Underleases - 9 PDF

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Summary

Alienation covenants in the superior lease Licence to underlet
Procedural steps in the grant of an underlease Term, rent and rent review...

Description

Underlease: A lease created by someone who is already a tenant. Original tenants lease is the headlease and the underlease is also known as sub lease which must be shorter than the term of headlease (even by one day). Why would a tenant choose to underlet his property? - To get the property back in the future - When part of the property is to be retained - When the tenant’s landlord might not consent to assignment - When the tenant does not want to be liable for the undertenant under an AGA in case of default Why would a landlord be concerned about an underletting? (i) The undertenant will become the Landlord’s direct tenant on: - Forfeiture of the tenant’s lease - Surrender of the tenant’s lease - Disclaimer of the tenant’s lease - Successful application by the undertenant for new lease under the Landlord and Tenant Act 1954 (ii)

Practical difficulties

How does a landlord protect himself when the tenant wants to underlet? Prohibitions in lease – possible lease to be contains an absolute prohibition on underletting of it only permits underletting’s of whole rather than part – many landlords prohibit underletting’s of part as the building may not be physically suitable for subdivision or they don’t want the estate management burden of dealing with multiple tenants. If underletting’s of whole or part are permitted, it is likely the conditions have been imposed in the alienation covenant in B’s lease and if these conditions are not complied with then B’s lease is at risk of forfeiture and any underlease created out of it will also be at risk. Conditions on permitted underletting’s: - Terms of the underlease must match those of the headlease – this will be a problem if the terms of headlease are particularly onerous but will ensure to the landlord that the covenants in the headlease are not being watered down -

Rent reserved by the underlease must be at least as high as the rent in the head and that the underlease rent must be reviewed at the same time and same terms as rent payable of headlease – reassures the landlord that rent levels of the property are being maintained and if headlease falls away and left with underlease there is no loss of income for the landlord. This condition can be problematic to the tenants with a headlease or sublease in a fall in the market as the rent payable under headlease might be much higher than the market rent – therefore a compromise. Often reached is a condition that the underlease rent must be at the market rent at the time of the underletting – not necessarily the original rent payable by headlease.

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Underletting must exclude s.24-28 in Part II Landlord and Tenant Act 1954 – gives business tenants the statutory right to stay on property and renew their list the expiry of the contractual term – the only way landlord will get stuck with underlease at the end of the underlease if they agree the granting of a renewal of underlease.

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Licence to underlet with direct covenant from the undertenant to the landlord – legal document that entered into by landlord, head tenant and undertenant. From the landlord’s POV the most important part of the licence is that the under tenant enters into a direct covenant with them to perform the tenant’s covenants in the underlease between the head tenant and under tenant and the headlease between head tenant and landlord. Only the obligation to pay rent payable under the headlease is excluded from this direct covenant. It is necessary because ordinarily no privity of contract so creates a contractual relationship between the landlord and under tenant. Means the landlord can sue the under tenant for any breaches other than for the headlease rent.

Two years ago your client entered into a lease of a whole building reserving an annual rent of £100,000 per annum, subject to rent review at five yearly intervals. Your client now wishes to underlet the whole or a substantial part of the property as it is planning to move all its operations onto one site in the next town. Your client has found a prospective undertenant, but the undertenant is only prepared to take an underlease of five years, for which it will pay an annual rent of £80,000 fixed for the whole five years. The relevant part of the lease is contained on the next page 19.1 The Tenant shall not underlet the whole of the Property except in accordance with this clause nor without the consent of the Landlord, such consent not to be unreasonably withheld. 19.2 The Tenant shall not underlet part only of the Property. 19.3 Any underletting by the Tenant shall be by deed and shall include: (a) an agreement between the Tenant and the undertenant that the provisions of sections 24 to 28 of the Landlord and Tenant Act 1954 are excluded from applying to the tenancy created by the underlease; (b) the reservation of a rent which is not less than the full open market rental value of the Property at the date the Property is underlet and which is payable at the same times as the Annual Rent under this lease; (c) provisions for the review of rent at the same dates and on the same basis as the review of rent in this lease, unless the term of the underlease does not extend beyond the next Review Date in this lease: (d) a covenant by the undertenant, enforceable by and expressed to be enforceable by the Landlord (as superior landlord at the date of grant), to observe and perform the tenant covenants in the underlease and the tenant covenants in this lease, except the covenant to pay the rents reserved by this lease; and (e) provisions requiring the consent of the Landlord to be obtained in respect of any matter for which the consent of the Landlord is required under this lease, and shall

