Commercial leases – the pitfalls
Buying commercial property can be expensive and requires substantial capital investment at the outset. Taking a commercial lease is viewed as a better option by many businesses as it allows greater flexibility for its business.
Despite this, and the usual Landlords’ claims that the lease contains standard or simple terms, commercial leases are complex and can be a minefield for the unwary.
It is important that tenants fully understand the terms of the lease before committing; entering into an unfavourable lease could prevent the business from fulfilling its potential or, in extreme cases, cause it to fail completely.
Set out below are some tips and key terms to consider when negotiating commercial leases.
Heads of agreement
The heads of agreement documents the key commercial and legal terms agreed between the parties.
Save for a few exceptions, the heads of agreement are not binding and do not compel the parties to conclude the lease on those terms, if at all. However, it does provide the basis for negotiations and for the drafting of the legal papers.
Although predominantly “non-binding”, care must be taken when agreeing the heads of agreement as they may well include clauses dealing with cost penalties for failing to complete.
Every lease will have a clause dealing with repair. The type of repairing clause will depend on a number of factors, for instance, the current state and condition of the premises, whether the premises are part of a larger building and the commercial bargaining position of the parties. In any event, the obligation to repair should be limited according to the length of the lease, age of the premises and the existing state of repair of the premises.
The landlord will undoubtedly seek a full tenant repairing obligation, being a covenant by the tenant to keep the premises in good and substantial repair, in order to protect its capital investment. If the premises are in disrepair at the beginning of the lease, the tenant will be required to put the premises into repair and to keep them in that condition for the duration of the lease. The reality of the matter is that the tenant could be required to put the premises in good repair twice, both at the beginning and end of the lease. The cost of repair could be substantial and impact greatly on the tenant’s business aspirations.
If the premises are not in good repair at the start of the lease, the tenant should seek to limit the repairing obligation either by reference to a Photographic Schedule of Condition, or by asking the Landlord to carry out repair works or by negotiating further concessionary terms.
The lease should be amended to reflect any limitation of the repairing obligation as Landlords have an uncanny knack of forgetting oral arrangements as soon as they are agreed!
The longer the term of the lease, the more important it is for the tenant to incorporate an “exit route” in the form of a break option. Put simply, the break option allows the tenant to terminate the lease either on a fixed date or on the happening of a prescribed event. The break option is a protective clause designed to assist the tenant should its business fail or should other premises become available on more favourable terms.
It is likely that the Landlord will include pre-conditions that the tenant must satisfy before the lease can be terminated. No Landlord will give up guaranteed income stream without a fight!
If the Landlord insists on pre-conditions, the tenant should ensure that these are clear and not overly onerous. Failure to exercise the break option correctly will see the Tenant on the hook for the remainder of the lease, or in starker terms paying thousands of pounds’ worth of rent.
Ordinarily, the tenant of a business lease has a statutory right to stay at the premises and request a lease renewal following the end of the current lease. The landlord can object only on very limited grounds and may be forced to pay the tenant compensation in certain circumstances.
The Landlord can seek to exclude the statutory protection, and in such circumstances the tenant will have no automatic right to remain at the premises after the end of the lease. If this occurs, the tenant will have to negotiate a new lease with the landlord, who could take advantage of the situation by charging a higher rent or by imposing more onerous lease terms!
It is always advisable for the tenant to have the lease granted within the statutory protection, but this should be insisted upon if the lease is for longer than five years or if having to vacate the premises would impact greatly on the tenant’s business. Ultimately, whether the Landlord concedes the point will depend on his or her future intentions for the premises.
There will usually be a clause dealing with the tenant’s contribution towards the service charge, which are the common expenses incurred by the Landlord and payable by the tenant for repair, maintenance and services.
Details of the services rendered by the Landlord and payable by the tenant will be set out in the lease but service charge provisions are notoriously complex and difficult to understand.
There is, of course, no substitute to obtaining professional advice. However, should the tenant be faced with negotiating the service charge provisions, it should seek to have (i) its contribution limited to what is fair and proper and subject to an agreed cap; (ii) items of extraordinary expenditure (for instance lift replacement) omitted; and (iii) services that it has not benefited from removed.
The points highlighted above are far from exhaustive but do provide an indication of matters to consider when agreeing and negotiating premises leases and the need to instruct professional advisors from an early stage.
Done properly, commercial leases can provide businesses with flexible and cost effective premises tailored to their commercial needs. Done incorrectly and the tenant could be wishing that it had bought the premises at the outset!
Iwan Williams, Solicitor, Commercial Property