What landlords should look out for in commercial lease negotiations

What landlords should look out for in commercial lease negotiations

Top Midlands law firm Thursfields Solicitors has issued a new raft of advice on what landlords should look out for in commercial lease negotiations.

Thursfields Advice

Stewart Coles, associate director in the Commercial Property team at Thursfields, explained that such leases were complex and that landlords should take care when signing up new tenants.

In particular, he was keen to explain the differences between a full repairing and insuring lease (FRI) and an internal repairing insuring lease (IRI).

He also provided guidance on how to manage repair costs, security of tenure, financial security and guarantors, tenancy at will, periodic tenancy and new considerations introduced by the Covid-19 pandemic.

Stewart said: “An FRI is the most common lease when a tenant occupies the entire building and is responsible for the whole of the property, inside and outside, including the structure and roof, with the landlord insuring the building but the tenant paying the premium.

“In contrast, an IRI lease is more appropriate when a tenant is taking part of the space, say a floor in an office building or a ground floor shop, taking responsibility for the interior and contributing towards insurance.

“With an IRI lease, landlords need to consider who pays for the exterior or how to recuperate repair costs, either through formal service charges or charging tenants as and when repairs are required.

“Tenants will want to limit liability by making sure they are only responsible for the interior, not for exterior repairs which could become expensive.

“If the tenant is taking the whole building they will usually be responsible for external and structural repairs, but are likely to want to limit their obligations.

“This can be by reference to a photographic schedule of condition, so they cannot be required to put the property into any better state of repair than it was in at the start of the lease.

“It is in both parties’ interests to ensure that a clear and accurate schedule of condition is prepared and attached to the lease, to avoid any potential disputes later.

“Tenants may also want to put a cap on any service charge or one-off repairs where the landlord is responsible for certain areas, which will be part of the lease negotiation.”

Stewart mentioned that “at the Heads of Terms stage a landlord will also negotiate things like rent free periods, break options and rent reviews”.

He explained that both FRI and IRI leases would most likely be for a fixed term, but the parties will need to consider whether the tenant will have security of tenure under the landlord and Tenant Act 1954, or whether that protection is to be excluded.  He commented:

“It is important to be aware of security of tenure the 1954, which means the lease doesn’t automatically end at the end of a fixed-term lease.

“The tenant is entitled to apply for a new lease on substantially the same terms, and the landlord’s ability to oppose the grant of a new lease is limited.

“However, it is possible for this protection to be excluded.  Where security of tenure is excluded it doesn’t mean the landlord won’t allow the tenant to renew, but it will be entirely at the landlord’s discretion, meaning that the terms can be changed and are not tied to previous agreements.

“Similarly, if the landlord wants a break clause that allows the landlord to terminate the lease at a set point – say five years into a 10-year lease – then security of tenure has to be excluded in order for the landlord to be able to exercise that break option and recover possession of the property.”

Stewart added that tenants may be reluctant to opt-out of security of tenure, especially if it is retail space in a good location or they plan to make major investments in a fit-out.

He said another issue for landlords to considerduring lease negotiations was financial security to cover rent if a tenant’s business fails – either a personal guarantor for a limited company or a rental deposit of three or six months rent.

Stewart said: “It is important to have any deposits properly documented so there’s no debate about whose money it is or when you can use it.”

These additional forms of security have been  particularly important during Covid-19, as legislation was introduced that means landlords cannot forfeit a lease if the pandemic impacts a tenant’s business and they cannot pay rent.

He said: “The legislation remains until 25 March 2022, but with guarantors or rental deposits in place landlords still have a means of recuperating arrears.”

Stewart highlighted that another pitfall for landlords is giving keys to a tenant before a lease is signed.

He said: “Legally, such an arrangement could create a ‘tenancy at will’ which means either party can terminate the arrangement without a fixed notice period – but only if it is short term.

“A landlord quite often gives a tenant the keys thinking ‘we’re nearly there’ with the lease, and then the impetus to finalise and sign the lease gets lost.

“Once a tenant has been in occupation and paying rent for several months, it could be deemed a ‘periodic tenancy’, protected by the Landlord and Tenant Act, with security of tenure.”

Stewart said that as the pandemic eases, the commercial landscape is shifting, with more office space on the market as businesses review commitments or adopt flexible working.

He said: “This means more flexibility is creeping into negotiations, with shorter terms being requested and easier termination.

“Landlords perhaps look at a change of use so properties can be rented out for different purposes, such as serviced offices.”

Finally, Mr Coles warned that more flexible leases, shorter leases and new leasing models all require more hands-on property management.

He added: “Landlords and property managers should have robust systems in place to manage the increase in critical lease dates and changing lease arrangements, such as cloud-based document storage, online payments for tenants, accounting integrations and more.”

Anyone needing expert legal advice on commercial property can contact Stewart Coles on 0345 20 73 72 8 or by emailing scoles@thursfields.co.uk.