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Signing a commercial lease

What do I need to know if I am signing a commercial lease?

Granting or taking a lease of a property used for a commercial purpose? Here is a quick guide on the key considerations when signing a commercial lease.

Property

The Landlord and Tenant will need to carefully consider what property is being granted under the lease and how this is to be defined.  As a tenant, do you require a lease of the property as a whole? Or will you require only one floor in a building, and therefore only require a lease of part? The difference is crucial as you will need to consider any costs of maintaining any common areas (areas used by you and other tenant’s of the building, such as corridors or stairways) when you are looking to take a lease of part.

Does the use fit your need?

It is important as a Tenant to ensure that the use of the property fits in with your desired commercial use of the property. For example, if you are planning to run a retail business you will need to ensure that the use defined in the lease allows for this type of use. If you are going to use the property for storage but will also have use of a small office, you will need to ensure that office use is permitted in the lease.

Rent and Rent Review

The Tenant and Landlord will be required to come to an agreement as to the amount of rent to be paid. However, both parties will need to consider how that figure has been reached, in other words has the value of the rent been based on the property’s rental value?

Another consideration to bear in mind is when the rent shall be paid. Most standard tenancies require rent to be paid on quarterly dates (25 March, 24 June, 29 September and 25 December); however both parties will need to consider whether this is suited to them and their business. The Tenant or the Landlord may require rent to be paid on a monthly basis, and this is something that will need negotiating and agreeing to prior to signing the lease.

As a Landlord and as a Tenant, you will also need to consider the rent commencement date. This is simply the date on which payment of rent commences. Some leases have the payment of rent commencing on the date of the lease, however, there may be room to negotiate a rent free period. This period of time between the date lease commences and when the rent becomes payable. For example, the lease may commence on 13 September 2019 but the rent commencement date is described as 13 October 2019. And therefore this gives the tenant a rent free period of one month.

Depending on the length of lease, there may also be provisions for rent review. There are several types of rent review (open market rent review, stepped rent review etc.) and both parties will need to ensure that they are aware of when rent review is to take place. For example, in a fifteen year lease, there may be a requirement for rent review to take place every 5 years from the date of the lease. Careful drafting of the rent review provisions will be required, and the parties to the lease will need to agree to the frequency of the rent review.

Landlords will want to make sure that there is an upwards only rent review clause in the lease, which allows for the possibility for rent to increase during the term of the tenancy and not to decrease. Tenants would prefer to include an upwards and downwards rent review, which would allow for the possibility of rent to decrease during the term.  However this is dependent on the bargaining power of the parties involved and what agreement can be reached between the parties. Either way you will need to consider that whatever is agreed between the parties is reflected accurately in the lease prior to signing.

Alienation

In the future, the Tenant may wish to sell the business or terminate the occupancy of the property. This can be due to any number of commercial reasons, including that the property may no longer be suitable for their needs. Therefore, some tenants will need to consider whether there is scope for this within the lease.

An alienation clause in a lease allows for the current tenant to assign their rights and obligations to a new incoming tenant. Landlords will want to keep close control over any assignment to ensure that the premises do not become occupied by an unsatisfactory tenant. The new incoming tenant will be responsible for the rent and the landlord will need to ensure that the new tenant is in good financial standing. Due to this, the Landlord will require a provision in the lease that allows the assignment of the whole with their written consent. Most tenancies do not allow for the assignment of part due to the difficulties this can create for the estate (such as apportioning rent).

When assigning the property, there may be a provision in the lease which requires the outgoing tenant to enter into an Authorised Guarantee Agreement (‘AGA’). An AGA essentially means that the outgoing tenant guarantees the new incoming tenant’s performance of the obligations contained in the lease. This means that if the new incoming tenant fails to perform the obligations in the lease, the Landlord can seek a remedy from the outgoing tenant under the AGA.

The tenant may also wish to sublet the property, which is different from assignment in that the tenant still has obligations under the original lease. The tenant essentially creates a lease out of the current lease to a new sub-tenant. Again, the Landlord will want to ensure that the sub-tenant will be in good financial standing to pay the rent, and therefore it is common to see a clause preventing the sub-letting of the whole without the written consent of the Landlord.

