In this final part of our 8-week series of top tips for negotiating Heads of Terms in commercial lease transactions we look at the final boilerplate provisions – provisions which are considered ‘standard’ in leases. Here we explain why they are not always the best thing for a tenant to agree certain aspects and why, as with the rest of the top tips, it’s important to take into account all the necessary considerations such as, who is the tenant, guarantor, limited company, repairing obligation and other factors.
The main provisions to consider are
- Indemnity – There will usually be a clause in the lease that the Tenant must keep the Landlord fully indemnified against all losses arising directly or indirectly from any act, omission or negligence of the Tenant. The Landlord would also usually seek to extend to any persons under the authorisation of the Tenant. A potential tenant should avoid entering into such indemnities as a general indemnity such as this is too wide, particularly if the lease is guaranteed or take in a personal name. It is in essence a ‘catch all provision’ which should be rejected. The tenant can argue that the lease itself (forfeiture and claims for non-payment or non-performance) as well as the common law and statute adequately deal with any loss or damage that a Landlord can recover requires and an indemnity clause such as this goes what a tenant should accept. Indemnities should be resisted and the tenant should fully appreciate the consequences of agreeing to such a clause. One possible compromise as a last resort is to limit the indemnity to losses arising from a breach of covenant by the tenant or asking the landlord to provide a mirror indemnity for any of their breaches – something they will almost certainly reject!.
- Insurance – There should be a provision in the lease that the Landlord is required to provide a copy of the insurance policy and recommendations of the insurers to the Tenant. This is because there will usually be a clause that the tenant must comply with the terms of the insurance, by act or omission, at all times. This is again particularly important as the lease will usually state that the Tenant must not do or omit anything that could cause any insurance policy to be become wholly or partially void. It is important here to limit this provision to the Tenant must not “knowingly” do or omit anything that may void the insurance. This small amendment imparts the pressure of knowledge to ensure that the tenant is not strictly liable for an event or occurrence of which he is not aware.
Many tenants do not like the standard lease provision requiring the tenant to comply with all insurers’ requirements as a tenant would then be bound to carry out any works that the insurers may require, even if unreasonable, or, most importantly, inadvertently vitiate the insurance policy by not complying with terms that they had no idea existed! Ignorance is not a defence and a scenario that could arise is that the tenant fails to have adequate firefighting equipment on the property which was required by insurers (or specific equipment) and the building burns down. The insurers wills take the insurance is vitiated and invalid. The landlord will move to say the tenant is personally liable for failure to comply. The implications can be huge! However, from a landlord’s point of view, it cannot have one tenant of a development or a building refusing to comply with insurers’ requirements and therefore invalidating the landlord’s insurance policy as a whole.
The parties must get a balance here.
Rent review Rent review is the most common method of increasing the rent during the term of a lease. It is usually based on a hypothetical lease scenario with an open market valuation of the rent. Most rent reviews are on an upwards only basis and this is not preferable for a tenant. The rent is increased to the higher of the basic rent, then payable under the lease at the time of review and the open market rent. Therefore the basic rent cannot go down if market rents are in decline, and will not be set at less than the then current rent – a guaranteed increase even in depressed times. That is not to say that upwards and downwards rent reviews do not exist but they are very rare. If ever agreed by the landlord, there would be some cost involved for the tenant such as an initially high rent or some other compensation due to the landlord.
From a tenant’s perspective It would be sensible to negotiate a right to terminate the lease once the revised rent is known and the rent review is settled, so that if the rent is set too high on review there is an exit and any such break would also give the tenant a substantial bargaining position in any rent review, as the landlord will be aware that if he seeks too high a rent the tenant will terminate the lease. However, for the exact same reasons the landlord will resist this. The rent review is essentially the valuation of a hypothetical lease in the open market at the review date, but assuming and disregarding certain things about the lease. The dates in negotiation of break and when rent review needs to be initiated and discussed are very important therefore. The basic starting point is that the rent review provisions should reflect reality and should not assume or disregard any matters to create an artificial position in the hypothetical lease position.
Common assumptions are:
• That the premises are let on the open market without a fine or premium. This means that the lease is valued in the open market and without any capital sum being paid by either the landlord to the tenant or the tenant to the landlord as this would distort rental levels.
• With vacant possession. It is only reasonable that the premises being let are assumed to be empty, as otherwise it could be assumed the tenant or any subtenant or other party is in occupation which could either have the effect of driving down the rent (to the landlord’s detriment) or the landlord could contend the tenant who is already in occupation would pay far more for the premises than any other party, therefore driving up the rent (to the tenant’s detriment).
• By a willing landlord to a willing tenant.
• For a term commencing on the relevant Review Date and either equal to the unexpired residue of the term or perhaps 10 or 15 years (depending on the actual length of the term- the hypothetical term should never be assumed to be longer). The tenant will want to ensure that the term deemed to be remaining is the shortest possible and the landlord will want to assume the longest possible term remains. The reason behind this is that the basic principle is that the shorter the assumed term the lower the rent that can be demanded because of the certainty of rental income a longer term provides. In reality this will actually depend on a number of factors, including the type of property (retail, restaurant, office etc).
• That the letting is of the premises as a whole. This could be for both parties benefit as it is conceivable that splitting the premises into parts and letting to a number of different tenants could either increase or decrease the rent compared to letting the premises as a whole.
