Testing times: Practical tips commercial landlords should consider when granting a lease

13th December 2018 | Caroline Vernon | Residential Property, Commercial Property, Landlord, Leases

Sterling is weak and Brexit is lingering. Business uncertainty, particularly the risk of tenant insolvency, is undoubtedly one of the biggest concerns for UK commercial landlords in the current climate. 2018 has seen increasing indicators of stress and change in... Read more

Sterling is weak and Brexit is lingering. Business uncertainty, particularly the risk of tenant insolvency, is undoubtedly one of the biggest concerns for UK commercial landlords in the current climate. 2018 has seen increasing indicators of stress and change in the retail and restaurant sectors in particular, with tenants entering into CVA’s (company voluntary arrangements), administration & negotiating store closures.

All is not doom and gloom – indeed some report that we are seeing an evolution of the “store” and the high street which may present its own opportunities. Whatever the weather, projecting ahead to what are likely to be testing times, commercial landlords might want to consider how better to safeguard their position on grant of leases, going forward.

Here are our top tips:

1. Heads of Terms

Negotiating and agreeing heads of terms is a critical time in any transaction. Getting lawyers involved at this stage can put the landlord in good stead for covering key matters relating to the specific circumstances of the parties, the property and the transaction. Getting it right at this stage often avoids the need for renegotiation later down the line which can carry the risk of a ‘no deal’ and wasted costs.

2. Rent Deposit

Quite routinely, a landlord will collect a lump sum as security from the tenant on the grant of a lease which is held for the duration of the term. It can be used by the landlord to cover any unpaid rent or damage to the property caused by the tenant. There are various ways to hold a rent deposit but a landlord faced with the increased risk of tenant insolvency will want to consider a requirement for the rent deposit to be held using a charge structure. Using a charge structure means the landlord will be a secured creditor (of the rent deposit sum) in the event the tenant becomes insolvent (such as falling into administration, liquidation, or entering into a CVA).

If a charge structure is not used, there can be greater restrictions on whether and how commercial landlords can draw down and use the rent deposit sum, where valid, if the tenant becomes insolvent.

Of course, the other consideration to factor in is the amount of deposit that will be taken. Depending on the financial strength of the tenant and the term of the lease, a landlord will want to negotiate an amount which is an adequate security buffer – and preferably hold that under a charge structure.

3. Guarantors

Landlords will often, as additional security, require a guarantee from (1) a personal guarantor or (2) a parent company so that there is a further party to pursue if the tenant breaches the lease. A tenant who is in financial difficulty might fail to pay rent or fail to comply with its repair obligations, leaving a dilapidations liability. In this situation a landlord can often be left with an immediate cashflow problem. Furthermore, long term, if the property is significantly damaged or dilapidated, the landlord could be left out of pocket. Having other parties of financial worth to pursue is essential.

To a commercial landlords dismay, some insolvency procedures can affect enforceability against a guarantor. CVA’s have been criticised for “guarantee stripping” as case law has left some uncertainty as to whether these can operate to release guarantors of their liability owed to landlords (based on terms agreed in a CVA between an insolvent tenant and its creditors which can bind the landlord).

For the avoidance of doubt, landlords should be mindful to ensure that any guarantees taken are on the basis that they will expressly apply in the event that a CVA or any other voluntary arrangement is agreed by the tenant with its creditors.

Whilst there is no guarantee that this will be airtight – as the point in case law remains somewhat uncertain – having clarity of what the parties intend in an agreement is essential and is more likely to help protect the landlord. Generally speaking, it is important that the guarantees the commercial landlord takes are drafted to maximise strength.

4. Contracting-Out of Renewal Rights

A tenant who has a lease for a term of at least 6 months (or a tenancy without any fixed term) in occupation and operating its business at the property has a statutory right to apply for a renewal of its lease on similar terms. A landlord can only refuse to grant a lease renewal on certain statutory grounds.

If a tenant is financially strapped when it comes to the end of the fixed term, rather than allow a renewal of the lease and have problems trying to evict the tenant, a landlord will understandably want a clear right to regain possession of the property so that it can be re-let on the open market again.

This can be achieved by the tenant agreeing to contract-out of its statutory right of renewal. The procedure for contracting-out is specific and must be followed properly before the grant of a lease to be effective. The reward of getting this right can often avoid unnecessary hassle and costs at the end of the term.

5.Existing Leases & Throughout the Term

There might be some tell-tale signs to look out for during the course of a landlord-tenant relationship which can indicate the tenant is in difficulty. A landlord who sees these signs may well need to start proactively thinking of alternative plans.

The obvious one – late payment of rents – is not the only one to look out for. A tenant might make applications for consent to assign, sub-let or change permitted use. A landlord might simply agree to an assignment or subletting if this means rent is coming in from a more financially reliable tenant or undertenant. Alternatively, a landlord might want to consider agreeing a surrender of the lease with the tenant, at a premium. This can allow both parties to cleanly move on.

The key is to achieve a solution before the tenant falls into an insolvency situation as otherwise the landlord can be at risk of little or no return of monies owed, once insolvency rules kick in. Contact Caroline for more information.