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LPC Elective – Commercial Leases Part 1

LPC Elective – Commercial Leases Part 1
Commercial Leases is an elective about leases relating to commercial property. You may have covered a little about leases in Property Law and Practice, but this elective goes into much more detail and also looks at the commerciality of the leases: the motivations of the parties to the lease. Personally I found this elective very useful when doing my commercial property seat – understanding the basics of leases and the positions of landlords and tenants when it came to negotiations really helped me get to grips with the work.

One of the fundamental things you should keep in your mind when dealing with leases is who you are acting for: landlord or tenant. Each party will want different things from the lease and you will need to find the best possible compromise for your client. The fun part is that your client may not realise what they want until you ask them, so you have to be a mind reader of sorts. The key to this is an understanding of the lease provisions and where this sits for landlord and tenant.

Commercial Leases is an elective about, you’ve guessed it, leases – specifically those relating to commercial property.

Another key interaction for commercial leases is between the provisions of the lease and money – some provisions may idealistically be the best for your client but could increase the rent dramatically or make the property difficult to let. This will depend on the market – for example, as a result of the economic downturn, there are currently a lot of empty properties and in many cases it would be better for a landlord to have a tenant in his property than play hardball. Therefore, this is a tenant’s market, as they have a good bargaining position; getting them into the property is going to be more important to a landlord than the provisions of the lease. One of the important places for a lawyer to appreciate this interaction is in relation to rent review, which I will discuss in Part 2 next week.

I am going to look at some of the provisions that all commercial leases should include in some form and how this interacts with the motivations of landlord and tenant. This is not an exhaustive list, but should cover the main clauses of a commercial lease:

The term and break clauses

The term of a lease will be dictated by your clients, but it is important to understand how the term clause should be drafted. Ambiguities relating to term can make the whole lease void. It is better to include specific days and remember to use the right terminology:

  • ‘on’ = starting that day
  • ‘from’ = starting the day after.

Break clauses allow one or both parties to serve a notice on the other to bring the lease to an end. This provides them with a bit of flexibility on a longer lease but are usually accompanied by conditions that must be in place before the break can be exercised: for example, no breaches of the lease covenants, all rent paid in full, notice served in a particular way. Failure to comply with the conditions of a break clause will invalidate the notice and that party will be unable to exercise its right to break.

Drafting for landlords will involve making break clauses as difficult to exercise as possible. You should note that the courts will imply substantial performance in relation to break clause conditions unless drafted to require strict compliance.

Demised premises

This means the property to be let out. Property can be more flexible in leases than when being sold; you can let a space in a building, up to the paint covering on the walls and ceiling and the floor covering, but keep the walls, floors and ceiling for the landlord. Again, it is important to be certain; ambiguities could make the lease void.

A lease of whole will include everything. A lease of part is more difficult, as you will need to consider each aspect of each area to be let.  It is important  to consider who owns the pipes and conduits, etc., and also if any airspace will be included – you can exclude the airspace above the roof, but may need to grant a right to enter for repair.

The demised premises interact closely with the repair obligations within the lease. Each party will usually be responsible for maintaining his part of the property, so if the landlord is retaining the structural parts of the building, he is likely to be responsible for keeping it in repair, potentially expensive. If a tenant only has wall coverings, the landlord may wish to specify how those areas should be decorated and how often.

You may think this is basic, but it is an area I have had particular difficulty with in practice. If the demised premises are not described properly with an accurate plan, the land registry will not register them, which can cause huge problems. I have actually dealt with a lease that described the premises as ‘two rooms in block b’. Considering block b had 1000 rooms, it’s not really surprising that that description wasn’t sufficiently accurate!

Alienation

Alienation clauses describe if, and how, a party may transfer, sell or assign his interests in the lease. Allowing a tenant to assign will make a lease more attractive, as the tenant will be able to get out of a lease that is no longer attractive or that he cannot afford. However, the landlord will want some control over the assignee, to make sure he isn’t stuck with a bad new tenant and to ensure he can manage his portfolio of property correctly.

Usually the landlord will restrict how the tenant can share or further devolve its interest in a property through subletting, etc. This will depend on the particular kind of lease but, generally, it is not in the landlord’s interest to allow third parties to use the property with whom he doesn’t have a direct relationship, as if they do something wrong, he has no way of controlling their actions. He could complain to the tenant but by the time the tenant comes to deal with it, the damage may have already been done. The landlord will also not want to be in the position where he grants a fairly cheap rent to a tenant, who then sublets for a profit.

The alienation provisions will interact with user – it is all well and good having an open alienation clause, if the user provision is so specific that only the current tenant can comply with it. It will also affect the rent review provisions and other general covenants – the landlord will want to ensure a tenant cannot assign without its duties having been completed up to the date of transfer.

It is also common to see an Authorised Guarantee Agreement (AGA) clause in a lease in relation to alienation. This means that the out-going tenant agrees to guarantee the performance of the lease by the in-coming assignee. It gives some comfort to the Landlord and will ensure the tenant finds a suitable assignee. AGAs have generated a lot of case law about their operation and scope and it will be important to get to grip with this. I am not going to cover it here (as I know it has changed again recently!) but it should be something you read up on before your exam!

User

User provisions dictate how a property may be used. This can be described broadly or restrictively, depending on the motivation of the parties. A broad user provision will be an attractive lease, allowing a range of tenants and making the lease easy to assign. However, the landlord wish to keep a mix of tenants, or only one type of tenant, in his property, and will restrict the user provisions accordingly. There may also be restrictions imposed by the planning authorities – buildings will have a use class that dictates what they may be used for.

It is important to look through the whole lease when considering user provisions. Often there may be a list of tenant covenants, may be in a schedule, which state how the building will operate. The building may be only open between certain hours or there may be a restriction on loud noise. Your 24-hour takeaway shop would not be happy to find out they had taken a lease of a building that shuts at 5.30pm. Similarly, the landlord will not be happy to discover a tenant in his up-market business estate noisily fixing cars at all hours.

The user provisions will be a delicate balance between the needs of the landlord and tenant and the commerciality of the lease. In summary:

Landlords concerns:

  • to maintain value of interest /adjoining premises
  • avoiding damage to reputation
  • avoid competition to his own business and maintaining a mix of commercial uses
  • overly restrictive measures will lower rental value and market for tenants.

Tenants concerns:

  • a narrow user covenant = benefit at rent review
  • a narrow user covenant = limited market for assignment or sublet
  • need to have regard to its potential future use of the premises
  • no wider user than necessary, so better for rent review.

Come back for Part 2 next week on rent, rent review and repair.

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