Commercial Leases: Heads of Terms

In this advisory note on Heads of Terms, Owen Walsh in our Commercial Property team will analyse the key aspects of what make up well-written heads of terms:

  1. What they are and why they are so important
  2. Negotiating the commercial terms:
    1. Rent
    2. Length of term and security of tenure
    3. Break clauses
    4. Dealings
    5. Repairing obligations
    6. Alterations
  3. Tenant’s financial covenant strength
  4. Conditions to the lease

The focus of this note will broadly be from the perspective of tenants but include important considerations for all parties to a commercial lease.

If you are considering taking a lease of commercial property and would like to know more about the obligations and financial implications, speak to our experienced team of commercial property advisors.

At GoodLaw we can advise on all aspects of commercial leases, call us on 01273 956270 or email [email protected].

Commercial property contract

1. What Are Heads of Terms & Why Are They So Important?

Heads of terms are usually prepared by the commercial agent that has brokered the deal between a landlord and tenant. They set out, among other things:

  • Property: The heads need to identify the address of the property and importantly whether the lease is to be the whole of the building or part – for example, ground floor only.
  • The parties to the deal: This can include the landlord, tenant, guarantor, head landlord, and mortgage lender.
  • Commercial terms: This will be the key terms of the deal, to include rent, length of term etc. We will analyse these points in more detail later.
  • Conditions to the transaction: The deal should be subject to contract (as to which see below). It may also be subject to survey, references, board consent, mortgage lender’s consent, head landlord’s consent.
  • Contact details of the professionals: This can include landlord’s agent, tenant’s agent, any surveyors, managing agents, and solicitors for each party.

Commercial agents are important in putting together the key terms, the professional team, and negotiating what is important to both the landlord and tenant. Agents are also an important conduit throughout a transaction to ensure smooth communication between all parties.

Heads of terms should always be made subject to contract. This will ensure that they are not contractually binding. That said, if there is a dispute after completion of the lease, they can be relied upon as evidence of what the parties intended to agree.

Well-written heads of terms can cut down the amount of time spent by solicitors negotiating the terms of the lease.

Each party should think carefully before agreeing to heads of terms – when negotiating the terms of the lease the parties will always look back to what was agreed in the heads of terms. This can have an impact on your negotiating power if looking to undo what was agreed at heads of terms stage.

2. Negotiating the commercial terms

a. Rent

What most people will consider the most important aspect of the Heads of Terms – the annual rent! This represents to the landlord the value of their asset and is an important liability for the tenant.

Parties should always consider seeking professional expert advice on the annual rent to be agreed. Key considerations in respect of rent will be:

Rent-free periods

Rent-free periods are usually given at the beginning of a tenancy, during which no rent is payable by the tenant for a fixed period of time.

Rent-free periods may also be given during the period immediately following a break clause, as an incentive for a tenant not to exercise their break option.

All other things being equal, the rent-free period will usually reflect the cost and duration of the work an incoming tenant needs to carry out on the property to enable it to operate its business. If the Property is in a significant state of disrepair, the landlord is likely to agree to a longer rent-free period to compensate for the works required to bring the property up to scratch.

This is one reason why it is important to seek expert surveyor’s advice on the condition of the property.

In a falling market, rent free periods can also be used by a landlord to incentivise tenants to take the lease. Shopping centre landlords, institutional landlords or those with multiple properties in an area may also agree to an extended rent-free period to keep headline rents higher for comparisons.

Rent payment

The parties should also consider the following at heads of terms stage:

  • Rent payment dates: weekly, monthly, or quarterly? Landlords are likely to prefer quarterly payments, whereas some tenants may prefer shorter durations to assist with cash-flow
  • Method of payment: landlords will prefer a direct debit. Tenants may prefer to have some control and refer a standing order or CHAPS instructions on each rent payment date
  • Interest: when and how much interest will be payable on late payments? The Law society suggests 4% above the base rate of Barclays Bank, which is the industry standard for commercial leases

Rent reviews

A commercial lease of more than 5 years is likely to contain a rent review provision. Most rent reviews are upwards only – enabling the landlord to seek an increase in rent usually to reflect a rise in market conditions.

