Structure and content of lease

Question 1

What are the essentials of a lease?

Answer 1

• Exclusive possession
• Formalities are complied with
• Fixed term / periodic tenancy
• The reversion (the interest that the landlord holds subject to the lease)

Question 2

What are the formal requirements for a lease?

Answer 2

• Term is over 3 years = must be created by deed
• Term is 7 years or more = deed and registration at Land Registry
• Tenancy of 3 years or under = can be created in writing or orally (no formalities required)

Question 3

What are the advantages of having a lease (compared to a licence)

Answer 3

A lease is a proprietary right in the land, which means it can be enforced against third parties and tenants have greater protection and remedies available

Whereas a licence is only personal permission to occupy someone’s land and cannot be enforced against third parties. There is no security of tenure and no statutory protection

Question 4

What are common lease provisions (content of the lease)?

Answer 4

• Repair
• Insurance
• Alterations
• User and planning
• Rent and rent review
• Alienation

Question 5

Drafting and negotiating the terms of the lease - solicitor’s objectives acting for the landlord (checklist for interview / clauses which need to be included in the lease)

Answer 5

• An institutional landlord should insist on a full repairing and insuring (FRI) lease. This means that the costs are met by the tenant
• The landlord’s primary concern is to maximise their investment

Landlord’s concerns/objectives:
- insure the premises
- keep premises in repair
- only use premises for permitted purposes
- control over who occupies (e.g., assignment of the lease)
- alteration by the tenant
- increase the rent in line with market value

Commercial considerations:
- The reputation as a landlord - to what extent is it important that the landlord builds a strong reputation

Question 6

What is an FRI lease?

Answer 6

It is a commercial lease where the tenant is responsible for all costs of repairs, maintenance and insurance, for both the exterior and interior, even if the property is in poor condition when the lease begins

Question 7

Drafting and negotiating the lease from the tenant’s perspective

Answer 7

The tenant will want a lease which allows them:
- to use the premises for the intended purpose
- contractual term which is satisfactory

The tenant will not want:
- onerous restrictions which prevent the tenant from using the premises for its intended purpose
- onerous restrictions which make it difficult to assign to a third party
- excessively unfair provisions

Question 8

Questions to ask a landlord client when taking instructions regarding drafting a lease

Answer 8

Opening question - what their experience is in leasing (personal or commercial)

1. Describe the premises –> understand the premises physically
   - if the Landlord has an agent - obtain their details
   - ask about roads / entrance / communal spaces
   - service charges?
2. How much are you planning to charge for rent?
   - annual rent
   - service charge per tenant (if communal)
3. How long do you anticipate the leases being for?
   - Would you open to the tenants wanting to stay in the premises longer?
   - Break clause - is there a minimum you want the tenants to be in the property for? Tenants may want to end a lease early by a break clause
   - Do you want the break clause built into the lease (or something which is negotiated on a tenant by tenant basis)
   - Would you like the break clause to be mutual or just you as the landlord?
4. What is the current use?
   - Only one use / or are you open to other uses?
5. Security of tenure - the lease does not come to an end and the tenant has the right to ask for a new one. The lease continues after the end of the contractual term.
   - How do you feel about security of tenure?
   - Have you spoken to your agent about this? They can advise you on whether this would make your lease more attractive to tenants (based on the general market)
6. Rent review?
7. What is the state of repair of the premises at the moment?
   - Need the premises to be in a good state of repair
   - If it is currently in good repair, can build into the lease a higher standard of repair
   - service charge to recover the landlord’s responsibilities
8. Do you have building insurance in place?
9. What is your feeling on a tenant moving out and selling their lease to someone else? (Assignment)
   - alternatively, what are your feelings about subletting the lease (part or whole)?
10. How do you feel about altering the premises?
    - knocking down walls / interior changes / changes to the layout or structure
    - we can insist that the tenants hand it back in the way they got it
11. (If relevant) Have you opted to tax?

Question 9

What you need to remind / advise a landlord client on

Answer 9

Take instructions regarding their objectives / wishes, but advise that the tenant may come back to try and negotiate the lease

Question 10

Advising a landlord client on assignment

Answer 10

• We can insist on the tenant getting your consent
• We can build into the lease standard situations whereby you can say no (to them assigning / selling on their lease to a third party)
• As soon as you require consent in the lease, you must be reasonable in refusing consent. You need to be objective in refusing
• To provide you with comfort, we can build into the lease that the current tenant you have must guarantee the tenant coming in (this is an AGA - authorised guarantee agreement)

Question 11

What information might you require from landlord client after taking instructions (client next steps)?

