In this article, Commercial Property Partner Oonagh McKinney provides advice for IPs on working with commercial leases – including complying to code of practice, assignments and break clauses.
This article is lifted from Oonagh’s presentation at our first annual insolvency conference.
What is included in a commercial lease?
Usually, a commercial lease will include the following provisions:
- A description of the property
- The lease term
- Rent provisions – amounts, when to be paid, review provisions
- Tenant’s covenants
- Landlord’s covenants
- Ability to deal with the lease (including assignments and underletting)
- Forfeiture
- Insurance
Some elements you may not always find include:
- Additional rights granted to a tenant
- Rights reserved to the landlord and others
- Break clause
- Guarantor covenants
- Service charge provisions
- Exclusion of the security of tenure provisions of the Landlord & Tenant Act 1954
What is the commercial lease code of practice?
The Code of Practice for Commercial Leases (2007) is a voluntary arrangement applying only to new leases, which intends to ensure that the parties involved are open and honest with each other.
The code is not mandatory, so the parties can choose not to follow it. However, a judge in a dispute may be influenced.
To try and standardise commercial leases, the Law Society produced two standard forms of leases for commercial lettings. One for a letting of whole and one for a letting of part.
They are fairly short in length and are generally in plain English.
Let’s look at some practical lease provisions in a bit more detail.
Property description
The property description must fit in with the repairing liability. If the lease is to be registered, then Land Registry compliant plans will be needed.
Term
Take care over the dates in leases, as the date of the lease and the commencement of the term are not necessarily going to be the same date.
Other dates to be careful of are dates within break clauses, rent commencement dates and rent review dates.
Tenant’s Covenants
In all commercial leases you have a long list of obligations with which the tenant must comply.
This usually starts with payment of rent and follow on with other restrictions such as the tenant’s ability to deal with the lease whether by assignment, underletting or charging, or matters such as changes of use, alterations or compliance with laws.
Repairing obligations
These need to be considered alongside the definition of the property.
The lease may well be subject to a schedule of condition prepared by the parties at the start of the lease identifying any particular areas where there is a lack of repair which will limit the tenant’s obligations.
Repairing obligations are a common area of dispute, so the lease needs to be really clear as to whose responsibility it is to carry out repairs and also, to what standard.
Restrictions on use
The Landlord also needs to consider the nature of use restrictions that are being imposed on the tenant, if it’s too restrictive, it may limit the Landlord’s rental income and may at the same time restrict the tenant’s ability to assign the lease.
Assignments
What is a lease assignment?
A lease assignment is the process of transferring or assigning the legal interest of a lease to someone else. (read more here)
If the lease is silent about alienation and there is no covenant, then the tenant is free to assign or otherwise deal with the lease without reference to the landlord.
The majority of leases will allow assignment, but with certain restrictions.
The assignment process
Currently, once a lease has been assigned – the tenant is released from a continuing liability under lease covenants.
However, the landlord can require the outgoing tenant to enter into an Authorised Guarantee Agreement (AGA).
If an outgoing tenant has entered into an AGA, he will act as guarantor for the new tenant but only while the new tenant holds the lease.
The outgoing tenant will still remain liable for any breaches of covenant arising before the assignment.
Obtaining a licence to assign
The landlord must deal with any licence application within a reasonable time. The tenant, if they have suffered loss as a result of the delay by the landlord, can sue for damages.
The landlord can attach conditions to a consent but those conditions themselves have to be reasonable.
Acting for a tenant
In the full presentation, Oonagh went on to outline everything you need to know when acting for a tenant wishing to assign their lease in more detail. However, in this article, it’s just the basics…
If you are acting for a tenant who wishes to assign their lease, consider the following:
- The undertaking to cover the landlord’s costs – who will pay?
- Tenant financial status & references
- Producing the last three years accounts
- The potential need to seek head landlord or mortgagee consent
- The potential need for the proposed assignee to put forward a guarantor or a rent deposit
- In some circumstances, you can get insurance against losses following assignment.
Rent Deposit Trusts
Many landlords will request a rent deposit- commonly 3/6 or 12 months. This could be the only valuable asset left (at least on the face of it) on a tenant insolvency. There are basically two types:
- Landlord holds the deposit on trust for the tenant
- Deposit held by landlord in name of tenant and charged to the landlord.
If there is no suitable deed in place, then the parties have to rely on the contract alone to take or recover the deposit and this may not be satisfactory on an insolvency.
Deposit on fund
Looking at the first option (landlord holding the deposit on trust), the tenant is only entitled to repayment of the deposit at the end of the tenancy or in other defined circumstances (e.g. after a set time if rent is up to date or once the tenant can show a certain level of profit).
If held on trust it does not form part of the insolvent estate if the tenant becomes insolvent, so the landlord can dip into the deposit if needs be.
Deposit held in tenants name
Looking at the second option (deposit is held in the name of the tenant, but charged to the landlord), the landlord would be a secure creditor to the extent of the deposit.
Landlords that have the right to enforce security and take it out of the deposit may be restricted during an administration by the moratorium which it imposes.
Break clauses
Break clauses are now very common in commercial leases. Generally, a break clause will be subject to conditions. These need to be adhered to strictly.
There are many cases where the validity of a break clause has been challenged on the basis that conditions have not been fulfilled.
Situations where break clauses might not work:
- If the tenant has not paid all rent and performed all the covenants (if the lease states so)
- If fire risk assessments and asbestos reports aren’t up to date (if the lease states so)
- Where the tenant hasn’t ‘materially’ or ‘reasonably’ complied with the terms of the lease (depending on what the lease states)
There are ways of watering down the covenants and when acting for a tenant, we would advise that the tenant agrees only to a condition that the rent has been paid and that the tenant gives up occupation.
Annual Insolvency Conference
The presentation, on which this article is based, was given by Oonagh McKinney at Frettens’ first annual Insolvency Conference with 50+ practitioners in attendance; and went into much more detail.
To receive invites to our insolvency events, webinars and conferences please sign up to our insolvency email list here.
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