It is extremely rare not to have an upward-only rent review. However, if a tenant genuinely considers the market to be falling and the property is in a location with a lack of investment and development, the landlord may agree to upwards and downwards rent review as an incentive for a potential tenant.

In this challenging post-covid, inflationary time, landlords may need to consider more creative ways to entice tenants into difficult to let spaces. This is especially true for most landlords that will have to pay Business Rates on properties which are empty for more than three months.

Also, bear in mind that upwards only rent reviews do not necessarily mean the rent will go up – it simply means that it cannot go down. In a falling market, an upwards only rent review will result in the rent remaining the same.

The majority of rent reviews will be by reference to one of two things:

  • The open market (ie by reference to what a willing tenant is willing to pay for the same lease in the same area as the property on the date of the review).
  • Inflation – usually the Retail Prices Index or the Consumer Prices Index. This means the lease will increase by the same percentage as inflation from the date of the lease up to the date of review. This method usually provides for a collar and cap, meaning that the minimum increase will be, say, 2% and the maximum increase would be, say 5%.

A suitably qualified and experienced lawyer can advise on the pitfalls when it comes to the details of a rent review. When it comes to negotiating the heads of terms, the parties should consider these important factors:

  • when the review will take place
  • a tenant should consider having a break right at a similar time to rent review, in case the likely increase will make the premises unaffordable
  • upwards only – in twenty years of practice, I have seen upwards and downwards reviews once, in very specific circumstances
  • method of review – open market or RPI/CPI
  • whether tenant’s alterations are to be considered in the review. If the tenant is seeking to install, say, a mezzanine floor, the parties should consider how this will have an impact on rent at review
  • what happens if the parties cannot agree the revised rent – will it go to an independent surveyor to act as an expert, or as an arbitrator. This can have an impact on the costs that could be incurred if the parties cannot agree the revised rent

b. Length of term and security of tenure 

Broadly speaking, a landlord will want the term to be as long as possible, while a tenant is likely to want a short term to ensure flexibility.  There are exceptions to this general rule of thumb, for example:

  • a restaurant/bar operator may have a fairly high capital expenditure when taking occupation so will want security of tenure for a minimum period to ensure return on investment;
  • a landlord of property with development potential may only require income for a short period while it obtains planning, goes to tender and lines up the start of a development;
  • pop-ups or short term lettings may be desirable to a landlord of a newly developed estate/shopping centre while the landlord achieves full occupation – in these cirumstances the landlord will not want to fix an artificially low rent for five years if full occupancy is expected in one or two years, at which point the landlord may be able to command a higher rent

A tenant will need to consider the Stamp Duty Land Tax implications.  A longer term will result in the Net Present Value of the lease to be higher and therefore cause higher SDLT to be payable.  It may be possible to agree with the landlord a shorter lease term with an option to extend.  However, bear in mind that in the long-run this will not save SDLT as the lease extension will be considered a linked transaction to the original lease meaning SDLT is calculated on both transactions as a whole – if the initial saving is low, then the increase in professional fees may mean this is not worthwhile.  

Parties should always consider seeking professional expert advice on the length of term to be agreed.  

Security of tenure – the Landlord and Tenant Act 1954

The other important aspect regarding the term is security of tenure – will the lease be granted within the provisions of the Landlord and Tenant Act 1954?

Unless the parties go through the “contracting out” procedure, a tenancy of business premises will have security of tenure.  

If the lease is contracted out of the security of tenure provisions of the 1954 Act, the tenant will have no right to stay in the premises at the end of the contractual term.  It will then be down to negotiation between the landlord and tenant to agree terms for the tenant to stay – and if the landlord does not want to grant a new lease, it does not have to do so.

If the lease is granted with security of tenure under the 1954 Act, at the end of the term the tenant will have the right to call for a new lease unless the landlord can prove one of the statutory grounds to oppose a renewal.

Landlords should always seek professional advice to ensure that they properly “contract out” of the security of tenure provisions and not inadvertently grant a protected tenancy when it is not intended to do so.

Broadly speaking, as security of tenure offers significant protection to the tenant, it would be usual for the landlord to charge a higher rent in return for these protections. 

