With the economy slowly recovering, the negotiating strengths of commercial landlords and tenants in lease renewal negotiations are changing. Nic Maunder Taylor provides a beginner’s guide to the issues for landlords, tenants, and their advisers
Commercial lease renewals tend to come around fairly regularly nowadays, due in no small part to modern leases being granted for shorter periods than in the past. Renewals can be an opportunity for tenants to secure lower rent, for example. In this article, I consider the key issues facing tenants in the lease renewal process, both for those new to the area and those wanting to brush up their skills and knowledge.
The majority of commercial tenancies in England and Wales fall under part II of the Landlord and Tenant Act 1954 (LTA 1954). The act confers security of tenure, meaning that when the lease contract comes to an end, the tenancy governed by that contract continues until it is formally determined. This occurs by one or other of the parties serving a formal notice. When the tenancy is determined, the tenant then, usually, has a right to a new tenancy. In this article, I cover the process for extensions of leases covered by the LTA 1954. For more details on tenancies outside this act, see the end of this article.
1. Before the lease ends
Regardless of whether a tenancy is inside or outside the LTA 1954, an early consideration of the matter is key. Both parties should start considering the lease renewal at least 15 months prior to the end of the existing lease, allowing for plenty of time for terms to be negotiated and the new lease to be documented. Alternatively, if the tenant is vacating at the lease end, this gives ample time for dilapidations to be ascertained, the tenant to relocate, and the landlord to seek a new tenant.
The truth is, however, that many parties do nothing until much closer to the lease expiry date. In such cases, communication between the two parties, and between their respective solicitors and valuers, is vital.
2. Service of the notice
The process is kicked off by the service of one of three notices, as follows.
- A section 25 notice – a landlord’s notice to determine the existing tenancy. The notice will either propose terms for a new tenancy, or object to the grant of a new tenancy.
- A section 26 notice – a tenant’s request for a new tenancy. Again, terms for a new tenancy must be proposed.
- A section 27 notice – a tenant’s notice to quit the premises.
Section 25 and 26 notices are in a prescribed form, and must give between six and 12 months’ notice to determine the existing tenancy. Thus, the earliest date such a notice can be served is 12 months prior to the end of the existing lease.
Some parties are better at playing tactical games than they are at dealing with the litigation itself
As mentioned above, a landlord’s section 25 notice can object to the grant of a new tenancy. If the tenant serves a section 26 notice first, then the landlord can still respond with objections to the grant of a new tenancy. Such ‘hostile’ notices are outside the scope of this article. Suffice it to say, however, that if a hostile notice is received, then specialist litigation advice will be required as quickly as possible.
Regardless of whether a tenancy is inside or outside the LTA 1954 (see the end of this article), and regardless of whether the landlord is expected to be ‘friendly’ or ‘hostile’, tenants and their advisers would be prudent to start considering their objectives and options well in advance – at least 15 months prior to the end of the existing lease. It can often be the case that the tenant leaves it until the last minute before consulting solicitors and valuers, which can obviously limit their options. Thus, the expiry of the notice is a critical date to be borne in mind.
3. Expiry of the notice
By the time the notice expires, the tenant will be in one of five alternative positions.
- A new lease will have been agreed and completed.
- The tenant will have quit the premises and returned possession to the landlord.
- The parties will have agreed an extension of time to the deadline contained in the notice, thus buying extra time.
- One of the parties will have made an application into court, requesting that the court orders the grant of a new tenancy.
- The notice expires, the tenant loses their rights, and effectively becomes a trespasser.
If the intention of both parties is to negotiate a new lease, then it is likely that discussions will have taken place in the months leading up to the expiry of the notice. If further time for negotiations is required, then an extension to the deadline in the notice must be agreed by both parties in writing.
If the landlord wants to grant a new tenancy but the tenant wishes to vacate, then the tenant can serve a section 27 notice and quit the premises and return possession to the landlord. Section 27 notices are not required in all cases, but it is usually considered prudent to serve one in order to formalise and clarify the position. If a section 25 notice has already been served, the tenant can still opt to vacate. Even if a court application has been made, and even if it were made by the tenant, the tenant can still change their mind by serving a notice of discontinuance.
If the tenant wants a new tenancy but the landlord does not wish to grant one, a dispute is likely to arise. The landlord can only object to the grant of a new tenancy on certain grounds; specialist advice will be required to test the landlord’s ground of objection.
4. Negotiating terms
In agreeing new lease terms, the LTA 1954 gives the parties the freedom to negotiate whatever terms they want.
If instructed from an early stage, then it is likely that the valuer will have been actively negotiating the terms of the new lease. As the deadline under the notice approaches, the solicitor should expect the valuer to be in a position to provide a full status report. The valuer will also need to advise the solicitor as to the appropriate proposals for a new lease, which should be made in the tenant’s application to court.
Valuers tend to assume that solicitors will deal with the general updating of the lease terms. It is often the case, however, that the parties agree to more substantial and specific changes, for example, permitting sub-letting where the previous lease contained an absolute bar. In these cases, the solicitor should expect the valuer to detail these in full.
More often that not, agreement between the parties is reached well before the notice deadline. As such, the valuer should be expected to prepare a full heads of terms agreement, detailing the following as a minimum:
- names of the parties;
- any rights granted with the demise (such as car parking);
- term of years (including start date);
- whether the new lease is inside or outside the LTA 1954;
- annual rent and when it is to be paid;
- rent review pattern (detail such as hypothetical terms may also be included);
- service charge / common expense clause / insurance;
- alterations; and
- full contact details of the agents and solicitors for both sides.
