Heads of Terms: What are they and why are they important? (Part 1/8)

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

What are Heads of Terms?

Heads of Terms are the main terms of a commercial transaction put together by an agent, usually a commercial agent, to set out what has been agreed between the parties. They are important because they set out to the parties and the professionals advising them what has been agreed.

It is not just the rent and the length of a lease which are referred to in a commercial agent's Heads of Terms. 

Most importantly, several key points are also referred to here. A tenant needs to be informed what these other points are, such as break clauses, rent-free period, fit-out works and approval, signage, or whether the lease is within the lease Landlord and Tenant Act 1954 and so on.

Commercial property agents are incredibly important in this role. They are the glue that can keep the deal together and ensure that all the parties have agreed terms set out before solicitors are instructed.

They must always be SUBJECT TO CONTRACT. Sometimes it is difficult to have a client who has agreed to Heads of Terms without taking a solicitors' advice and doesn't fully appreciate the implications of what they have agreed to, either from a landlord's point of view or a tenant's point of view.

Relied upon as evidence of agreement – important because both sides can become obstinate and stubborn if things are not agreed before Heads of Terms are issued. The first important point to focus on is the parties provision. This is, in essence, who is going to be the tenant and the landlord.

The landlord obviously cannot change its structure once the property is owned in a particular format. So, if the landlord is an individual and holds the property as an investor, then the landlord will be granting the lease personally. The focus here is always on the tenant and the legal entity the tenant will have.

So what should you consider and why?

The landlord will want security. It's a simple fact, so having the individual as tenant best suits the landlord because all the terms bind that individual. It means the tenant is held responsible for all liabilities under the lease personally.

The tenant, however, needs to make careful consideration as to what entity they wish to take the lease in. Obviously, taking a lease in your personal name makes you personally liable for all of the obligations under the lease. 

It is amazing how many times as a solicitor we see this, and the tenant has gone from bank manager to accountant, to agent and then to us, and the deal has been 'agreed'.

Your solicitor should be involved at the outset and explain the implications of why taking a lease personally will not always be beneficial.

Another option is for the tenant to be an incorporated limited company. A limited company has legal capacity as an entity and, once it has entered into a contract (a lease in this instance), is the responsible party. It is always better for a tenant as the company is responsible and not the individual director and person of significant control of the company. This is very important to note. 

Therefore, the landlord often wants additional security and therefore requests a personal guarantee for the tenant company or even a tenant in an individual capacity. 

A person should avoid this unless they are fully aware of the risk of a guarantee and what they are guaranteeing. It means the landlord has ultimate protection against not only the tenant but also a guarantor.

A guarantor may limit their liability (if it's absolutely required) by asking for a financial cap on the guarantee. It is fundamentally important to remember that a lease isn't just an obligation to pay rent. The personal guarantee can bankrupt the guarantor of a tenant. 

We have seen situations where, under a personal guarantee scenario with an un-capped liability, a guarantor was forced to pay £100,000 for repair to the structure of the building, including the roof, scaffolding, repairs, repointing, and other items for the maintenance of the building once the tenant company had failed. 

So, do not give a guarantee un-capped, or at least try to negotiate this with the landlord in an amicable way.

Why else should a tenant not take a lease in a personal capacity or limit a guarantee? One of the particular provisions in a lease that is often ignored is the general form of indemnity in the lease. 

An indemnity is effectively an uncapped guarantee given by the person promising to indemnify the other, that if anything happens, which the other party suffers loss for, they will pay for that loss. 

This should at least be attempted to be removed from the lease but discussed at the point of negotiating the Heads of Terms.

Tenants who take leases in their individual names and agree to that full indemnity are putting themselves at risk of potentially having a personal claim, not only under provisions in the lease but also the indemnity. Tenants who give guarantees and landlords should also look at capping this. 

Therefore, the key is that the landlord wants to make sure they have a tenant as long as possible, and if that tenant fails, they have a way to continue getting rent/payments. 

Tenant's need to ensure they are not putting their personal assets, home and potentially a third-party guarantor on potentially crippling financial liability indefinitely and uncapped.