Opposing a renewal of a 1954 Act protected tenancy

The statutory grounds for opposing a renewal are:

  1. Fault grounds:
    1. Disrepair
    2. Persistent delay in paying rent
    3. Other substantial breaches, or tenant’s use and management of the property
  2. Non-fault grounds:
    1. The landlord offers suitable alternative accommodation
    2. Reletting or disposal as a whole – this is not frequently relied upon because it can only be used:
      1. Where the superior landlord is the competent landlord
      2. When terminating a sublease, meaning that the landlord must also prove it can gain possession of the property comprised in the head lease
    3. Landlord intends to demolish or reconstruct the property for redevelopment
    4. Landlord intends to occupy the property

Landlords should also be aware that they may be required to pay compensation if it successfully opposes a renewal on the basis of the last non-fault grounds (b), (c), or (d).  Compensation is calculated as being the rateable value of the property, or double the rateable value if the business has been in occupation for fourteen years or more.

Opposing a renewal of a 1954 Act protected tenancy is complex – specialist legal advice should always be sought before a landlord embarks on opposing such a renewal.  Equally, tenants should seek advice if they face a landlord unwilling to grant a renewal to see what their rights are and whether they can challenge an opposition, or if they cannot if they have the right to claim compensation.

c. Break clauses 

In order to offer a balance between certainty for both parties and flexibility, the parties will often agree to an option to end the lease early.  This is known as a “break option”.

There are several aspects to what makes up a break clause:

  • On a fixed date? Usually by reference to the date of the lease – third or fifth anniversaries for example.
  • Rolling after a certain date? For example “any date after the third anniversary”.
  • Landlord-only, tenant-only, or mutual?
  • Notice period? Usually on 6 months’ written notice, although the parties may agree a shorter or longer notice period.
  • Conditional?  For example, payment of compensation, giving up occupation, being up to date with rent payments etc.
  • Personal to the original tenant/landlord or benefitting successors in title?

The majority of break clauses will be tenant-only.  However, landlords may insist on a break option being mutual as a “quid pro quo” – receiving something in exchange for giving something.  

Landlords may have plans for the property that require vacant possession, but they maybe unsure as to when they will realise such plans.  In these instances, landlords may seek a landlord-only break option, and instead of being on a fixed date, will be rolling after a certain date.

Break options will usually be subject to 6 months’ written notice.  Specialist legal advice should be sought if you are considering serving a break notice – they are technical and if you get them wrong, you will be on the hook for the tenancy for the remainder of the term.  Particular traps can include:

  • Sending to the wrong address or wrong party.
  • Missing the deadline (for example the notice clause in the lease may state that “deemed receipt” is two working days after postage).
  • Emailing the notice when the lease requires the notice to be posted.
  • Typographical errors in the notice.

Parties should be wary when it comes to conditions attached to a break option.  The impact of falling foul of any condition is severe – it will mean that you will be on the hook for the lease for the remainder of the contractual term.  Common conditions that tenants should be wary of:

1. Complying with the terms of the lease

Tenants should always resist such a condition, even if offered with qualifying words such as “substantially complying with the reasonably material terms of the lease”.  

Such conditions will be strictly interpreted by a Court.  If, for example, the tenant has hung pictures on the wall using a small nail, it will be arguable that the tenant is in breach of the repairing covenant and therefore failed to comply with the condition.  

Even with the qualifying words, a dispute may be had as to whether putting nails in a wall is material – perhaps one nail in a large wall is not material, but what about 100?  There are no set formulae for what is “substantial compliance” and so it would be down to the power of argument.

In one Court case, a break right allowed the tenant to end the lease if the local authority objected to the user. The local authority objected and the tenant tried to break. Unfortunately, the break was conditional on absolute compliance with the lease covenants. The court decided the break was invalid as the tenant was in breach of the repairing covenant in failing to repair a fence. One minor breach—none of the other breaches alleged by the landlord was proved—cost the tenant £70,000 in damages and the lease continued after the break date.

2. Payment of rent and all other sums due under the lease

Landlords will want a condition that the tenant is up to date with all payments under the lease.  