Words along the lines of “as per existing lease save for reasonable updating to be agreed between solicitors” will often be used in the renewal, reflecting the fact that the tenant is entitled to a new tenancy on the same terms as their existing one. However, commercial updating of the terms is to be expected – for example, to take account of any new legislation which has been introduced since the previous lease was granted. However, if one of the parties wishes to change a term of the new tenancy, then it must be fair and reasonable in all the circumstances. These circumstances could include, for example, the following.
Changes to market conditions
Take, for example, the length of the new lease term. 25 years ago, ‘institutional’ lease lengths were 25 years. By modern standards, this is an unduly onerous length of time. The Royal Institute of Chartered Surveyors last year reported that the average lease length in the UK is now less than six years.
A change in the personal circumstances of the parties
For example, a landlord may want a new 15-year lease, but a 70-year-old tenant aiming to retire in five years’ time might not want to be bound in for that long.
Break clauses are often a feature of new leases. They also play a large role in many lease renewal negotiations, reflecting both market conditions and the personal circumstances of the parties. However, there has been a recent spate of cases where tenants have failed to comply with conditions attached to break clauses, such as payment of rent or yielding up vacant possession. In these cases, tenants who have already vacated a property and secured alternative premises are then forced into taking back their original premises. They end up with two sets of rent and outgoings to pay. From a tenant’s point of view, break clauses should be as unconditional as possible.
5. Dispute resolution
Often, the different aspirations of the parties conflict, as the tenant will seek terms that most compliment their business operation, and the landlord will seek terms that most compliment their property investment. If terms cannot be agreed, then the matter can be referred to a court or other dispute resolution process. Under those circumstances, the LTA 1954 sets out parameters for the terms that the court can determine.
Tenants and their advisers would be prudent to start considering their objectives and options well in advance – at least 15 months prior to the end of the existing lease
Constant dialogue between solicitor and valuer is critical here, particularly when the dispute focuses on valuation-sensitive terms. In such instances, it is usual for a draft lease to be sent backwards and forwards between solicitors, while valuers attempt to negotiate the rent.
Many cases involve protective applications being made into court. This does not necessarily signify a dispute; few of these go all the way. It is often the case that one or other of the parties only starts negotiating on realistic terms once the court application has been made. Some see the threat of dispute, with its costly implications, as a way of negotiating better terms. During the past few years of recession, it has been tenants who have been more likely to assume this. As the economic recovery continues, however, more and more landlords are expected to employ the tactic.
In such instances, it should be borne in mind that some parties are better at playing tactical games than they are at dealing with the litigation itself. Solicitors should ensure that they have procedures in place so that they are not ‘tripped up’ by such behaviour. Again, communication between solicitor and valuer is vital.
If a dispute arises, however, an early consideration of the merits of each case, and therefore the appropriate route of litigation, is likely to mitigate costs for both sides.
The court process
If litigation appears likely, then a statement of agreed facts and issues should be prepared as early as possible. Many valuers are used to preparing a statement of agreed facts, but fewer seem to regularly identify and agree on the issues in dispute. Setting out these issues will often concentrate minds and lead to compromise and / or settlement.
Once the court’s wheels are set in motion, the solicitor should keep the valuer informed of the court timetable and relevant directions. In a post-Mitchell world, compliance with timetables is a must. At the directions hearing, a timetable will be set for the exchange of expert witness reports. The solicitor should advise the expert witness valuer of the timetable requirements and request confirmation that the valuer can and will comply with them.
The solicitor or client should also ensure that the valuer is aware of the duties of an expert witness and has training and / or experience appearing in court in such capacity.
Alternative dispute resolution
Professional Arbitration on Court Terms (PACT) is an alternative to, and which offers several advantages over, court proceedings. It is a cheaper and less expensive process, and decided by a property professional (whether solicitor or surveyor) rather than a lay judge. For these reasons, in many cases PACT is to be preferred. I am not aware of any lease renewal case where mediation has been adopted instead of court or PACT, although it is an interesting alternative. Statistically, mediation carries a high rate of resolution, and could offer a quick and cost-effective solution that benefits both sides.
The question of costs depends upon the merits of each case and the preferred method of dispute resolution. But an early consideration of the renewal, agreeing facts and issues, will give both sides more time to negotiate, thereby reducing costs.
The service of offers to settle the claim, under part 36 of the Civil Procedure Rules 1998, will assist in protecting the costs position of a party. The timing of such offers is often important, as if the offer fails, it may result in an adverse costs award. Once again, agreeing facts and issues at an early stage will assist.
Tenancies outside the LTA 1954
It is possible to contract a tenancy outside of the LTA 1954, so that when the lease contract comes to an end, so does the tenancy. As the commercial market moves towards greater flexibility, ‘contracted out’ tenancies are becoming more and more common.
Under a contracted out tenancy, the tenant has no right to a new tenancy afterwards, although the parties are free to negotiate terms for a new tenancy if they want to. Terms must be agreed as if the property was available in the open market. The canvas is largely blank. If there is a dispute, then this must be resolved by negotiation.
If a tenancy is outside the LTA 1954, then no notices are required. Tenants must be aware that the landlord can simply turn up on their doorstep the day before the lease ends and remind them that the following day they need to clear the property, yield it up in compliance with the lease terms, and hand the keys back. In reality, landlords tend to offer a little more warning than this, but tenants need to be aware of the impending expiry.
The point to make here is that the critical date is the lease expiry date. The tenant must have a new lease agreed and completed before this date if continued occupation is required. If this has not happened, then the tenant is often at the mercy of the landlord.