This is part three of our eight-part series looking in detail at negotiating the important points in commercial heads of terms, and what a tenant and landlord should consider. In Part Two we considered the impact of the Landlord and Tenant Act 1954 in relation to the negotiation of lease terms. This third part of the series will focus on the issues around alienation and transferability of the lease. Part One of the series is also available here.
What is alienation?
Alienation is the general term for the tenant’s ability to deal with the lease. Most commonly this will refer to the tenant’s ability to either;
- transfer the lease to a third party;
- underlet the whole or part of the premises; or
- share occupation of the premises.
It is equally important for both a tenant and a landlord that the agreement in relation to alienation is clearly set out in the heads of terms and followed through in the lease. Failure to consider these terms could result in the landlord giving the tenant complete freedom to deal with the premises however they wish, or could result in the tenant not having the flexibility to assign the lease when circumstances change.
Assignment involves the transfer of the whole, or part of, the lease to a third party. The assignee becomes responsible for rent and other obligations under the lease, and so the landlord will want to ensure that it is of good financial standing. Without an express restriction on assignment, the tenant’s benefit in the lease can be freely transferred to another party. For this reason, commercial leases will often contain restrictions on the tenant’s ability to do this. These terms should be clearly defined and agreed in the heads of terms so that there is no dispute when drafting the lease.
Underletting, or subletting, is where the tenant retains its own lease, but a new lease is granted to a third party from the tenant’s own lease. There are several situations where this arrangement is appropriate (for example where there is an area of the premises which is surplus to the business requirements), however Landlords will want to retain a degree of control over any subletting, as there are circumstances where the sub-tenant can become the immediate tenant of the landlord.
Covenants that prohibit a tenant from sharing occupation, prevent them from granting a licence to third parties for use of part of the premises, and therefore sharing occupation of the premises. It can also prevent sharing with companies from within the same group. Therefore, tenants should resist an absolute bar against this type of restriction, unless they can be sure that they will not require to share possession of the premises in the future.
Restrictions on Alienation
As you can see these provisions have the potential to cause dispute given the differing requirements of the landlord and tenant. Heads of terms should therefore record what restrictions have been agreed on the tenant’s ability to deal with the lease.
An absolute covenant against dealings would be unusual in a business lease, because a tenant is unlikely to agree a complete bar on their ability to deal with the lease. A tenant should resist any such restriction except in very short business leases.
A common compromise is for the lease to prohibit assignment of part of the premises, but allow the tenant to assign the whole of the lease with the landlord’s consent. Where a lease does permit assignment with the landlord’s consent, it is implied by Section 19(1) LTA 1927 that such consent cannot be unreasonably withheld. This should still be expressed in the lease. As a tenant you must remember that the requirement for the Landlord to act reasonably does not prevent them from requesting that the tenant pays their reasonable legal, or other, expenses in connection with the consent.
It is usual for assignment of part to be restricted in the lease as this would raise issues to do with apportionment of rent and service charge which could be a complication. However, the wording must be carefully considered as a simple covenant not to assign or underlet any part of the premises could result in a complete restriction of assignment of the whole of the premises (Field v Barkworth  1.E.G.L.R. 1).
As a result of the LT(C)A 1995, s19(1A) was inserted into the LTA1927, whereby the Landlord can stipulate certain conditions that must be met if they are to grant their consent to any assignment. The landlord can withhold its consent on one of the agreed grounds without acting unreasonably. The type of conditions that can be imposed are left to the parties to decide, and should be recorded in the heads of terms.
One of the conditions that is most onerous for the tenant is that they may be asked to provide an Authorised Guarantee Agreement (AGA) on any assignment. This is where the outgoing tenant is required to guarantee the assignees obligations under the lease, and is one of the most common restrictions that a Landlord may request. The AGA itself must comply with the requirements of S.16(2) LCTA1995, and importantly will only apply for as long as the assignee is liable. Tenants should consider whether it is appropriate in the circumstances for them to provide an AGA, particularly if it is likely that they will assign to someone in a better position. It is also important for corporate tenant to always ensure that any director of the company is not required to provide an AGA for any incoming tenant on assignment, otherwise this could result in them becoming personally liable for the lease obligations, including payment of the rent.
Another common condition that can be imposed by the landlord in the lease is that a person of standing acceptable to the Landlord, acting reasonably, enters into a guarantee and indemnity of the tenant covenants of this lease. A tenant must consider each of the conditions carefully and decide whether in the circumstances it is appropriate. From the landlord’s point of view, extensive restrictions on alienation are not always a sensible idea as they can have a downward effect on rent at rent review as it can result in the lease being less marketable.
Certain restrictions may also apply to subletting. For landlords they should consider whether they should require that the sub-lease contains provisions that require the subtenant to enter into direct covenants with them, prohibit any further dealings of the sublease or require the subtenant to comply with all covenants with the headlease. Tenants should consider each restriction carefully as they can restrict the pool of tenants that can be let to. For example, where there is a provision preventing the tenant from subletting at less rent than currently payable under the headlease, if rents have fallen since the latest rent review then it may prove difficult to sublet.
You can see that it is therefore key for landlords and tenants to agree all aspects of alienation during negotiations for the lease and ensure that the heads of terms reflect the agreement. This guarantees that the lease does not become a burden to the tenant if they are not able to dispose of it, but allows the landlord to keep control over dealings with the lease to ensure that any incoming tenant is of good financial standing, and will not have a detrimental effect on the landlord’s other existing tenants.
At SO Legal our team of commercial property solicitors are here to assist you and provide expert and experienced advice on any matters relevant to your lease. Please do not hesitate to contact our Head of Commercial Legal Services Hamed Ovaisi on 01323 407555 or firstname.lastname@example.org