Taking a commercial lease: Why are Heads of Terms important?

Heads of Terms (or HoTs for short) are a document that sets out the parties’ agreement in respect of the main terms on which the lease is to be entered into.

The HoTs do not normally cover the agreement in great detail, but if well drafted can significantly speed up agreeing of the lease draft, identify any potential issues early in the transaction as well as give the contracting parties clarity on the terms agreed before money is spent on legal fees.

Many prudent clients will obtain legal advice before the HoTs are fully agreed, so the parties can ensure that the agreement takes into account any possible issues. From the tenant’s perspective, it is also often much easier to negotiate better terms (such as a rent free period) at the outset before committing to the transaction fully.

What points should be covered in the HoTs?

Most commonly the HoTs are prepared by the landlord’s surveyors or agents. Code for Leasing Business Premises, England and Wales (1^st edition, February 2020) issued by the Royal Institution of Chartered Surveyors (RICS) sets out a range of points to be covered with some being best practice and some being mandatory and binding on its members.

The following areas are considered a minimum that the document should set out:

• Boundaries and identity of the property to be leased together with confirmation of the term length and what the tenant will be allowed to use the property for;
• Any additional rights being granted to the tenant such as car parking for example;
• Financial terms such as any rent deposit, the lease rent (and any items included in the rent such as business rates to include whether VAT is chargeable on rent), rent reviews (if any), service charge and insurance rent and payment frequency and methods for calculation of these items;
• Any obligations that would bind the tenant such as repairing and decorating of the property;
• Rights to make changes to the property to include any initial fitting out and whether the property would have to be put back in the original state and condition at the end of the term;
• Any terms regarding the tenant’s rights to renew or break the lease early, or being allowed to assign the lease or underlet the property to another party, as well as whether the tenant would have a security of tenure (which entitles them to remain in the property when the initial lease expires and request a new lease)

It is also good practice to cover any matters that the transaction may be subject to such as a consent of the head landlord, the property inspections or the timings for completion, so the parties’ expectations are clearly recorded.

Importance of the accurate HoTs

The HoTs are not normally legally binding, and this is normally achieved by marking the document subject to contract.  However, the document can serve as good evidence of the agreed terms in the event it transpires that the lease has accidental drafting errors and can assist in rectifying these errors after completion. All parties should therefore ensure that the HoTs circulated by the agents reflect the terms accurately. The property lawyers will often ask their clients to confirm that this is the case, and any draft lease will be checked against the agreed HoTs.

In the upcoming months, we will examine a set of standard HoTs in more detail highlighting any areas that may require a more careful consideration to include any problematic aspects to be aware of.

 If you need any advice, please do not hesitate to contact a member of the Commercial Real Estate team.