Tenants should only accept a condition that the principal rent is up to date. Generally speaking, the principal rent will be a fixed amount and payable on known payment dates.  Other payments (for example service charge and insurance rent) may fluctuate and be subject to a genuine dispute. 

In one case, a tenant fell foul of an absolute condition which confirmed that the break notice was of no effect if any sums due under the lease were unpaid at the break date. The tenant had believed that there were no outstanding payments. However, under the lease, default interest did not have to be demanded. Unpaid interest of just £130 was sufficient to invalidate the break and cost the tenant £337,500 (the rent for the remainder of the term). The court acknowledged that the result was harsh. The sum was small and the landlord had been scouring the payment records to find instances of late payment even though it had not demanded the interest. Best practice for tenants is to agree to confine a condition that the payments are up to date to the principal rent to avoid such a scenario.

3. Vacant possession

This is a strictly interpreted important legal phrase.  Tenants should generally resist a condition requiring vacant possession of the property on the break date.  A requirement to deliver up vacant possession has three aspects:

  1. People: the tenant must have ceased using the premises
  2. Items: has anything been left behind that ‘substantially prevents or interferes with the enjoyment of the right of possession of a substantial part of the property’
  3. Legal interests: the property must be free of rights of third parties to take possession

In one case, the tenant was held by the Court to have failed to provide vacant possession when a security guard and workmen carrying out repair works were present at the property.

Landlords’ break clauses may also be subject to conditions, commonly:

  1. Compensation: Payment of compensation for the cost of fit out if the break is in the first five years, usually on a straight line depreciation basis (ie if the break is in the first year, 100% of the cot is refunded, in year 2, 80% and so on).
  2. Planning permission: If the break is for the purposes of redevelopment, the tenant may wish to insist on the break notice being accompanied with evidence that the development is genuinely intended (for example, planning permission has been granted).
The Lease Code

The Code for Leasing Practice 2020, issued by the Royal Institution of Chartered Surveyors states that the only conditions that should be imposed on a tenant break are payment of the basic rent, giving up occupation (not “vacant possession”) and leaving no sub-tenants or other occupiers.

While the Lease Code is not binding, there are several institutional landlords that have signed up to the Code.  If tenants are struggling to reach an agreement on what conditions are acceptable, it is always worth referring to the Code in an effort to be more persuasive.

Return of over-payment of rent

The tenant should ensure that the landlord commits to return any rent paid for the period after the break date.  

In a particularly notorious case, Marks & Spencer was required to pay the rent yearly in advance on the usual quarter days. On 25 December 2011 M&S made a full quarter’s rent payment for the period 25 December 2011 to 24 March 2012. M&S had complied with the pre-conditions to the break and the lease came to an end on 24 January 2012.

The Supreme Court held that the landlord, BNP Paribas, was not required to return the rent for the period from 25 January to 24 March 2012 as there was not clause in the lease requiring such repayment.

The rule is now therefore clear that when negotiating the terms of a lease, if the break is conditional on payment of rent, the tenant should ensure that either (1) the break date is the day before the quarter date; or (2) the lease contains a clause requiring a landlord to refund the rent from the break date to the end of the quarter.

Break clauses are extremely technical and as set out above can have numerous traps both in the drafting of the clause and in the exercise of the option to break.  Care should always be taken and expert legal advice should always be sought when considering a break clause.

d. Dealings (aka “Alienation”) 

Along with the break clause, alienation can offer the tenant a “plan B” if the business at the property does not go as expected.  This needs to be balanced with the landlord’s requirement for control to ensure (among other things):

  1. The tenant paying the rent has sufficient financial covenant strength to enable it to comply with the terms of the lease.  A well-advised landlord will have carried out checks on a new tenant prior to the grant of the lease.  It does not want to end up in a position where the lease is assigned to an inferior tenant who may not be able to afford the rent.
  2. A good “commercial mix” can be important for landlords of retail parks, shopping centres and even office buildings.
  3. A single-let building does not become occupied by multiple businesses, making management and administration more burdensome.

There are several ways a tenant can deal with a lease – assignment, sub-lease, share occupation, or more rarely charging the lease (which may only be available on leases with a longer term).  It may be that the property lends itself to being divided into parts.  However, for the reasons given above, a landlord will need to consider carefully whether an assignment of part is permitted.

