Commercial Leases

Important Disclaimer: These notes are a general statement of the law – there may be errors or omissions. I do not accept responsibility for any loss resulting from reliance on them – please see my full disclaimer

Some common questions about commercial leaseholds:

What are the differences between leasehold and freehold?

A lease has a limited life (from 1 to 1000 years) and on expiry may not be renewable.   A freehold is unlimited in duration. A leaseholder will have to pay rent: either a nominal ground rent or a full market (“rack”) rent.   Many leasehold properties also involve paying a service charge.If you own a freehold property, you are in sole control of it (subject to statutory obligations, such as those that apply to listed buildings and tenanted properties).   If you are a tenant of a leasehold property, you only have a right to occupy it on the terms set out in the lease. The lease is designed to protect the landlord’s interests and will cover every aspect of your occupation. For instance –

  • A freehold owner can (within limits) choose whether, when and how to maintain and decorate their property; a tenant will be obliged constantly to maintain the property, to redecorate at fixed intervals and often to comply with a defined colour scheme.
  • Subject to planning permission and Building Regulations, a freeholder can make alterations to their property; a leaseholder will need the landlord’s consent for all but very minor work, and this consent may be refused or subject to stringent conditions.
  • A freeholder can arrange their own insurance for whatever sum they consider appropriate (subject to any mortgage lender’s requirements; a leaseholder’s landlord will insure the property as they see fit and charge the tenant(s).
  • A freeholder can sell the property whenever they choose; a leaseholder needs landlord’s permission.

What should I consider when negotiating a new lease of commercial property?

All the terms in a commercial lease are (in theory) negotiable and, therefore, flexible.   However, the extent to which any terms are negotiable in practice depends on various factors: market forces, the particular circumstances of each landlord and tenant and the financial standing of the tenant.   Ultimately, it is supply and demand that determines the scope for negotiation and flexibility The following points should be borne in mind throughout any negotiations:-

Generally Tenants should be aware that the letting agent, when negotiating the terms of a proposed new lease, is acting solely for the landlord, and trying to get the best deal for the landlord.   Unless the tenant has plenty of experience of leases and their potential problems, therefore, they would be well advised to appoint a suitable adviser (either a suitably-experienced lawyer or a suitably-experienced surveyor) to negotiate and advise on the proposed lease terms.   It is expensive and frustrating to try to renegotiate the fundamental lease terms once the draft lease has been submitted on the basis of terms which the landlord thought had already been agreed

Continuing relationship The relationship between the landlord and tenant will continue after the lease has been signed.   It is therefore sensible to pursue negotiations constructively and fairly, so as not generate bad feeling for the futureRepairing obligations A tenant’s repairing obligations should reflect the condition of the property at the start of the lease and the length of the lease term: someone taking on dilapidated premises for a one year term should not be expected to carry out the same repairs as someone taking on a brand new building for a 50 year lease.   The “standard” repairing obligation would require the tenant to put the property into a good state of repair, even if it was not in that state at the outset.   If a tenant wants to limit liability to maintaining the original condition of the property, a “schedule of condition” setting out the state of the property, will need to be agreed between landlord and tenant

Alterations and improvements Most commercial leases prohibit completely any structural or external alterations, and require the tenant to obtain the landlord’s consent (at the tenant’s expense) before carrying out any internal, non-structural changes.   As this can be an expensive and lengthy process, it is worth combining it with negotiations for the new lease itself (if the tenant knows at that stage that alterations will be required);   approval tends to be given more quickly if it is a precondition to the completion of the lease itself It is important to ensure that, if alterations are carried out by the tenant (or at the tenant’s expense), they should be ignored when it comes to a rent review: the tenant should not be expected to pay the capital cost of the alterations and to pay an increased rent because the alterations have improved the property

Permitted use It is vital to ensure that the proposed use of the property is permitted under the terms of the lease and not in breach of planning control: both the landlord and the local council must be content with the proposed use.   Just because the landlord agrees to the proposed use, it does not follow that the council will, and it is the tenant’s (not the landlord’s) responsibility to check this: the tenant would still be obliged to pay the full rent under the lease, even if the council prevented the proposed use of the property Also, the use of the property can have an impact on rent reviews: if the use is restricted, this will depress the rental value, but some landlords seek the best of both worlds, by restricting the permitted use but expecting the rent review to be on the basis of a more open use.   This should be resisted.

Initial rent In a falling market, where supply exceeds demand, a tenant can negotiate good terms.   In a rising market, where a landlord can afford to wait for the first rent review, confident that the reviewed rent will be a substantial increase, it may be worth the tenant’s while to agree a slightly higher initial rent than would otherwise be payable if by doing so the rent can be fixed for a longer period than normal

Insurance Under most commercial leases, the landlord arranges the buildings insurance cover but the tenant is obliged to pay the premium.   This would include insurance against loss of rent if the property is unusable as a result of an insured risk, in which case the rent payable by the tenant would be suspended.   The tenant should arrange insurance for contents, loss of profit, etc, as these aspects would not normally be covered under the landlord’s insurance

Service charges In addition to paying the rent (and the insurance premium), the tenant may have to contribute towards (or pay the whole of) the costs of repairing and maintaining the structure and exterior of any buildings, and any facilities (service conduits, accessways, etc) shared with other occupiers. This can be a significant cost, so any survey report should cover these items as well as the property that is actually to be let

VAT Even where a lease does not specifically say so, a landlord can (and sometimes must) charge VAT on the rent payable under the lease.   If the tenant is not VAT registered, this can result in a significant increase in the tenant’s overheads