Answer 11

• Plans of the property sent over
• Title documents sent over
• Details of insurance policy

Question 12

Solicitor next steps when drafting a lease

Answer 12

• Timeframes - how quickly does the client want this done
• Firm standard precedent for commercial leases, can tailor this and work on this. Get draft to you as soon as possible
• Draft the lease and send an email to you about the information we need

Question 13

Practical information which you need to obtain from the landlord client

Answer 13

• How quickly do they want to start leasing the premises (timeframes)
• Do they have any current interest from prospective tenants
• Who are the intended tenants?
• What is their experience?
• Any other concerns?
• Ownership: do they own the freehold?

Question 14

The lease term

Answer 14

• Must be determinate
• FRI leases are generally a fixed term
• Typical commercial lease terms are 3, 5, 10 or 15 years
• The term commencement date is the date on which the lease term starts

Calculating the expiry of the lease term:
- “From and including” = term expires on the day before that day of the relevant year it expires
- “From” = term starts on the day after that day and expires on that day of the relevant year it expires
- “Commencing on” = expires on the day before that day of the relevant year

Question 15

Why is a break clause useful?

Answer 15

If a tenant is unsure about the commitment of a lease term and the landlord is unwilling to grant a shorter term

Types:
- Landlord break = only landlord can exercise it
- Tenant break = only the tenant can exercise it
- Mutual break = either party

Question 16

What can the parties do if the lease does not contain a break clause?

Answer 16

If the lease does not contain a break clause, neither the landlord nor the tenant can bring the lease to an end early without the agreement of the other

Question 17

Why might it be advantageous for a landlord to offer a tenant a break clause?

Answer 17

Exercising a break clause is not easy, it is onerous and can be easily forgotten. The tenant must comply strictly with its conditions to validly exercise it.
- A landlord can hope tenants do not exercise it. 10 year lease with break is more valuable than 5 year lease
- Tenant might be more inclined to stay where there is a break clause
- The strict conditions are not advantageous for a tenant client - advise on the onerous nature

The break clause conditions are typically that 6 months notice is given and be up to date with rent.

Example:
* If client [tenant] knows they only want a five-year lease – it is a big risk to take on a ten-year lease in the hope of exercising a five-year break clause – as it is onerous and risky to rely on this break clause
o Better to take five-year lease and negotiate for new lease at the end if they want to extend it

Question 18

Rent

Answer 18

• Rent in a commercial FRI lease is usually defined to include service charge and insurance premiums, as well as annual rent
• Rent usually expressed as a yearly figure, but payable quarterly

Question 19

Types of rent review

Answer 19

• There is no implied right for the landlord to increase the rent
• An FRI lease of 10 years or more usually contains a rent review clause. For a commercial lease of 10 years, expect a landlord to insist on at least one rent review
• Commercial leases almost always have an ‘upwards only’ rent review, which means the rent can only increase

Purpose:
- Account for upwards movement in the market rent, to allow the landlord to charge more in line with open market rent
- Parties will try to agree the rent review and if they cannot, they can appoint an independent third party valuer

Question 20

How will the independent third party valuer assess the new rent (upon rent review)

Answer 20

Rent payable for comparable premises (similar size and location) and the terms of a hypothetical lease

Question 21

What are basic assumptions for the hypothetical lease?

Answer 21

• The premises are vacant and available
• There is a willing landlord and a willing tenant

Question 22

What are common disregards?

Answer 22

Disregard what the tenant has done voluntary, and not as an obligation of the lease

The rationale behind this is that the tenant should not be penalised with higher rent if the tenant has improved the premises for its own use

Question 23

The fairness of assumptions / disregards

Answer 23

• It is fair to assume that the tenant has complied with its obligations, as otherwise the tenant can benefit from its disrepair. The tenant cannot cause disrepair to devalue the property and use this to stop rent increasing
• It is fair to disregard tenant improvements and goodwill, otherwise the tenant is penalised for voluntary improvements
• It is unfair to assume that the landlord has complied with its obligations, otherwise this would allow the landlord to charge higher rent even if they have not fulfilled their obligations. This would be unfair as tenants would be paying for services they are not receiving

Question 24

What happens after rent review?