Again, most commercial leases prohibit the sub-letting of part of the premises for many reasons; one being that subdivision of the property could lead to the property being divided into unattractive commercial units. The tenant will therefore need to have careful consideration of the nature of the premises, as they will not want to limit themselves from disposing of surplus space, and if the premises lends easily to subdivision, there may be room to negotiate sub-letting of part with the Landlord.

Repair

The Landlord will want to ensure that the rent it does receive is ‘clear rent’, meaning that they can take the entire rental income without any cost to themselves. To do this, the Landlord will want to ensure that the lease is a full repairing lease which obligates the tenant to bear the costs of repairing the property, regardless of who carries the repairs out.

The tenant will need to ensure that they are fully aware of the extent of their obligation to repair. They will need to ensure that the premises they are required to repair is clearly defined, so they are not left with an obligation to repair part of the premises which they do not use. This is even more particularly important when it is a lease of a part of a building. The wording of the clause is also important, as if there is an obligation to “keep” the property in repair, it also means that the tenant is required to put premises in repair even if they the premises is in disrepair at the date of the lease. In this case, the Tenant will need to seek to limit its obligation by reference to a schedule of condition. This will be photographic evidence of the condition of the premises at the date of the lease.

The Tenant will also need to ensure that they are not liable for any damage caused by an insured risk. This is a risk which the Landlord has insured against.

The Tenant may also be liable to repair inherent defects which are defects which are caused by design or construction faults. The Tenant will want to ensure that the Landlord is responsible for repairing these defects.

As with many terms in a commercial lease, the Landlord and Tenant will be required to negotiate these terms and come to an agreement before signing the lease.

Term and Break Clauses

The Landlord and Tenant will need to give careful consideration to the duration of the lease. The lease needs to be drafted so that there is no uncertainty as to when the lease begins and ends.

Some tenants may want the option to ‘break’ or terminate their lease prior to the expiry of the term. Again, this is a negotiation point with the Landlord and depends on exactly what the tenant requires. The lease will need to contain provisions specifying exactly when the break can be operated (for example after five years) and set out the process of how to exercise the break.

A key consideration for the tenant will be the impact the length of the term will have on its Stamp Duty Land Tax (‘SDLT’) liability. Essentially, the amount of SDLT that will be payable increases along with the length of the lease, and there is no tax refunds on leases where an option to break has been exercised. Therefore a tenant will pay less SDLT on a lease which is for a shorter term with an option to renew, than a lease which is for a longer term and includes an option to break.

The Landlord and Tenant will need to consider the impact that the Landlord and Tenant Act 1954 (‘LTA 1954’) may have on the term of the lease. The LTA 1954 grants Security of Tenure to tenants occupying premises for business purposes, and allows for the tenancy to continue even after the contractual term has ended until such a time as it is terminated under the provisions of the Act. It also gives the Tenant the right to apply to the court for a new tenancy and the Landlord may only oppose the application on certain grounds. It is therefore attractive for the tenant to ensure that the LTA 1954 applies.

The Landlord however, may want to ensure that the LTA 1954 does not apply as it limits what he can do with the property and to whom he can let. Therefore he may wish to follow the contracting out procedure to ensure that the Act does not apply. Again, this an issue which will require negotiating between the parties, however the Landlord and Tenant will need to ensure that whatever is agreed is reflected in the lease before signing.

For more information on the LTA 1954 and the process involved, please see the Crombie Wilkinson blog post by Emma Campbell “Do Commercial Tenants Have Rights?

The considerations when taking or granting a commercial lease are many, and each commercial lease will be dependent on each party’s commercial needs and therefore individual to each transaction. Our Commercial Property team can advise you on things you may wish to consider when granting or taking a commercial lease before agreeing to terms which may be detrimental to you. They will be able to negotiate terms on your behalf and ensure that you are fully aware of any rights and obligations you may have under the lease prior to you signing.

If you would like further advice on this topic, please feel free to contact a member of our Commercial Property Team.