Most commercial leases are drafted in favour of the landlord. Here are the five provisions that need scrutiny before you sign, and what to push back on.
Commercial leases are complex documents, and most of the complexity works in the landlord's favour. That is not surprising: landlords' solicitors draft them. Tenants who review leases carefully before signing, with proper legal advice, routinely negotiate more favourable terms. Tenants who sign quickly often discover the consequences years into a lease. Here are the five provisions that deserve the most scrutiny.
1. The Repairing Covenant
A full repairing and insuring (FRI) lease puts the entire cost of maintaining the building on the tenant, even if the building was in poor condition when they took it. The Landlord and Tenant Act 1954 provides some protection for short leases, but for longer terms, the repairing covenant can represent a significant hidden liability.
Before signing an FRI lease, obtain a schedule of condition: a photographic and written record of the property's state at the commencement date. Attach this to the lease and limit your repairing obligation to maintaining the premises in no better condition than evidenced by that schedule. Without it, you may be required to hand back a significantly improved building at the end of a lease.
2. The Alienation Clause
Alienation clauses control what you can do with your lease, covering whether you can assign it to a buyer if you sell your business, sublet part of the premises, or share occupation with group companies. Standard leases typically prohibit assignment without landlord consent, which 'shall not be unreasonably withheld'.
The issue is the conditions attached. Some leases require an outgoing tenant to guarantee the new tenant's obligations (an Authorised Guarantee Agreement or AGA) for the full remaining term. In a 15-year lease with 10 years remaining, that can be a very significant contingent liability. Negotiate the scope of any AGA obligation at heads of terms, not after the lease is drafted.
3. The Rent Review Mechanism
Most commercial leases of any length include upward-only rent reviews, typically to open market value every 5 years. 'Upward-only' means exactly that: even if market rents have fallen, your rent cannot be reduced at review. This is standard in the UK commercial market and largely non-negotiable in most markets, but the assumptions built into the valuation exercise can be negotiated.
Key Point on Rent Review
The hypothetical assumptions in the review clause, for example whether vacant possession is assumed or whether improvements carried out by the tenant are disregarded, can have a substantial effect on the reviewed rent. These assumptions are technical but important. Have them reviewed.
4. The Break Clause
A break clause allows either or both parties to terminate the lease early, typically at a specified date after a minimum period. For tenants, a well-drafted break clause provides valuable flexibility. Poorly drafted ones are routinely found to be ineffective by the courts, often on technical grounds that could have been avoided.
Common pitfalls include conditions precedent attached to exercise of the break, such as requiring vacant possession, the payment of all sums due, or compliance with all lease covenants at the break date. Any condition other than vacant possession and payment of principal rent should be resisted. Courts have found break clauses ineffective where tenants failed to comply with minor conditions they were unaware of.
5. The Service Charge
In multi-let buildings, tenants typically pay a service charge covering the cost of maintaining common areas, services, insurance, and the landlord's management fee. Service charges are notoriously difficult to control and have been a source of significant landlord-tenant litigation.
Before signing, review at least three years of service charge accounts for the building. Check whether major capital expenditure items (lifts, roofing, mechanical systems) are likely to arise during your term and whether you can negotiate a cap on service charge in the early years while these works are carried out. The Landlord and Tenant (Covenants) Act and RICS service charge code provide some benchmarks, but not binding caps.