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LPC Elective – Commercial Leases Part 2

LPC Elective – Commercial Leases Part 2

Read Part 1.

Rent

There are several types of rent for commercial leases:

  • Market rent = actual value
  • Peppercorn rent = nominal yearly amount
  • Ground Rent = a low or nominal amount of rent
  • Headline rent = ignores effect of concessions or rent free periods
  • Market Rent = best rent obtainable on the open market
  • Rack rent = highest market rent
  • RPI rent = increases with retail price index
  • Side by side/geared rent = between landlord and developer, ground rent and a share of income of underleases (this is not attractive for SDLT)
  • Turnover rent = based on tenant’s turnover at premises, expressed as a percentage. This entails a degree of risk between tenant and landlord and usually a basic rate will be payable regardless. The burden will be on the tenant to evidence turnover.

There may be an initial rent-free period for tenants at the beginning of the lease, to allow them to fit out the premises or to give them a lead-in period to generate business. Rent-free or reduced rent periods are more common in tenant’s markets.

Rent review

Rent review clauses allow a controlled process to review the rent and make adjustments to better align the rent paid with the current market conditions. They are crucial for a landlord letting premises on a long lease as after a number of years the rent initially paid will not be as profitable and the lease will reduce in value.

Types of rent review:

  • Escalation clause – the rent is varied by reference to changes in other rent value or index
  • Revaluation  – the amount of rent is reassessed
  • Stepped increases – set increases at intervals. This is usually for long leases, is simple and certain but is very rigid.
  • Indexation – change in line with an index
  • Value based increase – linked to increase in value of property
  • Market rent – open market value e.g. ‘market that includes all possible lessees each of whom has an equal opportunity of bidding’
  • Upwards only – rent can only increase and will be the higher of rent assessed and rent currently paid. Great for landlords but  can cause problems for tenant to assign

Rent review clauses will specify how a rent review is to be carried out and what should be taken into consideration. The landlord will wish to exclude any particularly restrictive covenants or provisions, especially in relation to alienation or user, as these will depress the value of the lease. The tenant will want to have a lease as close as possible to the actual lease, so as to reflect its true value. The tenant will also want to exclude any goodwill in the premises it has generated and any increase in value caused by improvements it has made.

The clauses will also specify the operational provisions of how a review will be carried out: how frequent, who initiates the process, how long will negotiations continue, who will value the rent, how are disputes resolved etc.

Rent review is very important – it is the only provision that ensures a lease retains its commerciality over a long period.

Repair

Repair in a lease is an important operational provision, to ensure that both tenant and landlord understand their obligations with respect of the maintenance of the building. Insurance closely follows the repair obligations, as the parties will wish to make sure they are insured for damage they are obliged to repair.

Leases of whole are usually FRI – Full Repair and Insurance. This means the tenant must maintain the whole and insure the whole. Fairly simple. It becomes more difficult when it is a lease of part. It may be easier for the landlord to assume responsibility for some areas and charge this back to the tenant through a service charge e.g. where there are pipes or conduits that run throughout the building. If the tenants were each to repair their little area of the pipes, the landlord would have to grant them all access and would have different standards of repair throughout his buildings.

The repair provisions should identify who has to do the work, on what basis and provide for access rights to do the work. It should also provide a mechanism where one party doesn’t comply with its obligations (both in an emergency and non-emergency situation). This could be withholding rent or service charge on the tenant’s side or a right to do the repairs and bill the tenant on the landlord’s side.

It will be important to specify the standard of repair for the lease. ‘Maintaining’ a building is a lower standard than to ‘keep it in good condition’. It may be that the tenant’s repair obligations will require it to make the building better than it was when it moved in – the tenant will want to avoid this situation. One way of limiting the possibility of repair is to include a schedule of condition to the lease. Not only will this make it clear where the distinction lies, it also means there is evidence against a claim for dilapidations if the lease comes to an end.

As stated above, this is not an exhaustive list – there are a lot of other clauses that will be important in a lease. In terms of the exam, you are likely to be asked to explain (or advise a client) on a particular clause, or what they need to be concerned about in relation to a lease. It is likely that rent review and repair will feature somewhere, as will alienation/user so it would be good to understand these. It may also be an idea to have a read of some leases – there are model leases in precedent banks – to see how these provisions can be drafted and how a lease is set out. This can help you rationalise the different clauses, as it is easy to get overwhelmed if you deal with each clause in isolation.

I will end with the one thing I think all lawyers dealing with leases should remember – read the whole lease! The meaning of each clause can only be determined if you appreciate how it interacts with the rest of the lease and it will be extremely unlikely that, for example, all the provisions relating to user will be included in the clause of that name.

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