The key is to try and find a balance. But also speak to your solicitor before agreeing on who the tenant will be.

What is the tenant favoured position?

So, what kind of entity can the tenant be, and what are the implications of that? The main one will be a limited company. From a landlord's point of view, rather understandably, a newly incorporated limited company is not an attractive proposition as a tenant. 

Still, actually, there are reasons for a tenant to take a lease in the name of a limited company. If the landlord has adequate protection, either in the form of a deposit or a personal guarantee from the tenant (see above), a limited company has very attractive qualities.

1. Tax implications. Note - We are not tax specialists, so you must speak to your accountant. Two such tax saving schemes are The Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme, which are significant tax factors for a tenant. The SEIS, in particular, provides the rebate of income tax paid by the investor if they hold less than 30% of the company shares and the company is less than two years old.
   
   
   
   For example, if somebody is setting up a restaurant and they want to take the lease, they could have an investor giving £50,000, and if that investor then holds less than 30%, they will get £25,000 back from the government against previous tax paid on their income. It's a very important incentive. Landlords should appreciate that tenants would want to be able to succeed in the business and this obviously allows them to limit the start-up cost by 50%, assuming they've paid tax previously. It will help the business to grow and to flourish. Landlords should be looking to help the tenant at the start.
   
    
2. Transferability. The transferability of a company is much more straightforward than an assignment where the landlord controls every aspect. You can as accompany owner, transfer your shares in the company when selling the business or if you wish to retire and transfer the lease This means you don't have to go through a potentially difficult assignment procedure under the lease terms which allows the landlord to ask for a guarantor, have his fees paid and verify and approve the incoming tenant.
   
    
3. Rates and small business rates relief. A very useful aspect of having a tenant company is, of course, business rates, and in particular, small business rates relief. If you have more than one property, you will lose small business rates relief unless both properties have a rateable value of less than £2,600, which is effectively a shed!
   
   
   
   For business rates, a company is also responsible (and any guarantee must be within a separate document). The local authority can only ever ask that company to be accountable for the rates and not any individual. Business rates can cripple a business, and if that business fails, like the landlord, the local authority will request rent until the end of the lease regardless of occupation. Therefore a company with no assets or money will continue to be responsible until it is dissolved or liquidated or the landlord agrees to transfer liability or bring the lease to an end.

Landlord protections against a limited company as tenant

For the limited company to be agreed, what kind of protections can the landlord obtain?

• The first of these, of course, is the deposit. A deposit shouldn't be seen as a guaranteed amount of cash for the landlord, as actually, it's held on trust for the tenant. A landlord should be looking at a deposit as suitable and adequate protection for the tenant that is taking the lease. From a landlord's point of view, if you have a newly incorporated limited company, asking for a six-month deposit is not uncommon.
  
  
  
  Therefore, the landlord has a six-month cushion to find a new tenant and let the property out. Each case and property will be different, and of course, the landlord must be happy with the proposal and the incoming tenant's business plan. However, six months of rent being held as a deposit can be considered reasonable security for the landlord, rather than the personal guarantee.
  
   
• Landlords also need to understand that a tenant company gives significant tax breaks to the tenant, allowing them more financial security and giving the tenant the best chance for success (see above). Therefore, the message here is do not be scared of tenant companies as there are significant reasons why a tenant would want to do this.
  
  
  
  With the adequate security of a deposit and in addition or in addition or substitution of a personal guarantee (capped, of course), the landlord can rest assured that they are covered in case of tenant insolvency.

To recap, from a landlord's point of view, obviously having a tenant as an individual and a deposit is the best form of security. It will, of course, depend on the strength of covenant of that individual as if they have no assets, then it makes no difference whether they are a company or not. 

From a tenant's point of view, a company with no guarantee and a deposit would be best. It's a balance, but the word of warning here is do not agree to take the lease in your name without speaking to a solicitor. 

There are many factors, and an agent will ask you who the tenant will be, and you will need to consider all the options before confirming.

Expert legal advice on Heads of Terms

SO Legal has commercial property solicitors based in London, Brighton and East Sussex, and we work with clients across the UK.