Heads of Terms: Rent-free periods and break clauses (Part 4/8)

Our eight-part series highlights the important aspects of negotiating Heads of Terms in a commercial lease and what tenants and landlords should consider and why.

Read the full series:

1. What are they, and why are they important?
2. Negotiating a commercial lease 
3. Alienation and transferability of the lease
4. Rent-free periods and break clauses
5. Service charge and insurance provisions
6. The tenant's covenant to repair
7. Making alterations to the property
8. Final boilerplate provisions in a commercial lease

Rent-free periods and break clauses

Landlords offering rent-free periods as an incentive can expect the property to be put into a very good state of repair as the tenant has resources to carry out a high specification and a tenant who is not a limited company, or subject to a guarantee can decide to leave early in a break clause, or, have some financial cushion in having a rent-free period.  

Rent-free periods: What are they and why use them?

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

• As an inducement to the tenant to enter into the lease which does not affect the headline rent; or
  
   
• Recognition of the fact that until the property is in a bad state of repair and the tenant’s fitting out works are complete, it cannot use the premises for its business, or
  
   
• For the landlord to get a tenant induced into entering a lease and then having the property put into a state of repair, which is better than at the start without working at the landlord’s cost (effectively using the tenant’s resources to do this).

However, one should be aware that a tenant is usually still obliged to pay “additional rent” or “maintenance charges” during rent-free periods. These can include operating expenses, costs related to common area maintenance, utilities, electricity, insurance, and all common items for services to the building or the estate the property forms part of.

Rent-free periods should always be requested. If you don’t try, you won’t get the concession. Empty properties most commonly mean a business rates liability for a landlord, so they want a tenant in occupation and are likely to offer such incentives.

What is the most effective method to persuade landlords to agree to rent-free periods?

1. If there is any disrepair at the property, the tenant would usually seek to have this rectified before the lease is completed. More often, this does not happen as it is not practical due to time constraints. Therefore, this is usually a good time to request a rent-free period to cover the extra costs incurred in carrying out the works instead of the landlord. Again, a surveyor is best placed to address the repair works that are required and potential costs. This will place the tenant in a better negotiating position with the landlord.
   
    
2. A similar principle can be applied to works required to comply with statutory requirements – fire safety, asbestos regulations, EPC regulations, or any other statutory controls. It is reasonable to suggest that the tenant shouldn’t be out of pocket so the property can be compliant with the current regulations. For example, if the property needs new fire exit doors and the cost of this is £6,000, and the lease rent is £2,000 per month, a rent-free period of 3 months could be requested. Landlords do, at times, however, have a ‘take it or leave it attitude’, so a Tenant needs to offer some justification for their request.
   
    
3. The landlord may use a rent-free period as a way to encourage the tenant to take the rent. This is typically the case where they have a property that is difficult to rent. This is why it is useful to get in touch with a surveyor or specialist who arranges rent-free periods for comparable properties in the area. The tenant may think they have found an attractive lease with a competitive rent-free period. However, if potential tenants are avoiding the property, you know that the landlord is just using this to cover up potential issues.
   
    
4. In most cases, tenants will have plans to complete fit-out works towards the beginning of the lease in preparation for whatever their business may be. The tenant may think that it is unlikely that the landlord would essentially cover the cost of this by giving a rent-free period. However, whether it is just applying a coat of paint or just basic home improvements, the landlord will be more likely to agree to this if the works will generally upgrade the estimation of their property.
   
    
5. One of the most obvious reasons for requesting rent-free periods is that whilst the above is being carried out, it is unlikely that the tenant will be doing any business. Therefore, the rent-free period somewhat compensates for their loss of business during this time and improves the landlord’s property. It would be unreasonable to request that the rent is paid whilst the property is unusable. Even in the early days of the business, this time would allow the tenant to develop it and take the weight off what otherwise may be some rough circumstances.

If landlords can avoid giving rent-free periods to tenants, they will, of course, do so. Therefore, it lies with the tenant to negotiate one. The tenant has nothing to lose, and in the worse scenario, the landlord would reject – but the best case could leave the tenant with a respectable rent payment period taken off its lease.

Break clauses: Why and when?

Break clauses can be included in a fixed-term lease allowing either the tenant or landlord to terminate the lease early. Some leases can include break clauses for both the landlord and the tenant. Exercising the break clause brings the lease to an end.

Depending on how the lease has been drafted, the right to break the lease may arise on one or more specified dates or be exercisable at any time during the term of the lease on a rolling basis. However, a formal notice is typically required to exercise a break clause.

