- 08 June 2017
- Commercial Real Estate
A large percentage of modern leases of business premises include break clauses and virtually all will include provisions restricting the assignment and underletting of the lease. A landlord will generally seek to control the exercise of a tenant’s break and the tenant’s right to assign or underlet its premises as far as possible without damaging any future rent review on the grounds that the lease contains onerous conditions.
The Code for Leasing Business Premises in England and Wales 2007 (“the Lease Code”) is a code resulting from the discussion between representatives of landlords, tenants and the government. The aim of the Lease Code is to provide a document to be used as a checklist for negotiations before the grant of a lease and lease renewals. Many major landlords have agreed to be bound by the provisions of the Lease Code.
Notwithstanding the existence of the Lease Code, we still see numerous leases for business premises which contain break clause and alienation provisions which are in direct conflict with the provisions of the Lease Code.
As a reminder for landlords and tenants the Lease Code provides as follows:
- Break Clauses – “the only pre-condition to tenants exercising any break clauses should be that they are up to date with the main rent, give up occupation and leave behind no continuing subleases”.
Notwithstanding this clear wording, many landlords and their solicitors still provide break clauses containing the provision that the tenant will not be entitled to exercise the break if “there is a subsisting breach of any of the covenants or conditions on the part of the tenant in this lease” or similar wording.
As landlords are aware, such wording is likely to make the break clause unenforceable. Any tenant is likely to be in breach of some provision contained in the lease, however minor, and this wording will entitle the landlord to prevent the exercise of the break. It should always be rejected by a tenant.
Although there is no mention in the Lease Code of the payment of any penalty by the tenant prior to the date on which the lease is to be broken, tenants need to remember that where such penalty payment has been agreed, it must be paid before the specified date. If it is not, the landlord will be entitled to refuse to accept any break by the tenant.
- Assignment and Subletting
- Assignment – the Lease Code provides that “leases should:
- allow tenants to assign the whole of the premises with landlord’s consent, not to be unreasonably withheld or delayed; and
- not refer to any specific circumstances for refusal although a lease would still be Code compliant if it requires that any group company taking an assignment when assessed together with any proposed guarantor must be of at least equivalent financial standing to the assignor (together with any guarantor of the assignor).”
The Lease Code also provides that “an authorised guarantee agreement should not be required as a condition of the assignment unless at the date of the assignment:
- the proposed assignee, when assessed together with any proposed guarantor, is of lower financial standing than the assignor (and its guarantor); or
- is registered or resident overseas.”
The above wording is generally ignored in modern commercial leases.
The majority of new business leases contain many specific conditions that must be complied with including:
- an absolute obligation on the part of the tenant (and the tenant’s guarantor if any) to enter into an authorised guarantee agreement;
- a requirement for a guarantor for the assignee (sometimes worded to provide that this will only be required if reasonable and on some occasions an absolute obligation);
- that the annual rent and any other money due is paid up to date and that there is no material breach of covenant by the tenant that has not been remedied;
- that the assignee and the tenant are not group companies;
- in the landlord’s reasonable opinion the assignee is of sufficient financial standing to enable it to comply with the tenant’s covenants and conditions contained in the lease;
- that the assignee is of the same or greater financial standing than the tenant or in the opinion of the landlord the value or marketability of the landlord’s reversionary interest in the business premises would not be diminished or otherwise adversely affected by the proposed assignment.
This is one of the worst provisions to be imposed as, if the current tenant is a very strong covenant, it may enable the landlord to reject a satisfactory tenant whose only issue is that he is of weaker covenant strength than the current tenant;
- the proposed assignee enjoys diplomatic or state immunity (but is not the Government of the United Kingdom or any department of it);
- the assignee is domiciled in a jurisdiction in which a Court Order obtained in England may be enforced without consideration of the substance of the case.
Where leases automatically impose the above-mentioned conditions, no consideration is given as to whether or not these conditions are reasonable. The obligation to be reasonable was imposed on landlords by the Landlord and Tenant Act 1927 but relaxed as a result of the provisions in the Landlord and Tenant (Covenants) Act 1995.
It may well be that it is reasonable for the assignee to provide a guarantor or for consent to assignment to be refused if the assignee is not of sufficient financial standing to enable it to comply with the tenant’s covenants or conditions. However, a tenant should argue very strongly against the inclusion of a provision automatically entitling the landlord to refuse consent where in the reasonable opinion of the landlord the value or marketability of the landlord’s reversionary interest would be diminished. It is not appropriate for a landlord to take this into account when granting consent to an assignment. Its only concern should be that the assignee is of adequate financial standing to enable it to comply with the tenant’s covenants, including payment of the rent and any other monies due.
As set out above, the Lease Code provides that authorised guarantee agreements (AGAs) should not be required save in specific circumstances. However, as most commercial tenants will be aware, new commercial leases almost always require an AGA on completion of an assignment. It is always worth pressing for a provision that an AGA will only be required where reasonable.
It is not unusual for landlords to require that any rent is paid up before consent for an assignment is given but a reference to refusal of consent because there is a material breach of covenant leaves open the question of what is a “material breach of covenant”. Such wording should always be rejected if possible. If there is a specific breach that the landlord required to be rectified, this may be treated as a reasonable ground for refusing consent but very open wording is not helpful.
- Subletting – the Lease Code provides that “if subletting is allowed, the sublease rent should be the market rent at the time of subletting.”
A landlord will generally seek to control the exercise of a tenant’s break and the tenant’s right to assign or underlet its premises as far as possible without damaging any future rent review on the grounds that the lease contains onerous conditions.
The Lease Code also provides that subleases to be excluded from the renewal provisions of the Landlord and Tenant Act 1954 should not have to be on the same terms as the tenant’s lease.
Modern leases generally, but not always, confirm that any subletting should be at the then current market rent. Wording providing that a sublease must be at the greater of the market rent and the passing rent must be avoided at all costs as such wording will result in the tenant being unable to sublet if there is a collapse in rents in the commercial property market.
Notwithstanding the wording in the Lease Code, it is unusual for leases not to provide that subleases must be on the same terms as the tenant’s lease insofar as they relate to the premises demised. It is worth mentioning the provisions of the Lease Code to the landlord if there are specific differences to the headlease that the tenant and the subtenant want to include in the terms of a sublease.
This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.
About this article
SubjectBreak Clauses and Alienation: Leasing Business Premises
ExpertiseCommercial Real Estate
Published08 June 2017