otherwise be consistent with and include tenant covenants no less onerous (other than as to the Annual Rent) than those in this lease. Which ONE of the following is CORRECT? a) If the landlord were to agree to your client granting the underlease on these terms but otherwise on the terms set out in the lease, the undertenant would have to pay rent of £100,000 per annum to the landlord if your client did not do so – obligation to provide direct covenant to the landlord in clause 19.3(d) makes it clear the undertenant does not have to covenant to pay rent payable under the lease b) The proposed underletting can proceed on these terms, but only if the client retains part of the property for its own use – lease contains absolute prohibition of lettings of part in 19.2 c) If the landlord were to agree to your client granting the underlease on these terms but otherwise on the terms set out in the lease, your client would be entitled to take back possession of the property at the end of the five year term of the underlease – underlease will have to exclude s.24-28 LTA 1954 – this is set out in clause 19.3(a) d) The agreed rent arrangements for the underletting may be permissible under the lease, but only if the rent of £80,000 represents the current open market rent for the property – undertenant wants a fixed rate for 5 years but 19.3(c) lease requires there to be a rent review in 3 year’s time at same time as lease rent Rent and Rent Review Jason Carter is a first time developer who acquired a small parade of shops in an up and coming area of Birmingham about a year ago. Planning permission for renovation works and to use the premises as shops within Class A1 and café use within Class A3 of the Use Classes Order was obtained shortly afterwards. The premises are now almost ready for occupation. Jason has agreed terms with a potential tenant of one of the units, the basic details of which are set out below: Tenant: Simon Denny – t/a The Big Cup Coffee Bar – address to follow. Term: 10 years from completion, to be reviewed on the fifth anniversary of the term. User: Coffee shop - as per the planning permission obtained last year. Rent: £20,000 pa exclusive of VAT. Repair: Tenant to repair the whole of the Unit. Alterations: Permitted, subject to the landlord giving consent. Insurance: To be covered by a block policy maintained by the landlord, tenant to pay 1/5 of the cost through the service charge. Assignment etc: Tenant may assign the whole only with landlord’s consent but no assignment of part or any subletting allowed. Look at the draft rental provisions that a trainee has produced to give effect to the client’s instructions which are on the next page. The wording the trainee has come up with is not perfect. Having read the letter, look at the wording of the provisions and identify at least 6 defects or issues. From the Definitions section of the lease:

“Rent” means the sum of £20,000 together with a sum which represents 1/5 of the cost incurred by the Landlord in insuring the Premises. The rent payment clause: The Rent shall be paid on the 1st January of each year of the term. The need for obligation to pay rent in the first place is not in this draft – is needed The clause should also include when the rent is payable. The trainee has drafted the clause making the rent of £20,000 payable in a lump sum on January 1st which is rare and more usual to spread in four equal instalments. If the lease is silent rent is deemed to be paid in arrears but more usual and in landlords’ interest to be paid in advance – that way the landlord gets their money earlier and avoids risk of getting end of the period and discovering the tenants is unable to pay. Unlikely the lease is to start precisely on one of the rent payment dates in the lease – the tenant will therefore need to pay an interim payment when it begins to occupy the property – will need to be less than a full quarter rent. Apportionment is usually done on a daily basis but however it is done, the lease will need to provide for it. It should also be considered how the rent is paid – usual to specify this often by direct debit or electronic transfer. VAT should also be considered – if and how it should arise and who will account for it. The trainee has forgotten to address this. There is no provision for rent review included – no matter how long a lease is the rent can’t change unless there are express provisions to that affect – our instructions stipulate to review halfway through the term and this needs to be dealt with in the lease.