Answer 24

• New rent review document is a rent review memorandum. This document records the new rent and is signed by the landlord and tenant
• If the rent review is before the 5th anniversary of term commencement date, the tenant may have to pay further SDLT / LTT

Question 25

Market rent and ground rent

Answer 25

- Market rent lease is usual in commercial FRI leases. They reserve a substantial monthly or quarterly rent, which is often payable in advance - Long lease (ground rent lease) is more common for residential long leases for a minimum of 99 years. The tenant pays an upfront premium at the start and then pays only a nominal rent that relates to the serve and maintenance of common parts

Question 26

What is the Code for Leasing Business Premises?

Answer 26

It sets out mandatory requirements and good practice intended to improve the fairness of lease negotiations As landlords generally have strong negotiation positions, it improves the quality and fairness of lease terms and makes drafting more efficient The Code does not fetter the parties' ability to negotiate terms, but it does require them to be transparent and ensure the terms are set out clearly

Question 27

Who does the Code apply to?

Answer 27

All members of RICS and RICS regulated firms - It applies to most commercial lettings, except tenancies of 6 months or less or licences

Question 28

Mandatory requirements of the Code

Answer 28

- 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 letting agent is responsible for ensuring the heads of terms compliant with the Code are agreed before the draft lease is circulated - Must prepare written heads of terms stating that it is subject to contract

Question 29

Good practice under the Code ('should')

Answer 29

- Heads of term should clearly define the Premises - Heads of term should clearly specify the length of term, renewal rights and break rights - Clearly state initial rent, payment of rent, and whether VAT is charged - Landlord's title: landlord is responsible for obtaining any consent to grant the lease - Repairs: tenant's repairing obligation should be appropriate to the length of term and condition of the premises - Insurance and damage: the lease should suspend the rent if the premises are damaged by an insured or uninsured risk

Question 30

What is the position under the Code for the break clause?

Answer 30

The tenant can exercise the break clause provided all outstanding rent is fully paid and the premises are left free of occupation (vacant)

Question 31

What are the feature of an FRI lease?

Answer 31

- Tenant is made responsible for keeping demise in full repair - Landlord insures the property, but recovers the cost from the tenant by insurance rent - Services are paid for by tenant by service charges - Any costs, such as applying for consents, are met by the tenant - Lease tightly controls alienation - Lease contains upwards only rent reviews FRI lease aims to maximise income stream from investment property

Question 32

Negotiation of lease provisions

Answer 32

Negotiation will depend on the bargaining strength of the parties and whether the market at the time favours landlords or tenants

Question 33

Under an FRI lease, what can a landlord require if the tenant's covenant strength is insufficient?

Answer 33

- Rent deposit (documented by rent deposit deed) - Guarantor (for a company, this could be from a director or a parent company)

Question 34

Drafting the lease

Answer 34

Landlord's solicitor drafts the lease

Question 35

Agreement for lease

Answer 35

In a grant of commercial lease, only usual to have an agreement for lease where there is good reason - E.g., parties want to bind themselves, but are not yet ready (construction) Usually contains final form of draft lease

Question 36

Tenant's solicitor's role

Answer 36

Risks of being unrepresented: - Unfair lease terms (lease often heavily drafted in favour of landlord) - Uninformed tenant - Title problems The solicitor should: - Negotiate lease - Advise tenant - Investigate title

Question 37

Completing the lease

Answer 37

- Landlord's solicitor sends a completion statement: shows the rent, insurance rent and service charge on completion - Lease is prepared as original (executed by landlord) and counterpart (executed by tenant)

Question 38

What happens on completion?

Answer 38

Landlord's solicitor acknowledges receipt of completion monies and agree to date and send each other executed original and counter part lease

Question 39

Post-completion

Answer 39

Landlord: - Landlord's solicitor sends the landlord the money - Standard summary or short term report setting out standard terms Tenant: - pay SDLT - registration of lease

Question 40

Repairing obligation

Answer 40

In full repairing obligation, the tenant covenants to keep the premises in repair. This is strict and requires the tenant to put the premises in repair, if they are not in repair. Practical advice to tenant taking on a full repair obligation: - Obtain a survey to advise if there are any wants of repair at the beginning of the lease

Question 41

What is good repair and condition?