• On the same terms and conditions as are contained in this lease. The tenant would want all onerous terms and all obligations contained in the lease to be assumed to be in the hypothetical lease being valued as without them, the value of the rent could be higher than would otherwise be achieved.
• That the premises are ready for immediate occupation and use ready to receive the incoming Tenant’s fitting out works. The point here is that the premises should not be deemed to be fitted out before the tenant takes the lease as fitting out works are time consuming and costly. It would be very valuable to a tenant (in terms of both time and capital outlay saved) if those works had already been carried out for the tenant, which would therefore drive up the rent on rent review.
• That the premises may lawfully be used for the use permitted by the lease. This essentially assumes that all necessary statutory consents for the use of the premise are in place. Therefore, if the parties know that this is not actually correct then this should be deleted especially if the tenant needs specialist consent or is under a permitted development use.
• That the tenant has complied with all his covenants and obligations under this lease. Some leases assume that the landlord has complied with all of its lease obligations but this should be resisted. It is not reasonable, if a landlord has allowed the building to fall into disrepair for example, that this is ignored when valuing the premises and the lease on rent review.
• That, if any part of the premises or any amenity serving it shall have been damaged or destroyed, they have been repaired and reinstated. Leases will usually contain rent suspension provisions in the event of damage so no rent is payable during periods of damage, but the landlord will require that once the damage is made good, and the rent becomes payable again, that this is at the full rate due on review. Therefore it is only reasonable to ignore any damage upon valuation.
• That no works have been carried out to the premises by the tenant during the Term which would diminish the rental value of the premises.
• That the hypothetical tenant will have had the benefit of such period (commencing on the grant of the hypothetical lease) free of rent or at a concessionary rent as he might be expected to negotiate in the open market for fitting out, so that any such rent period will have expired. There are three related points here:
- It is common for tenant’s to be granted a rent free period or other concession at the commencement of the term. Some landlords seek to exclude the whole of any such concession and therefore reserve a “headline” rent. Effectively by ignoring any concession, the aggregate rent across the term will not be reduced by any rent free period and so the corresponding annual rent payable will be higher than would otherwise have been achieved on review. This is unreasonable as the tenant will be penalised for something common in the market which should be a benefit.
- Only rent free periods for the “period” of fitting out should be disregarded and not rent free periods or concessions for the “purposes of fitting out”. The point here is that fitting out is thought on average to take about three months and so three months’ worth of rent free period will be disregarded. However, rent free periods or concessions given for the “purposes” of fitting out could be huge. Fitting out is expensive and time consuming and so any rent free period or concession equivalent to that cost is likely to be large and disregarding such large rent free periods offered in the market (which would otherwise have had the effect of reducing the rent) would cause the rent to be higher than that which would otherwise be obtained on review.
- A similar point arises in respect of disregarding rent free periods for the period of fitting out. Fitting out usually takes around three months and so it is fair to disregard three months of rent free period. However, disregarding anything in excess of that period is likely to increase the rent on review as landlords can sometimes offer extended rent free periods described as for fitting out when in fact they are for a combination of the fitting out period with a large element as an incentive. Disregarding any such large incentive offered in the market would cause the rent to be higher on review. Therefore, the length of fitting out periods disregarded should be limited to three months.
Common disregards are:
- The fact that the tenant, their sub-tenant or their respective predecessors in title have been in occupation of the premises. This is for the tenant’s benefit as this discounts a special bid that would be made by the tenant or their subtenant in order to remain in occupation, which would drive up the rent on review.
- Any goodwill attached to the premises by reason of the carrying on at the premises of the business of the tenant, their sub-tenants or their predecessors in title in their respective businesses. This is a variation on the same point as above.
- Any improvement, alteration or addition carried out by the tenant, his sub-tenant or their respective predecessors in title, at their own cost, with the written consent of the landlord (where required) and otherwise than in pursuance of an obligation to the landlord. Essentially, if the tenant has paid for, and carries out, works to the premises he should not be penalised on review by the tenant’s own works increasing the rental value. However, if the landlord paid for the works, or the tenant had a contractual obligation to the landlord to carry them out, it is not unreasonable for their value to be taken into account. Similarly, if the works required the landlord’s consent under the lease and this was not obtained, and therefore the works were carried out in breach of the lease, it is not an unreasonable penalty for their value to be taken into account on review.
- Works carried out by the tenant to comply with statute. The issue with taking into account the value of tenant’s works carried out pursuant to an obligation to the landlord (as explained above) is the lease will require the tenant to comply with statutory requirements. Therefore, any works the tenant caries out to comply with statute will be taken into account on review and could increase the rent by quite a margin. For example, disabled accesses, fire safety systems, works to comply with health and safety legislation and various other works required as a result of statute could all add up to a significant value. This would be unreasonable where the tenant has paid for these works already. However, a landlord would want a reciprocal assumption that where such works are to be disregarded the premises are still assumed to be compliant with statutory requirements, as otherwise this would reduce the value of the premises and drive down the rent.
On a final point, rent reviews quite often provide that the rent on review must be the “best” rent obtainable in the market. This should not be agreed as the word “best” would take account of any special over bidder who may pay an unusually high price. This should be excluded.
These provisions are vitally important to get right as well as the other provisions we have advised on in the rest of the Top Tip series. For any information on any aspects of this Top Tips please contact our experienced commercial team on 01323 407555 or our head of commercial legal services Hamed Ovaisi on firstname.lastname@example.org
Missed parts 1 – 7 of our Series. Read them here.