Most leases will state that:

  • Assignment and subletting of part is prohibited.
  • Assignment and subletting of whole is permitted, with consent.
  • Charging of whole is permitted, with consent (and sometimes subject to the charge being to a financial institution only).
  • Group sharing permitted.
  • Any other dealings prohibited.

Prohibited dealings 

If the lease is to an important “anchor” tenant of, say, a shopping centre, the landlord may want an absolute prohibition of any dealings in the first few years.  The landlord will likely spend money advertising the fact that the anchor tenant is at the shopping centre and will therefore want some security that its main draw does not leave early.

Landlords are usually unlikely to agree to an assignment of part.  Generally speaking, an assignment of part can be nearly impossible to do from a legal perspective, as there will be many difficult considerations regarding the repairing covenant, reinstatement, alterations, service charge etc.  

Sub-letting of part may also be resisted by landlords on the basis that managing a multi-let property is more difficult than managing a single-let property.  If the tenant fails for any reason, the landlord will have the administrative burden of dealing with potentially multiple tenants.

Broadly speaking any form of informal sharing of occupation or possession will be prohibited to avoid potential situations where the landlord is left with multiple occupiers.  Landlords will want to maintain control over their property and will want to know the identity and basis of which any business is occupying their building.  

Right of pre-emption

Landlords may also impose a right of pre-emption.  This has the effect of requiring the tenant to first offer a surrender to the landlord when it applies for consent to assign or underlet the property.

This gives landlords ultimate control over the identity of the tenant.  Such provisions are usual in shopping centres and retail parks particularly when high-profile tenants will be a draw driving footfall to the area.

Group sharing

Generally speaking landlords will agree to a tenant sharing the property with group companies.  This will not generally cause an issue for landlords of offices or industrial units.  Landlords of retail properties may be more circumspect – for example the landlord of a high end boutique in New Bond Street which has granted a lease to a household fashion brand will not want to see that the property is being shared with less high-profile group companies.

Concessions 

Some retail tenants will have concession agreements allowing for part of a shop floor to be used by a particular brand.  Such agreements can be common in department stores.  Tenants of premises will need to seek particular agreement to allow concession agreements – it may be a landlord will agree to concessions sharing occupation, provided that no more than say 15% of the floor area is taken up by a concessionaire at any one time.

e. Repairing obligations 

The key aim for a landlord is to maintain its investment value by ensuring that the property does not fall into disrepair.  It will do this by imposing an obligation on the tenant to keep the property in “good repair and condition”.  It is important for landlords to ensure that the covenant is acceptable to banks and pension funds, in case it needs to raise finance against its interest in the property, or sell.

It will generally also be in the tenant’s interests to keep the property in good repair.  If the business is open to the public, presenting a well maintained and decorated property will be important to maintaining its “brand”.  All occupational tenants will have duties imposed by legislation to ensure that the property does not pose a health and safety risk to its customers and staff.

The heads of terms should state the repairing obligations in the lease.  The usual options are:

i. IRI – “full repairing and insuring obligation”.  

This is usually taken to mean that the tenant will be required to keep the property in good repair and condition – this obligation will apply throughout the term of the lease.  

This obligation will usually mean that the tenant must keep the property in “Grade A” condition, even if the property was in a poor condition when the tenant first took occupation.

The tenant will also be required to pay for the cost of insuring the building.  It is usually in the landlord’s best interest to insure the building itself, then charge the premium to its tenant.

Strictly speaking, FRI should only be used on a lease of the whole building to a single tenant.  In practice, it is generally used for all leases even if they are leases of part.

ii. IRI – “internal repair and insuring obligation”

If the tenant is only taking a lease of part, it is standard practice for the tenant to be responsible for the internal parts of the demise only.  The landlord should have an obligation to keep the structural parts of the building maintained, and the cost charged back to the tenants via a service charge.

The tenant should always carry out due diligence on the condition of the property before it enters in to the lease.  From completion, the tenant will be under a continuing obligation to keep (and potentially put) the property in good repair and condition.  

