Thinking of taking on a new commercial lease?

If you are about to be a tenant taking on a new commercial lease of commercial property/land, how straightforward is it and what should you consider?

Theoretically, the landlord’s solicitor has sent you a new lease for you to sign, promising that the terms of the new lease are fair. All you have to do is sign and return the lease to the landlord’s solicitor. Once dated and completed, that is it, you are now the landlord’s new tenant.

In an ideal world, the first draft of leases would all be drafted fairly, with the terms of the lease striking a fair balance between the landlord and tenant respectively. Unfortunately, this is not always the case. Prospective new tenants should always be aware of potential disproportionate liabilities. It is important that they enter into negotiations for new commercial leases with their eyes open to potential pitfalls, especially in the case of a new start-up business.

So what should a prospective tenant be considering in relation to a new lease?

Automatic right of renewal

The law (in the form of the Landlord and Tenant Act 1954) gives commercial tenants the right to renew their lease on the same or similar terms when the contractual term of the lease expires. This can be valuable to new tenants, especially when they have built up their goodwill in a business at a particular geographical location. However, some landlords are becoming more savvy in negotiations for a new lease, insisting on excluding, or contracting out of, these ‘security of tenure’ provisions. Unsuspecting tenants may not think too much about this technical area of law, but if a deal has not been put in place by the end of the contractual term of the lease, the tenant must vacate. Failure to do so will result in the tenant being considered a trespasser and becoming liable for damages for the period during which the landlord is unable to let the property in the open market.

Tenants will often fail to begin negotiations far enough in advance of the expiry of their lease and can find themselves having to pay a higher price to the landlord to remain in occupation and ensure business continuity.

If tenants can negotiate the inclusion of the security of tenure provisions within the new lease at head of terms stage, then that is great news. If this is not possible, it is important for tenants to consider at the outset their preferred lease term length to suit their business requirements. Tenants should also ensure that renewal discussions are raised in good time of the end of the contractual term of their lease.

Break Option

It is wise for prospective new tenants to insist on the inclusion of tenant-only break options in the lease, especially for new business tenants who require an exit strategy.

The initial position for tenants is to request an unconditional break option. Tenants should be aware at negotiation stage that landlords may not be willing to proceed with an unconditional break. Any conditions imposed by landlords should be clearly defined and unambiguous. Tenants will want to be in a position to be able to comply with any conditions imposed by landlords. Any uncertainty surrounding compliance could potentially allow the landlord to frustrate the tenant’s ability to exercise their break option.

Assignment and underletting

By way of a further exit strategy for tenants, the ability to assign or underlet their lease is important. This gives flexibility if circumstances change during the contractual term of a lease.

At the heads of terms stage, tenants should ensure the ability to assign or underlet their lease is permitted. However, tenants should be aware that they are unlikely to be completely off the hook in the event the rights are exercised. It is usual for an outgoing tenant to give a guarantee of performance  for the terms of the lease being adhered to (including payments of rent and dilapidations sums) by the new tenant. This guarantee will remain in place until the new tenant assigns/transfers the lease once again, or the end of the lease (whichever comes first).

Repair obligations

Most landlords will require new tenants to enter into a full repair and insuring lease (FRI). The landlord will be keen to have a full tenant’s repair obligation; this may include handing the property back in a better state than it was in at the outset.

Proposed tenants should be aware that such repair liability can be onerous, especially where tenants are responsible for the structure of the property itself. This often comes as a surprise to tenants, and it seems unfair that they should be required to improve the state of the property where the underlying investment value remains with their landlord.

Any failure to return the property in the required state when the lease expires can result in the tenant being served with a hefty dilapidations claim. To give new tenants much needed protection, it is better to limit the tenant’s repair liability to the condition at the start of the lease. This should be evidenced by a photographic schedule of condition. This will be useful, especially for older properties.

Service charge

If prospective new tenants are also expected to pay a service charge, it is important to be wise to, and wary of, the responsibility for payment of unknown sums. Landlords will often exercise their discretion to carry out maintenance or even improvement works under a lease and recharge the costs to tenants by way of a service charge.

New business tenants will want to ensure they are not hit with unexpected high service charge bills. Tenants should budget for such expenditure and should aim to negotiate an inclusive rental figure or a service charge cap.

An alternative for tenants could be to insist on ‘carve-outs’ for items of expenditure which the tenant does not benefit from and is not expecting to contribute towards.

In summary, taking on a new commercial lease for your business is a significant commitment for a new tenant, especially for a start-up business. The financial liabilities associated with taking on a new lease (namely the annual rent) is a significant overhead for businesses and what seems as though it ought to be a straightforward process can prove an expensive minefield. Prospective new tenants should seek legal advice early on at the negotiations of heads of terms stage to protect their position and ultimately their business.

The team at Fraser Dawbarns will be happy to help you to negotiate your new commercial property lease. Contact Aashish Soni on aashishsoni@fraserdawbarns.com or 01553 666620.

This article aims to supply general information, but it is not intended to constitute advice. Every effort is made to ensure that the law referred to is correct at the date of publication and to avoid any statement which may mislead. However, no duty of care is assumed to any person and no liability is accepted for any omission or inaccuracy. Always seek advice specific to your own circumstances.  Fraser Dawbarns LLP are always happy to provide such advice.