Entering into a commercial lease exposes a tenant to a number of overheads and liabilities. Equally, from the landlord’s point of view, investment in a commercial property for letting generates income and the landlord will need to be certain that this asset is protected and that the incoming tenant is able to meet its obligations under the lease.

It is important to get matters off on the right foot and, to achieve that aim, a little time taken at the start of a transaction to produce a detailed set of Heads of Terms (HOTs) is recommended and pays dividends for both parties.

Benefits include:

• Key commercial points or “dealbreakers” are identified at an early stage - prior to both parties incurring costs for what might be an abortive transaction;
• Lack of detail in the HOTs usually means more time taken in the legal negotiations ironing out commercial points – conversely, if a matter is dealt with in the HOTs then negotiation of the lease can be concluded relatively swiftly, proving cost effective for both sides;
• For a tenant, negotiating the HOTs brings into focus the important issues for their business – a commercial lease and the costs and liabilities associated with it may be one of the biggest overheads a business faces and it is worth investing time and energy early on in the deal as these will have repercussions throughout the term of the lease.

This month we will look at the scope of and issues raised in relation to rent and other financial charges; whether financial security is required by way of guarantor or rent deposit; term length and break options; security of tenure and the repair covenant.

Part 2, next month, will cover alienation, alterations, insurance, rent review, permitted use, works obligations and rights and reservations.

Principal Rent

This is an annual figure, usually paid quarterly in advance. A tenant may wish to negotiate monthly payment to manage cash flow and may be able to do so in a strong tenant market.

Check the VAT position – has the landlord opted to tax the property for VAT purposes?

Rent Free Period

Often the tenant will benefit from a rent free period to cover the period of their fit out works. They may also be able to negotiate a further rent free incentive. Consider whether to stagger a rent free period (for example an initial 3 months with a further 3 months at the start of the 2nd year of the term). This may be preferable for a landlord who will not want 6 consecutive months without rent.

Additional Security/Guarantee

Personal Guarantor – a landlord will often insist on this where the tenant is a new business start-up. The guarantor will be financially liable if the tenant defaults and can be called on to enter into a new lease if the tenant defaults.

The landlord may require a Rent Deposit. The parties need to agree how much and for how long – the full lease term or for a shorter period?

Service Charge- Is there one and what does it cover? A service charge regime operated by or on behalf of a landlord is routine for a multi-let building/shopping centre/premises on a larger estate. Points to note are:

• Consider and define the scope of services and costs;
• Landlord obligation to produce audited accounts;
•  Consider whether the tenant will:
  • Have the right to challenge the service charge;
  • Benefit from a service charge cap – commonly no greater increase than in line with RPI annually;
  • Require that the service charge is in line with the optional code of practice.

Term

A longer term provides security but also extends liability and may not be suitable for a business start-up or one with rapidly expanding/changing operational requirements.

Security of Tenure

Is the lease within the protection of the Landlord and Tenant Act 1954? If it is, then the tenant is entitled to a new lease on substantially the same terms following the expiry of the lease term. This gives additional protection to the tenant but may be something that the landlord does not want to concede.

Break Options

A right to terminate the lease by exercising an option to break is an important concession for a tenant as it gives the opportunity to limit exposure to ongoing liabilities in the event of a failing business or changing needs.

A landlord may also wish to secure a right to break the Lease although this is less common.

Consider:

• A break on a specific date(s) or an ongoing right throughout the term;
•  What conditions?
  • Service of [6] months’ written notice;
  •  Payment of all sums due up to the break date;
  • No ongoing [material] breaches of the lease terms.

Repair

Will the lease be an FRI (full repairing and insuring)? This is the common commercial position and requires the tenant to keep the premises in “good and substantial” repair and condition. The sums required to fulfil this obligation and to put right dilapidations at the end of the term can be a substantial cost to the tenant

If the premises are not in good repair at the start of the term it is advisable for a tenant to negotiate a qualified repair covenant i.e. to take a photographic schedule of the condition of the premises together with a covenant that the tenant shall not be required to reinstate the premises at the end of the term to a better standard than they were in at the start.

Ortolan can provide advice on proposed HOTs at an early stage of a transaction and can provide a specification for a standard and/or bespoke set of HOTs prior to you finalising negotiations to ensure the needs of your business are adequately protected.