Commercial Lease Heads of Terms: what to look out for?

26/09/2019

By the time solicitors are instructed on behalf of a tenant in relation to a new commercial lease, heads of terms have often been agreed between the parties. However, this means that they have missed a vital chance to negotiate specific terms within the lease which may be to their advantage. By seeking professional legal advice BEFORE agreeing terms you can avoid costly negotiations and renegotiations.

Heads of terms are a summary of the terms that have been agreed between a tenant and landlord, often negotiated with the help of a surveyor, and act as the basis of a solicitor’s drafting of the lease.

As landlords are often represented by agents, it is unfortunate for tenants that, if they have not sought advice from a qualified professional on the proposed terms before they are agreed, there is often little ground for manoeuvre once heads of terms are agreed, and if further negotiations are necessary the process will become costly.  

Rent and reviews

Apart from the length of the term, the level of rent will be the most important consideration for a tenant. Not only will the tenant be contractually obliged to pay that level of rent until the end of the lease term but, depending on the length of the lease, there will be various opportunities for the landlord to increase its rent especially in a market in which rents are rising. In the current climate, retail rents are stagnating if not falling, but rarely will you find a commercial lease that allows for the rent payable under it to decrease in line with lower market rents. Instead, rents are reviewed upwards to market rent, if conditions allow, or remain the same. This is of particular interest to tenants taking leases of industrial units or offices, where the rental market remains buoyant and rents are increasing even in the current climate.

Whether a rent review is included is largely down to the length of the lease: the longer the term, the greater the need for rent reviews. The level of rent will also impact on any rent deposit (i.e. the higher the rent, the greater the rent deposit).

Breaks Clauses

Break clauses allow a party to terminate the lease at agreed points during the term of the lease and are another key consideration, particularly if the lease is for a new business. It is advisable to broach the subject of break clauses early in negotiations. If a tenant is opening a new business and has arranged for a shorter lease term of, say, 5 years (which is typical in such circumstances), a break will allow it to terminate the lease early limiting its liability for rent and other payments to those years preceding the break.

Occasionally, a landlord may insist on a mutual break, which allows both parties to break on a specified break date, and, on the rare occasion, a landlord may insist on a break if, for instance, it has plans for the property in future or, perhaps rarer, it is cautious about granting a lease to a tenant and wants the option to terminate should it be a late payer.

Tenants may wish to consider a fixed or rolling break, exercisable after a certain period, for greater flexibility, though these are often resisted by landlords in favour of fixed breaks to provide them greater certainty.

Repair clauses

One of the more contentious issues in a commercial lease is the tenant’s responsibility for repair. A full repairing lease, which the vast majority of commercial leases are, puts full responsibility for repair of the premises on the tenant, both inside and out. In such circumstances the tenant is responsible for keeping the premises in good, and sometimes substantial, repair. This can obligate a tenant to put a property in good repair notwithstanding that the property is in a poor state of repair at the point the tenant takes occupation. This is an onerous obligation and the landlord will expect the premises to be left in such a state of repair or will otherwise serve on the tenant a claim for dilapidations at the end of the term (i.e. a claim for damages for breaching the repair obligation, subject to statutory restrictions).

The tenant will be responsible through a service charge or similar clause for the structure and exterior of the building so that costs can be shared amongst all of the landlord’s tenants. With this knowledge, a tenant may be able to discuss with the landlord a schedule of condition for the lease which provides an itemised limitation of the tenant’s obligation to repair – though this is largely down to competition for the premises and the bargaining power of each party.

Security of tenure

You may hear the term “security of tenure” discussed by both surveyors and solicitors during negotiations or at the outset of a transaction, but the benefits of security are often overlooked, particularly as it is often the landlord’s agent who negotiates the heads of terms and it is rarely in the landlord’s interest to grant a lease with the benefit of it.

The Landlord and Tenant Act 1954 which introduced security of tenure, was intended to provide the tenant with protection against landlords exploiting any goodwill it may have built whilst trading in premises in order to secure better terms, such as higher rent. Although it allows a landlord to end the lease on particular grounds at the end of a term, for which a tenant could be granted compensation, the security of tenure provisions grant the tenant a right to a new lease at the end of the term on the same terms save for the contractual term and rent, which the landlord can set at market value. This is beneficial for the tenant and its exclusion should be resisted as far as possible.

Costs

Long are the days since it was customary for tenants to be responsible for the landlord’s costs on the grant of a lease, which also used to include disbursements and even stamp duty. The Costs of Leases Act 1958 relieved tenants of that custom and it is now typical for the landlord and the tenant to be responsible for their own costs, though it is not too farfetched to imagine a commercially savvy landlord insisting that a tenant pays its costs for the grant of the lease particularly if its premises are in high demand. That said, the grant of a new lease is beneficial for both landlord and tenant: both are in the deal to make profit, one from rent and the other from using the premises in a way that suits the tenant’s business. There is an element of risk for each party, such as the risk that either may withdraw before the lease has completed. However, this has always been the case and always will be and any attempts by the landlord to seek cover for its costs should be resisted, whether it is by way of a deposit, undertaking or otherwise.
Though it is now routine that a landlord and tenant are to pay their own costs as regards to the grant of a new lease or on any renewal, the option remains open for each party to come to a contrary agreement provided they do so in writing, such as including it in an agreement for lease or the lease itself, as appropriate.​

More information

Our experienced team of commercial property solicitors will always be happy to discuss the proposed terms of a new lease and a brief conversation at the outset of a deal can save a great deal of time and expense further down the line.

The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice. The law may have changed since this article was published. Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.

26/09/2019

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