As firms struggle to adapt to the pace of change in the legal market, premises costs can make the difference between success and failure. Steven Petty explains how you can manage these costs to the benefit of your firm
Premises are one of the biggest expenses that a firm faces; the size and cost of your firm’s offices should at the very least be considered as part of your strategic planning. This article presents three key questions for your firm to address in relation to its premises, and outlines strategies that you can implement to give you the flexibility you need to meet the challenges ahead.
Traditional offices were historically seen as a ‘shop front’ to give the firm a visible presence in its local town or city, but the majority of firms will now consider their website as their principal ‘shop front’
Do we need traditional premises at all?
Premises have traditionally served a number of functions, but traditional offices are not the only way these needs can be met. Below I explore four main functions, and some of the other options you could investigate to fulfil them.
Lawyers and support staff need a desk, computer, phone and printer / scanner. However, there is no particular need for those things to be provided in a formal office environment. I worked from a home office for six years, and although I have now moved back into a more traditional office setting, the idea that all staff must be gathered together in the same building is one that I am still seeking to challenge. A firm’s cashiering and secretarial functions can be outsourced, and an increasing number of lawyers are working from home.
Client consultations with solicitors have usually taken place in a traditional office environment, but this is no longer a necessity. It is often much more convenient for a client if their lawyer visits them at their place of business. Conference calls, video calls and the use
of meeting space rented by the hour are all alternatives to a traditional boardroom.
Traditional offices were historically seen as a ‘shop front’ to give the firm a visible presence in its local town or city, but the majority of firms will now consider their website as their principal ‘shop front’. Add to that the inconvenience and cost to clients of driving into and parking in many town and city centres, and the premium rents charged on offices in these locations may no longer be money well spent.
Historically, firms would use their premises to store files, but many have already utilised the benefits of remote storage, and the next stage in that evolution is to challenge whether physical storage of files is necessary at all. With the opportunity to dispense with paper files entirely and keep a completely electronic file, even storage in cheap warehouse premises may be seen as a waste of money, especially when the cost and delay of retrieving these files is factored in.
How can our premises support our strategy?
Although the above analysis might cause a firm to decide it doesn’t need premises at all, most firms will still conclude that there are benefits to retaining a formal office environment to cover at least some of those functions. But there may still be compelling reasons for seeking to move to different premises, either to reduce in size or move to a different location. Before deciding to move, however, a firm must think strategically in deciding where to relocate and the terms upon which it will take new premises.
What does your strategic plan have to say about your premises needs over the next three to five years? If the answer is ‘nothing’ or, even more worryingly, ‘what strategic plan?’, you need to take a step back and assess how the firm’s premises requirements might change over that timescale. This is because lease terms have tended to be for five, 10 or even 15 years. Committing to one set of premises for that length of time clearly has the potential to hamper the ability of a business to adapt to changing circumstances. One of the most prominent recent trends in the legal services market has been significant consolidation as a result of merger and acquisition activity. In this environment, many offices are becoming surplus to requirements; any firm considering moving premises in the near future must anticipate the possibility that a swift exit from any lease arrangements may be required.
Below, I outline a few obvious strategies for future-proofing your business.
Negotiate a shorter term
This has advantages and disadvantages. The advantage of flexibility is countered by the risk that it may not be possible to remain in the premises at the end of the term. This risk can be managed, though, by the following strategies.
Rights to renew
Business tenants have a statutory right under the Landlord and Tenant Act 1954 to a new lease at the end of the term. Landlords, particularly where your premises form part of a larger building, will seek to exclude that right, but this should be resisted wherever possible. If a landlord absolutely refuses (and assuming you cannot find a more amenable landlord), then an alternative is to negotiate a contractual right to renew the lease at the end of the term.
The right to bring a lease to an end early can be a powerful tool, both in terms of strategic planning and as a cost reduction strategy (more on that later). The difficulty is determining the timing of a right to break. In an ideal world, you would negotiate the right to terminate the lease at any time, but the reality of the current market is that you may not be able to secure more than a single right to bring the lease to an end on a fixed date. This is where the interface with the strategic plan is critical. Whoever is responsible for negotiating the terms of your lease must ensure that the timing of any break right supports the firm’s strategic objectives. It’s no use negotiating a 10-year lease with a break right after five years, if the firm’s strategy anticipates relocation within three years.
Ring-fencing lease liabilities
Traditionally, the partners of a law firm were named as the tenants on the lease. This left them with personal liability, and greatly reduced the opportunities for renegotiating lease terms. As firms have moved more towards corporate vehicles for their businesses, leases have tended to be put in the name of the main trading company or LLP, but this still leaves the trading business at risk of continuing liabilities under a lease for premises that have become surplus to requirements. A better strategy is to form a separate company to hold the lease. A diligent landlord may baulk at accepting a shell company as a tenant, but even if you have to offer a rent deposit as security, this is still preferable to putting the trading business on the line, as your liabilities are capped by the amount of the rent deposit.
How can we manage the costs of our premises?
Ensuring the terms of your lease facilitate the implementation of the firm’s strategy is only part of the picture. There are also a number of tactics for managing the day-to-day costs associated with your premises.
The all-inclusive rent tends to be a feature of serviced offices. The rent will typically be inclusive of business rates, building insurance costs and, often, utilities. The volatility of energy prices, in particular, can make an all-inclusive rent an attractive option. If other services such as office cleaning, a receptionist, and support functions such as photocopying and post-handling are included, then you can also potentially save money by reducing the number of directly employed staff to undertake those tasks.
Capped service charges
Service charges are frequently the source of dispute between landlords and tenants. Most service charge provisions are drawn very widely, enabling the landlord to re-charge a vast array of costs to the tenant, who will have no right to challenge those costs or even exercise any influence over whether the expenses are incurred. If your landlord decides to undertake a comprehensive refurbishment of your building just after you have moved in, you may be presented with an unpleasant financial shock.
The solution is to cap the service charge. Landlords will resist this, but almost any landlord will agree that it would be unreasonable for you to pay a service charge above a certain level, and that is your opportunity to commence negotiations.
Limit repairing obligations
Repairing obligations present the most significant financial risk when you are taking a lease of the whole of a building. If you are liable for keeping the structure of the building in full repair, then unless you have commissioned a full building survey in advance of signing the lease, you may discover there are significant unanticipated repairs required, both during and at the end of the term. There are a number of ways of limiting your repairing obligations, but the most common is to prepare a schedule of the current condition of the property, and agree with the landlord that you are not required to put the premises in any better state than as shown in the schedule. This limits your liability, but there are some occasions when this approach doesn’t work. For example, wooden window frames that are half-rotted at the start of the term, but completely rotted at the end of it, will simply have to be replaced, which won’t be any better than a full repairing obligation.
If you negotiate a term of more than five years, you will almost certainly have a rent review at some point. The most common types are the open market rent review – where the rent at the date of review is increased in line with current market conditions – and the index-linked review, where the rent is increased in line with a price index (commonly RPI). An open market review may seem fair at first glance, but it is incredibly difficult to predict what the state of the market may be in five or more years’ time. The index-linked review may appear a more certain option, but it is always prudent to ensure that such a review is capped (4% per annum is typical), to counter the risk of a sharp increase in inflation.
In addition to its use in strategic planning, a break clause presents an opportunity to renegotiate the terms of your lease part way through the term. The threat of exercising your right to end the lease is an effective precursor to an offer to remain in the premises if the landlord makes it worth your while.