For this instalment we wanted to look at the complicated yet necessary world of the commercial lease and the legal process behind it. Many owners will be tempted to negotiate their own lease. It's not something we recommend, so we thought we'd take you through some of the legal aspects and the timeline when it comes to negotiating and completing a new lease for a site.
We are not legal experts, that's why we've interviewed none other than Nico Beedle from Merali Beedle to help us lift the fog of war when it comes to legal speak and the potential potholes you need to avoid
In the interview we will cover:
What the role of a solicitor is in a deal?
How leases have changed due to Covid?
Terms - the good, the bad, and ugly terms to have or avoid in your lease.
What does 'Inside the act' and other important legal jargon mean?
Use classes, A1/A3/B1 etc. - what are they and how does the new E1 class work?
Who are you and how do you make a living?
I'm Nico Beedle, a partner at Merali Beedle, a commercial property solicitor and I run a law firm of 30 lawyers with my business partner, Adam Merali. We're a team of experienced lawyers who previously worked for larger firms and who now work on a consultancy basis for clients that we want to work for.
What is your role in a commercial deal?
For any solicitor that is involved for a tenant or a buyer, your job is to carry out due diligence on the property, negotiate the documents, and manage the transaction. Our work tends to start when Heads of Terms have been agreed with a landlord.
How has the world changed for you over Covid?
From a work perspective, a lot of existing clients are approaching their landlords and asking for rent holidays - and another thing, many tenants I act for who have a break clause in their contract coming up are now approaching their landlords and using this as leverage to get rent free periods. Effectively saying "if you don't give me a rent free period now I will have to terminate the lease when the break clause comes into effect".
Anyone who has a break clause is in a great position at the moment to renegotiate their lease. I'm sure we'll cover this more later, but the first thing I'd recommend anyone taking a new site to do in their contract negotiations is to request a break clause. I know it seems counter intuitive, but when you take on a site you need to consider your exit strategy.
There are two ways you need to think about an exit - firstly, worst case scenario exit. If the site doesn't perform well, how can you get out of the lease?
I would suggest you negotiate a break clause/break clauses to enable you to terminate your lease early at certain points during the term.
Secondly, and more optimistically, what does a good exit look like? If a company comes along and makes an offer for your site or business, can you assign the lease or sell the site to them? Or can your landlord for whatever reason block your sale or assignment of a lease?
There are nuanced ways to protect yourself from that nightmare scenario - 95% of commercial leases don't have a clause in there that you need consent from the landlord to change control of the tenant company. This means that even if you would need consent to assign the lease to a new tenant, you may well be able to sell the whole company without the landlord's consent.
A tenant has found their dream location - what steps do they need to undertake before putting an offer in?
It's a funny question to ask me, because usually we are not involved until Heads of Terms have been agreed by a landlord.
But with my lawyers hat on, to avoid issues, map out your costs before making an offer. Fit out is a large one. A sequence I see is that a tenant has an offer accepted on a space they want, but then the solicitor will point out that they may need planning permission to carry out the work you want, such as adding external extraction. And then find out it will cost £50k to fit the site out, and that makes the site untenable. So be clear about your costs before charging ahead.
On the topic of fit outs - I've come across cases where a landlord or agent has advertised a site as A3 or capable of having extraction, but then when it comes down to it, the tenant can't get planning permission from the council to do so. What can you do in this scenario?
The general principle for anyone entering into a lease/buying a property is Buyer Beware - which means that it is the tenant's responsibility to do their due diligence first. I would strongly advise any tenant to carry out proper legal due diligence rather than relying on advertising particulars and scoping out the site.
Due diligence is a crucial part of the lawyer's role. If you for example, want to put in air conditioning, but the landlord doesn't own the area where you want to locate the air conditioning units, then this could potentially jeopardise your entire operation. That's what makes fit out plans so important before taking on a lease.
This will also become more of an issue when the new use class system comes into play.
Let's take a step back, could you explain what use classes are and how they will be changing?
The way it used to work before September 2020 - each commercial property would benefit from a designated use class. To use somewhere as an office, it needed to be B1, as a restaurant A3, takeaway A5 etc. - and there will be specific rules a site must follow to fit under that class.
(Find out more here - Planning Portal)
Landlords do not guarantee what a site can be used as. Now, recently a new class has been introduced called E1, which takes a whole host of commercial use classes and lumps them into one class, giving you the flexibility to use a space for a broader use. But here's the kicker, you still need permission for things like external extraction, certain fit-out works, alcohol license, etc. People might think it is a slam dunk solution, but that's not the case.