Legal and other expenses Liability for each party’s legal expenses in connection with the grant of the new lease is a matter for negotiation.   In the absence of any specific arrangement, each side is liable for their own legal expenses, and this is the arrangement I prefer.   However, landlords often expect tenants to pay both sets of legal expenses – as though by granting the lease the landlord was doing the tenant a favour!   If the lease is of benefit to both parties, I see no reason why the tenant should take on the extra expense of the landlord’s legal costs.   If it is unavoidable, then it is important to get an early indication of the likely level of those costs, so that the expense can be budgeted for

Rent reviews The rent payable under a lease is likely to be reviewed during the lease term.   This review may be “upwards only” or “upwards or downwards”.   With an “upwards only” rent review, the rent will not drop if rents generally drop – good for the landlord, but bad for the tenant

Length of the lease term From the tenant’s point of view, where a full rent is to be paid, there is little merit in insisting on a long lease; this would simply mean that the tenant’s liability will last for longer.   It is better to take a short lease and renew it when it expires.   This does, however, depend on the tenant having security of tenure (see below)

Break clauses An alternative is to take a longer lease but with the right to “break” the term after (say) 5 years.   This can be particularly useful if the break clauses coincide with the rent reviews, so that the tenant can escape from the lease if the rent is reviewed to too high a figure.   However, sometimes a landlord will insist on a break clause being “two way”, so that the landlord can terminate the lease as well

Security of tenure Under the Landlord and Tenant Act 1954, a business tenant has the right to call for a new lease when the current lease expires.   The landlord could only successfully resist in specified circumstances (briefly, where the tenant has not complied with the lease obligations, or the landlord needs the property for its own business or to carry out repairs or redevelopment).   If, however, the relevant provisions of the Act are specifically excluded, the tenant would not have the benefit of them

Assignment and sub-letting Most commercial leases will contain provisions restricting the tenant’s ability to deal with the lease or the property: any transfer of the lease will need the landlord’s consent (which cannot normally be unreasonably withheld, though the landlord might insist on the outgoing tenant guaranteeing performance of the incoming tenant’s obligations;   subletting might be completely prohibited, or subject to the landlord’s unrestricted approval

Repossession The lease will normally include a right for the landlord to “repossess” (take back) the property if the rent is paid late or if any of the tenant’s other obligations is not fulfilled.   If the landlord seeks to use this right, both landlord and tenant should seek immediate professional advice, as the law relating to these provisions is both detailed and complex.   Tenants should note that repossession will not “wipe the slate clean”: they will still be liable to pay any money that is due, including (usually) the cost of any “dilapidations”: repairs needed to bring the property up to the standard required under the lease

Guarantors The guarantor (or surety) is responsible for compensating the landlord if the tenant defaults under the lease.   Guarantors should try to negotiate a provision that they will be automatically be released from liability if the particular tenant whose obligations they are guaranteeing assigns the lease. A guarantor’s obligations can be heavy, and should not be taken on without full consideration.   It is often appropriate for guarantors to receive advice independently of the tenant whose obligations they plan to guarantee   An alternative form of security for the landlord is to insist on a rent deposit;   the terms of the deposit should be explicit and recorded in writing at the same time as the lease wording is agreed.

What rights do I have to renew my lease?

Under the Landlord & Tenant Act 1954, a tenant of business premises has a right to renew his tenancy for a term up to 14 years and, pending the new tenancy, is entitled to use the premises under the terms of the old tenancy. At the end of the lease term, if the landlord serves an appropriate notice to quit (complying with numerous detailed legal requirements), the tenant can preserve his rights of renewal by serving a counter notice and applying to the county   court for a new tenancy.   The tenant must comply with various legal requirements and with a strict timetable. The landlord can only refuse a new lease on specified grounds; namely:-

  • that the tenant has failed to pay rent, repair the property or carry out other obligations imposed by the existing lease
  • that the landlord will offer “suitable alternative accommodation for the tenant on reasonable terms”
  • that the landlord intends to demolish the whole (or a large part) of the property, or intends to carry out substantial works to it, and cannot do so with the tenant still in occupation
  • that the landlord intends to occupy the property for his own business or as his home

If any of the last three grounds apply, the landlord would be expected to compensate the tenant for having to move premises, the amount of compensation depending upon the rateable value of the property and not usually being anything like sufficient compensation. If none of the specified grounds applies, a tenant’s application for a new lease cannot be successfully resisted. The new lease may be negotiated between the surveyors representing each sides or, failing this, can be fixed by the county court. The court will decide on the fair market rent to be paid under the new lease and on its other terms. Usually, the other terms are similar to those in the existing lease. If a lease is excluded from the security of tenure provisions of the Landlord & Tenant Act, these rights do NOT apply, and the tenant cannot insist on remaining at the property: his ability to stay depends entirely on whether the landlord is willing to let him stay. If a lease excludes the tenant’s compensation rights, the tenant will not be able to claim any compensation if and when a lease renewal is refused.

What should I do when I am nearing the end of an existing lease?

At least a year before the end of your lease, you should decide whether you want to renew it and check whether you can.   Many leases are not automatically renewable (if they are excluded from the security of tenure provisions of the Landlord and Tenant Act 1954). Even renewable leases may not be renewable on acceptable terms.   In either case you will need to allow enough time to find a acquire alternative premises.   Even if you are able to renew on acceptable terms the process is lengthy. Once you have checked with your lawyer that you are able to renew your lease, you should consult a surveyor about the terms and ask the surveyor to negotiate on your behalf.   I do not recommend that tenants negotiate directly as there are many technical pitfalls and most experienced landlords will be able to take advantage of a tenant acting without professional help.   I also do not recommend using your lawyer to negotiate terms: lawyers by training are too adversarial.

What are my rights if I want to renew an existing lease?

This is a complex issue. To download a pdf file click <here> [Link to PDF]

For a PDF file, click here: Commercial leases

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