Answer 41

This goes further than a simple repair obligation

Question 42

What is the ideal repair obligation for the tenant?

Answer 42

Qualified obligation: 'but in no better state of repair and condition than they were at the beginning of the term' This does not meet standard of an FRI lease

Question 43

What are latent and inherent defects?

Answer 43

Problems which emerge in a newly built building and which emerge due to errors in design or workmanship. A tenant should not be obliged to repair these matters. A landlord should accept the risks and they have a remedy against the relevant contractor, under their warranties

Question 44

Insurance

Answer 44

In an FRI lease, the landlord insures the premises and recovers the cost from the tenant (insurance rent) - Tenant also bears the shortfall Lease sets out insured risks - These are standard Insurance should provide for full costs of reinstatement

Question 45

Damage or destruction by insured risk

Answer 45

1. Before advising - need to work out if it is an insured risk and/or if the tenant is responsible This is excluded from tenant's repairing obligation, unless the insurance is not payable because of the tenant's breach If the tenant is unable to occupy the premises, the rent is suspended, until damage is repaired Landlord covenants to use insurance monies to repair the premises

Question 46

Alterations

Answer 46

- If the lease is silent on alterations, the tenant is free to carry out alterations. This is provided the tenant does not do anything to devalue the premises (doctrine of waste) - The landlord will want to control this, meaning there is likely to be a covenant regarding alterations - The landlord is most concerned with alterations to the exterior of the premises

Question 47

Qualified covenant for alterations

Answer 47

If the lease contains a qualified covenant against alterations, it is converted to a fully qualified covenant, insofar as the tenant's proposed alterations are improvements from the tenant's perspective This means that the landlord cannot unreasonably withhold consent if the tenant considers the works amount to an improvement - If there is a fully qualified covenant - the tenant will not need to prove that the works are improvements - Note that the statute does not provide anything about unreasonable delay

Question 48

What conditions for consent to alteration can the landlord require?

Answer 48

- The landlord can require as a condition of giving consent reinstatement of the premises at the end of the lease term - Landlord can require payment of a reasonable sum for any damage or drop in value of the premises - Landlord can require payment of its legal expenses in giving consent

Question 49

Licence for alterations

Answer 49

The landlord's consent is documented by a licence for alterations. It contains details of the works consented to and any time limit for carrying them out Tenant's covenants in the licence: - Carry out the works in compliance with landlord's requirements - Obtain all necessary consents - Pay landlord's costs - Reinstate premises

Question 50

What can the tenant do if the proposed alterations are improvements but there is an absolute covenant against alterations?

Answer 50

The tenant can serve a notice on the landlord of its intention to carry out improvements. If the landlord objects, the tenant can apply for the court's permission to carry out the improvements. The court will grant permission if the improvements: i) add to the letting value ii) are reasonable and suitable to the property iii) will not diminish the value of any other property If the landlord does not object within three months, the tenant can carry out the improvements

Question 51

User and change of use

Answer 51

- Absolute covenant - prohibits change of use - Qualified covenant - allow changes of use with consent - Fully qualified covenant - allows changes of use with consent not to be unreasonably withheld There is NO statutory conversion of a qualified covenant to a fully qualified covenant

Question 52

What are the statutory provisions for change of use?

Answer 52

If a landlord decides to give consent to change of use, the landlord is not permitted to charge a large sum or increase the rent for giving consent, unless the change of use requires structural alterations

Question 53

Planning law for alterations and changes of use

Answer 53

- Alterations may involve building works and change of use may involve a change of use class (development) --> planning permission may be required The tenant must ensure they have the relevant consents and planning permission

Question 54

How is the change of use recorded?

Answer 54

Vary the lease using a deed of variation

Question 55

What is an absolute covenant?

Answer 55

An absolute covenant means that the act is not permitted under the lease. If the tenant wants to do the prohibited act, they can ask the landlord for consent, but the landlord is under no obligation to even consider the request. This means the tenant would be in breach of the terms of the lease if they were to go ahead with the act, without the landlord's consent

Question 56

What is a qualified covenant?

Answer 56

This is only permitted with the landlord's consent

Question 57

What is a fully qualified covenant?

Answer 57

The landlord must act reasonably in deciding to withhold consent