The following points should be raised by the tenant and their solicitor during negotiations for, and included within, the heads of terms:

    • The lease should be subject to survey – tenants should always have a professional survey carried out before entering into the lease.
    • Does the landlord have any guarantees or warranties that apply to any works carried out in the last twelve years?
    • Are any product guarantees available?
    • Is a latent defects or decennial insurance (for example NHBC) policy in place – this is especially important of the building was built in the last ten or twelve years.
    • If the tenant wishes to avoid putting the property into a better state of repair than at the start of the tenancy, a photographic schedule of condition should be requested.  The schedule of condition would then be attached to the lease and the words of the repairing covenant amended to refer to it.

The tenant will want to argue that it is not responsible for any repairs covered by warranties, third party rights, guarantees or latent defects policies either in its repairing covenant or via the service charge.  The landlord will want to ensure that the extent of any exception is limited in scope and duration to the ability of the landlord to recover those repair costs elsewhere.

The repairing obligation will usually be suspended if the property is destroyed or damaged by an insured risk.  It is becoming increasingly common for landlords to also agree to exclude damage by uninsured risks.  If this is agreed, the lease will usually define an “uninsured risk” as a risk against which insurance was available, but is no longer available on commercially viable terms.  Uninsured risks therefore are unlikely to include everything.

The repairing covenant can have serious financial implications for tenants from day one of the lease.  It is therefore important to always seek expert advice to ensure that tenants are not writing a “blank cheque” to the landlord.

f. Alterations

Landlords will want some form of control over what the tenants does to the property during the term of a lease.  This is to protect the value of the landlord’s investment.  Therefore leases will usually prohibit or restrict the tenant’s right to alter the property.  The following should be considered when negotiating heads of terms and the lease itself: 

  • Balancing the landlord’s need for controls on the types of alterations and the standard of workmanship against the tenant’s need for flexibility to ensure the property meets the tenant’s business needs.
  • There will usually be obligation to reinstate any alterations at the end of the term.  The tenant should seek to limit this obligation to only reinstate those alterations that reduce the landlord’s ability to re-let the premises at the end of the lease.
  • The landlord will want any alterations that adversely affect the rental value of the property to be disregarded at rent review.

The landlord should also be aware that if the restrictions on alterations are considered onerous, this could negatively impact the rent review and depress the rent achievable.  

Most leases will usually have an absolute prohibition on structural alterations and additions.  Care should be taken to consider whether this is appropriate for the tenant – will they want to install a mezzanine for example?  Discussions should be had at heads of terms stage to ensure a tenant is not prohibited from carrying out works it intended later on.

Internal non-structural alterations will usually be permitted subject to landlord’s consent – the heads of terms should make it clear that the landlord cannot unreasonably withhold or delay consent.  

Tenants should prepare their specification and drawings for their initial fit out and send to the landlord for approval as soon as possible.  

We always recommend that tenant’s seek landlord’s consent to the initial fit out before completion of the lease.  If consent has not been granted by the time the lease is entered into, then the tenant will be on the hook to pay rent (or eat into any rent free period), service charge, rates etc on a property which it cannot use or fit out until consent has been granted.  Once the lease has been completed, it is human nature for a landlord to be less focused on granting consent to the fit-out and delays can ensue.

3. Tenant’s financial covenant strength

A landlord will usually want to avoid taking on a tenant that does not have the assets or prospective income to enable it to pay the rent and comply with the other obligations under the lease.

Generally speaking, solicitors will not be qualified to advise on the financial covenant strength of prospective tenants. For landlords, this is where an expert commercial agent is invaluable to a landlord. They will collect professional references and, if appropriate, seek a business plan from the prospective tenant. This will enable the agent and the landlord to assess the tenant’s financial covenant strength and advise on measures to mitigate the risk to the landlord.

If the landlord has some concerns regarding the financial strength of a tenant, for example if the tenant is a newly incorporated limited liability company, it may wish to consider the following options:

  1. Request a rent deposit
  2. Request one or more guarantors
  3. Take a letter of guarantee from the tenant’s bank

Rent deposit

If a rent deposit is agreed, then this will need to be documented by a rent deposit deed. The deed will, among other things, set out:

1. The amount held

Usually 3 or 6 months’ rent (plus an amount equivalent to VAT if the landlord has elected to charge VAT on the property).