A break clause may only be exercised if any conditions attached to it have been satisfied. The lease will outline these conditions. For example, it may specify that the tenant must give vacant possession of the property at the date when the lease is to come to an end. A break clause will be strictly construed by the courts, and any conditions must be strictly performed. Therefore, it is crucial that the tenants pay particular attention to this.

The 2007 Lease Code recommends that: “The only pre-conditions to tenants exercising any break clauses should be that they are up to date with the main rent, give up occupation and leave behind no continuing sub-leases. Disputes about the state of the premises or what has been left behind or removed, should be settled later (like with normal lease expiry).”

Although it sounds simple enough, in practice, a tenant wishing to exercise a break clause that is subject to pre-conditions may find it anything but straightforward.

Practical issues for tenants to consider when exercising a break clause

• Once a notice exercising the break clause has been served, it cannot be withdrawn. Therefore, the tenant must be sure that they want to end the lease early before serving the notice triggering the break right.
  
   
• Tenants should comply with all the relevant requirements in the break clause and keep evidence of their compliance to help protect their position.
  
   
• Serve the break notice in good time and strictly in accordance with the terms of the lease – the lease may contain provisions relating to serving the break notice that is not in the break clause itself. If the lease says six months’ written notice, you must give a full six months in accordance with the notice and service provisions of the lease. Do not miss your date!
  
   
• Pay any outstanding sums due, even if these are in dispute. Payment can be made on a “without prejudice” basis and discussed later. Again, this is particularly important where such payment is a condition of the break clause.
  
   
• The tenant might not be aware of all the money it owes. The lease may oblige the tenant to pay interest in respect of late payments, so check if any such interest is due in respect of arrears in the past. The tenant may owe interest on historic arrears, even if the arrears have been cleared and the landlord has not requested the interest. Unless the tenant has received a demand for such interest, it may have difficulty knowing precisely how much interest is due, but the landlord has no obligation to tell the tenant how much interest is owed. The tenant should try to estimate the amount due and err on the safe side when paying. The cost of over-estimating the amount due for interest is likely to be far less than the cost of remaining bound under the lease. The exact amounts owed can be settled later.
  
   
• Ask the landlord for confirmation of the steps required to comply with any conditions in the break clause. In particular, the tenant may want to be sure that it has complied with its repairing obligations under the lease. In order to do this, the tenant may ask the landlord to prepare a list of items that are in need of repair and for which the tenant is responsible under the lease. This list is known as a schedule of dilapidations.
  
   
• If a tenant agrees to carry out works to the property before the break date, be careful to ensure that the works are completed, and vacant possession is given by the break date.
  
   
• Remember that there may be general obligations that apply at the end of the term of the lease, which will need to be complied with before the break date. For example, the lease may require the tenant to remove signage, reinstate alterations and redecorate the property. You should also check supplemental documents, such as any licences granted for works to the property, in case these contain obligations that are relevant to the break.
  
   
• Consider asking the landlord to accept the break notice on payment of an agreed amount as liquidated damages for any outstanding breaches of covenant. Liquidated damages are a fixed or determined sum agreed by the parties to a contract to be payable on a breach by one of the parties.
  
   
• Ensure that any waiver of a break clause condition by the landlord is not made “without prejudice” and that it is clear to which condition(s) the waiver applies.
  
   
• Do not assume that the tenant is only obliged to pay an apportioned part of sums due under the lease for the period up to the break date. The lease may require full payment.
  
   
• If the tenant is obliged to pay any sums in advance, such as rent, service charge or insurance rent, check to see if the landlord is obliged to refund any part of those sums that can be attributed to the time after the lease ends. The tenant will not usually be entitled to a refund of rent paid in advance unless there is an express provision in the lease to the contrary.

Landlords looking to protect their reversion and to keep their options open could also request a break clause. This suits the landlord because it can retain control of a valuable property in a shorter period of time. Importantly, any lease with a landlord’s break must be excluded from the Landlord and Tenant Act 1954 (see part three of our series).

A break clause is an important provision of a lease. At the head of terms stage, the tenant should not be prevented by breaches of covenant or other conditions attached to the break clause. 

This is why it is vital that tenants take expert legal advice before agreeing to the heads of terms with the landlord and should also insist that the exercise of the break clause not be subject to the pre-conditions.

Expert legal advice on your commercial property matters

SO Legal has offices across the South East. Our team of commercial property solicitors in London, Brighton, Eastbourne, Hastings and Uckfield can help you understand your options.