As a prospective tenant, you've found that perfect space for your business in a brilliant location for a rental price that you are happy with. Alternatively you are a landlord and have finally found a tenant for that empty unit. Robert Lusher of Russell-Cooke reviews the issues you need to consider when negotiating heads of terms to help avoid any misunderstandings and to save time and costs when it comes to agreeing a business lease.
Making it clear who the contracting parties are from the outset can avoid a lot of wasted time and effort. The Landlord may be expecting the parent company to be the entity contracting with it but sometimes, for perfectly valid business reasons, it may be a subsidiary or indeed a new corporate entity entirely. It will be important for the Landlord to ensure that the prospective tenant has the financial strength to pay the rent for the duration of the term and it would be advisable for references to be provided as early as possible. If need be, discussions can be had in relation to ways around the problem that are mutually acceptable to both parties (such as rent deposits, bank guarantees and/or third-party guarantors).
The extent of the property should be described and if possible by reference to a plan. A tenant may be expecting to have exclusive use of car parking spaces, toilets and/or storage areas when in fact the landlord may consider them to be communal spaces. As detailed in the 'repair section' below, the extent of the demise will also be important in determining who is responsible for repairing what. For example, is the whole structure to be demised to the tenant or is it an 'internal' demise only (excluding the roof, foundations, etc.)?
The length of the lease may be as short or as long as the parties agree but it is also important to establish whether the lease is 'inside' or 'outside' the Landlord and Tenant Act 1954. If the lease is 'inside' the 1954 Act this gives the Tenant an automatic right to renew the lease at the end of the term (subject to meeting certain criteria) and in certain circumstances will also entitle the tenant to compensation if the Landlord wants the premises back.
Rights to break
The landlord and tenant will also need to agree if either or both parties have a right to break the lease early and if so when and on what basis. The break could be a specified date or a rolling break exercisable at any point after a certain date. In addition, the parties will need to agree on what notice period is required and whether there are any conditions to the break.
A landlord may want the break to be conditional on payment of all sums due under the lease but this may make the break difficult to exercise if such sums are not known at the time of the exercise of the break. As such, a break may often be conditional on payment of the principal rent only. Furthermore, does the Tenant have to give the property back with 'vacant possession' (which may include not just ensuring that there is no-one in the premises but possibly removing the Tenant's equipment, alterations and additions)? Another condition you may sometimes see is compliance with the tenant's covenants in the lease, which some commentators argue would make the break almost inoperable. Consideration should also be given as to whether there is a break penalty if the Tenant exercises the break or alternatively a rent free period (or another incentive) if the Tenant does not exercise the break.
Although not as common, sometimes a landlord may want the right to determine the lease early if, for example, it wants to redevelop the building. In such cases, what conditions are attached to the landlord's break right? For example, does it have to provide a copy of the planning permission for the redevelopment as a condition to it serving a break notice?
Rent and rent review
It is likely that the parties have concentrated on agreeing on the initial annual rent (and rightly so) but you will also need to clarify whether this is inclusive or exclusive of rates, service charge, utilities, and/or insurance costs.
If there are going to be any rent reviews during the term when will they occur and on what basis? Some reviews may be open market reviews and others may be fixed uplifts or based on the Retail Price Index ("RPI") (or other indexes).
You may also wish to consider the rent payment dates. Traditionally, the rent is paid quarterly on the usual quarter days but more frequently we are seeing monthly rents being agreed.
As mentioned above, there may be service charges payable in addition to the principal rent. If this is the case it will be important to establish how the service charge is calculated, what is included, what the likely costs will be and whether any significant expenditure will be required to the building during the term of the lease. It may be advisable to obtain a survey of the building if this is a concern.
A service charge cap may be a good way of limiting a tenant's exposure but is it a fixed cap throughout the term or perhaps increased periodically in accordance with RPI (or another index). The Tenant may also want to consider what service charge exclusion items it is not willing to pay for. For example, the tenant might not want to contribute towards the service yard if it does not use it.
Normally you would expect to see the Landlord insuring the building and the Tenant paying a proportion (or the whole) of the cost of doing so. Again the Tenant will want to know what the cost of this will be and the Landlord may have to check with its insurers as to whether its cover will be affected by the Tenant's proposed use.
The parties should also consider what happens if the premises are damaged by an insured (or even an uninsured) risk. Usually, a rent cessor would apply and there would be a right for either party to determine the lease after a certain period if the premises are not usable.
The Tenant will need to make sure the property has planning permission for its intended use. However, the Tenant may want the ability to apply to change the use throughout the term of the lease if its business develops or if it wants to assign or sublet the lease. Conversely, the landlord may want to control what the Tenant uses the premises to ensure that the tenant mix in the building or the estate does not affect its reversionary value.
Assignments and subletting
The parties will need to agree on how the tenant can deal with its premises. An absolute prohibition on all dealings may be appropriate if the lease term is quite short. Alternatively, assignments and sublettings of the whole (and sometimes part) of the demise are permitted subject to obtaining the Landlord's prior written consent. Quite often a Landlord may want the outgoing tenant to act as a guarantor for its immediate assignee under what is called an Authorised Guarantee Agreement (AGA). If the Tenant itself has a surety the Landlord may also want the Tenant's surety to guarantee the Tenant's covenants in the AGA. It will be important for both parties to agree on these issues early on to avoid complications further down the line.
The Tenant will usually be responsible for maintaining and repairing the property demised to it and as mentioned above, it is important to be clear what parts of the property are demised to the tenant. For example, is the air conditioning part of the Tenant's responsibility or would this be the Landlord's responsibility under the service charge regime? Furthermore, is the Tenant obliged to keep the property in good and substantial repair and condition or is the repairing obligation to be limited by a schedule of condition?
The parties will need to establish what alterations a tenant can make to the premises and whether the Landlord's consent is required for such alterations. A Landlord may want an absolute prohibition on structural and/or external alterations but such alterations may be imperative to the Tenant's brand. If alterations are made to the premises the Landlord may also want to make it clear that they have to be removed at the end of the term (which could be quite costly for the tenant).
It will be important to ensure that the property has sufficient telecommunications infrastructure to enable the Tenant to operate effectively or for the Landlord to agree that new cabling (if required) can be installed. It would be wise to check the infrastructure capabilities at an early stage as agreeing on the necessary works, wayleaves, and easements can be a time consuming and costly process.
The above points are some of the headline issues that will need to be identified and resolved as soon as possible and obtaining legal input to the heads of terms at the outset is a good way of saving time and costs further down the line.