2. How it is to be held

Usually in an interest-bearing account in the landlord’s name.

Tenants may seek to insist that the deposit is held in a separate deposit account designated with the tenant’s name, to avoid the funds being utilised for something other than the purposes of the deposit.

Some landlords may resist this if they do not have the function with their bank for a separate deposit account

3. The circumstances in which a landlord can withdraw

Usually, the deed will set out circumstances in which the landlord can make a withdrawal – usually because of non-payment of rent or some other breach.

Tenants may seek to insert a notice provision, so that they are notified before a withdrawal is made. A compromise may be that tenants are notified within 5 working days after a withdrawal.

4. Top up

Most rent deposit deeds will require the tenant to top up the deposit in the following circumstances:

  1. If a withdrawal has been made following tenant’s breach
  2. If the landlord elects to charge VAT at some point after the grant of the lease
  3. Following a rent review which has resulted in the rent increasing

5. Return of the deposit

The deed will also set out the circumstances in which the deposit is to be returned to the tenant. The usual points at which a deposit is returned can be:

  1. If the tenant produces accounts for three consecutive years showing net profits exceeding three times the annual rent (known as the 3 times 3 provision) – this would need to be negotiated at heads of terms stage
  2. On lawful assignment of the lease
  3. On expiry of the contractual term of the lease

A point of contention can be whether the deposit will continue if the lease is renewed in accordance with the Landlord and Tenant Act 1954. A tenant is likely to argue that, at the point of renewal, the tenant should have displayed several years of complying with the covenants and payment of rent. A landlord may argue that the deposit should continue until the tenant vacates the property as continuing security.

Guarantor

If a guarantor is agreed, it would usually be someone connected to the tenant – either a director or a family member with known assets.

Tenants should be wary of agreeing a lease that is forfeitable in the event of insolvency of a guarantor. A compromise might be that, if a guarantor becomes insolvent, the tenant must offer a replacement guarantor within a certain period to the reasonable satisfaction of the landlord.

Usually, a guarantor will have primary responsibility for the tenant’s performance of its obligations under the lease.

Guarantors will usually be liable until the expiry of the lease. On an assignment, the landlord may insist that the guarantor continues to guarantee the assignee’s performance under the lease.

It is possible to agree with the landlord for a release of the guarantor earlier than the expiry of the lease, for example by reference to the 3 times 3 provision referred to above or the expiry of a set number of years, subject to the tenant complying with its obligations under the lease.

Bank guarantee

These are fairly rare as they can prove expensive to the tenant and will usually require the tenant to deposit with the bank funds to cover the guarantee.

They may be useful for an overseas company that has significant overseas assets but is venturing for the first time in the UK, with a UK group company.

4. Conditions to the lease

It is always advisable for a tenant to ensure that the heads of terms are subject to:

  1. Survey of the property.
  2. Legal due diligence.
  3. Agreement of the terms of the lease and supplemental documents.
  4. Board approval, if necessary.
  5. Bank consent, if appropriate (for example if the landlord’s title is subject to a financial charge).
  6. Superior landlord’s consent, if appropriate.

Special care should be taken to consider whether there are to be any other conditions, which may relate to the condition of the property. For example, the tenant may wish to ensure the lease is taken on the condition that:

  1. Specific works are carried out by the landlord, to the tenant’s satisfaction.
  2. Rectification of some defect identified in the inspection/negotiation process.
  3. Vacant possession being obtained if the property is currently occupied.
  4. A contribution from the landlord to cover the cost of some works required to the property.

The expert commercial agent will be able to advise on whether any other property/transaction-specific conditions are required by either party. We make a point to liaise with the agent and our client to ensure that nothing is missed in this respect.

If you are considering taking a lease of commercial property and would like to know more about the obligations and financial implications, speak to our experienced team of commercial property advisors.

At GoodLaw we can advise on all aspects of commercial leases, call us on 01273 956270 or scroll down and submit a contact form.

By Published On: March 5th, 2024Categories: Insights

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