That said, these changes will not necessarily have an impact on existing leases with a specific use class. So if you buy an existing lease, the site can only be used as is written in the lease.
You're still ring fenced by the existing lease's terms.
Jargon buster time, what does 'inside the act mean'?
In 1954 a law (the Landlord and Tenant Act 1954) was passed, which included provisions that stated that unless the parties specifically agree otherwise, a tenant is entitled to a new lease on the expiry of their lease on market terms. This was introduced to stop landlords unfairly hiking rents.
In short, you benefit from security of tenure from the 1954 Act if you satisfy certain conditions, This means that for instance, if you get a 10 year lease you will be entitled to remain in occupation at the expiry of your lease unless the landlord can establish certain grounds requiring you to vacate, even though your 10 year term has expired.
Outside the act though is more common practice now (which means that you will be required to vacate at the expiry of your 10 year term), so do not be surprised if that is the case when you take on a new site.
Is it something worth fighting for?
Definitely. It's more common now to have new leases outside the act though.
Are there protections in place that you can have to offset this if a landlord refuses this term?
In most leases you'll have a rent review after 5 years - which will be either pegged to market rents or stay the same if the market doesn't change.
If you are not getting security of tenure, then you can negotiate to include an option for an extension to the existing lease. So let's say you ask for a 10 year lease, you can also ask for an option for 5 more, set at market rates.
What is a break clause?
A clause in a lease that allows one or both parties to terminate a lease before the expiry date. Very common with a 10 year lease, you'll have a break clause at the end of year 5. Usually this is in the tenant's favour, where they can turn to the landlord and say "this isn't working for me, I am cancelling my lease early". Greater flexibility. BUT it's very important to negotiate the break clauses carefully to ensure you are able to satisfy the conditions.
If you do exercise a break clause, what happens to the value of the fittings and fixtures at the site?
The way it usually works is that a tenant is obliged to take out the fittings they put in and leave the site as it was originally found.
What are dilapidations?
It's a technical term that refers to the cost of the work/work that a tenant needs to carry out to put the shop back into good condition. In some cases, you are responsible for the condition and the upkeep of the building (again, it will depend on the wording of the lease).
Rent deposits - good or bad?
The first thing is tenants might think they are annoying, but in many cases the other alternative is to offer a personal guarantee. And rent deposits are generally a much better option.
A personal guarantee is generally a bad idea because usually a tenant will set up a limited company when taking on a lease - that will ring fence the liabilities they have for the business to only the assets of the business.
Now landlords understandably don't want to grant a new lease to a company that was only set up a week before on Companies House with no trading history. And often they're willing to enter into a lease with you only if you provide some security, and that means if you don't pay rent they have someone or something to go after to recoup their losses.
Now imagine if in a scenario the building burns down, and you did something that caused the building's insurance to be invalid, under the terms of the lease then the landlord is within their right to come after you to pay for the cost of rebuilding the building. If you are a company, then the landlord only has recourse against the tenant company and the rent deposit. But if you have given a personal guarantee then you will be personally liable, and your liability is unlimited.
A deposit is a much better alternative, and you will be entitled to this being returned to you (less the cost of any breaches) at the end of your lease.
What sort of clever deal structures are coming up due to covid?
Turnover rent is becoming far more common, where you pay a set percentage of your turnover as rent. The biggest issue is tracking it.
What about rent free?
Yes, this is the most common and was very much the case before the Covid period. I think rent free is common because a landlord wants to give tenants a chance to help an owner get off the ground running for a new business or site.
But for certain landlords they will prefer a deal that is lower rent but a steady income from day 1. It's a good idea to ask your landlord what type of deal they would prefer before making an offer.
Last question - what are alarm bells for you when dealing with a landlord?
I probably say the issues will probably come out of our due diligence. The only other thing I can think of is word of mouth/reputation. What other sites do they have, and how have they dealt with their tenants? Big landlords sometimes get a bad reputation in the market, but in all honesty the majority have acted very well over the Covid period in my experience. For them the reputational damage is worse than squeezing a few months rent out of struggling businesses.
People have a longer memory than we give them credit for, especially when it comes to negative experiences, so if you cross them - they will tell their friends/business associates, and the property world is small...