature to original and send
counterpart to tenant’s signature
Arrange for tenant to sign counterpart lease
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Prepare and send completion statement, detailing the money due on completion (eg, any apportioned annual rent, service charge and insurance rent)
Obtain funds from client needed to complete as per completion statement
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5.3 Pre-completion
Raise pre-completion searches
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5.3.1 Completion statement
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.
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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, which is found by dividing the yearly rent by 365 (or 366 in a leap year)
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5.3.1 Completion statement
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.
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5.4 Completion
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
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5.5 Post-completion
Send summary of main provisions of lease to
client
Arrange to submit SDLT or LTT return and pay appropriate SDLT or LTT if necessary
Register lease if necessary
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5.6 Summary
* A grant of lease transaction may follow the same steps as a freehold transaction, ie, preexchange, exchange, pre-completion, completion, post completion.
* Exchange is not always necessary, but may be if the parties have conditions to satisfy before completing the lease. If exchange takes place, the contract is referred to as an agreement for
lease.
* Pre-exchange is similar to a freehold transaction (title investigation, searches and enquiries) but additionally the lease (and, if appropriate, agreement for lease) must be drafted and agreed.
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5.6 Summary
* Exchange is similar, but a deposit is not usually paid.
* Pre-completion involves circulation of a completion statement and the tenant’s solicitor will carry out pre-completion searches.
* Completion is straightforward, and simply involves payment of the completion monies and
dating of the executed leases.
* Post-completion will involve payment of SDLT and
registration of the lease, if appropriate.
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6 Post-completion for grant of lease
6.1 Stamp Duty Land Tax (SDLT) and Land Transaction Tax (LTT)
For the basic principles of SDLT and LTT (such as the deadlines and paperwork required), see the relevant sections on post-completion of freehold. Note that for the grant of a residential long lease, the calculation is similar to that for purchasing a freehold.
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6.1 Stamp Duty Land Tax (SDLT) and Land Transaction Tax (LTT)
The basis of calculation, however, is different for a commercial lease with a market rent payable.
Note that this is included for completeness and will not be tested on SQE1. SDLT and LTT rates can change frequently and those shown are correct as at July 2023.
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6.1.1 Net present value
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).
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6.1.1 Net present value
This calculation uses a complicated formula, but both HM Revenue & Customs and the Welsh Revenue Authority offer an online calculator that can be used. The NPV, once calculated, forms the basis of the SDLT or LTT calculation
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What do you need to calculate the NPV?
* 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. The SDLT calculator can be found at https://www.tax.service.gov.uk/calculate-stamp-duty-landtax/#/intro
The LTT calculator can be found at https://lttcalculator.wra.gov.wales/
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Example
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.
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6.1.2 SDLT on commercial leases
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.
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Example
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.
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6.1.3 LTT on commercial leases
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.
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Example
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.
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6.2 Registration of leases
Unlike freeholds, not all leases need to be registered. Leases are treated differently depending upon the length of term granted.
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Term of leases
Up to 3 years
Treatment for registration purposes
Does not need to be registered. Cannot be noted against the landlord’s title.
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More than 3 years up to 7 years
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).
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More than 7 years
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).
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6.2.1 Procedure for registering a lease
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
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6.2.1 Procedure for registering a lease
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.
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6.3 Summary
* SDLT and LTT are calculated on the Net Present Value, which is derived from the rent for each of the first five years and the term of the lease.
* Once the NPV is known, the calculation of SDLT or LTT is very similar to the calculation for a freehold purchase price, except that the rates and thresholds are different.
* Lease of 3 years and under are not registrable and cannot be noted against the landlord’s title
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6.3 Summary
* Leases of over 3 years up to 7 years are not registrable but can be noted against the landlord’s title.
* Leases of over 7 years are registrable and will be noted against the landlord’s title.
* On registering a new lease, the tenant’s solicitor will receive official copies for the new leasehold title and the landlord’s updated title.
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