Type of rent review Fixed increase rent review  it is possible to have a rent review clause that at various set dates the rent will increase to a set amount. Although this has benefits of certainty and simplicity it is not often used due to difficulties of predicting rent levels in the future. Index-linked rent review  rent is linked to external index-link such as retail price index. Will allow rent to be altered with inflation. This however doesn’t track the property market specifically and therefore there still may be discrepancies. Tenant’s receipts  from their use of property – often linked to tenants’ turnover but can also be linked to. Other receipts like profits or sums received from sublease. Allows landlord to track tenant’s financial health and therefore ability to pay rent and provides landlord’s incentive to do all it can to increase the tenant’s trade. However, downfall for landlord if business is slow.

Open market rent review  rent is adjusted at regular intervals during the term by reference to the open market rent value of the premises at time of the review. Open Market Rent Review (OMRR) Aim is to determine the rent that a tenant would be prepared to pay where the property lets in the open market on terms defined in the lease. The reality is that no such exercise is going to be carried out. The tenant is staying in the premiss so is a hypothetical assessment of what the property would be worth if it was let on the open market. Two elements to consider: - The physical premises - Terms of the lease itself Hypothetical assessment should be based as closely as possible to the reality of the situation. Therefore, if the property is new and modern and in a desirable location, the rent review should be assessed accordingly. If the lease terms are onerous on the tenant, this too should be reflected. Not always possible to assess the reality of the situation. For example, if the premises are dilapidated and rundown, it may be deemed that the rent be assessed accordingly. However, if the property is in such state due to tenant breach, it isn’t fair for the property to be assessed at a lower level than it should be because the tenant would be profiting from its own breach of the lease. A well drafted rent review clause will make assumptions for example the tenant has complied with repairing covenants and also certain disregards (e.g. disregarding the elevating effect on rent of voluntary improvements made by the tenant) Assumptions and disregards 1. What is the effect of that event/circumstance on the rental value of the premises? 2. Is that effect fair? 3. Would an assumption or disregard be appropriate? Hot Shots is in occupation – 1. The effect on rent is to decrease it because a hypothetical tenant would not want to share occupation with Hot Shot 2. Not fair because it undermines the whole basis of the rent review method the parties have agreed on 3. The lease should include an assumption of vacant possession in order to level the playing field Hot Shots’s premises have been badly damaged by fire one week before the rent review – 1. The effect would decrease the rent due to damage of the premises. 2. No – because the landlord doesn’t have the opportunity to repair the premises so should not be penalised with low rent for next period 3. Assumption that if the premises is damaged, it is fully repaired Hot Shots is very successful and has generated goodwill

1. Increase the rent as more attractive to a hypothetical bidder 2. No – has been generated through hot shot’s hard work and therefore it is not fair for the landlord to profit from it at Hot Shot’s expense 3. Disregard on good will

By a willing landlord to a willing tenant – assumption that there is a landlord who wants to grant the lease to a tenant in the market for taking it. Without them, the hypothetical letting would not take place at all – so this needs to be made clear Subject to the provisions of this lease (excluding the provisions relating to rent and rent review) – in the interest of fairness, the lease should state that the provisions of the hypothetical lease are the same as the real lease – but with the exception of the rent payable because the rent figure is likely to change – would not be fair for a rent review clause to create a hypothetical lease with more generous terms. For a term of 15 years – what if the review is taking place 10 years into a 15 year term – is it fair for it to be assessed as if there were 15 years left when in reality there is only 5 – could have an effect of level of rent – difficult to predict so a good compromise is to provide that the hypothetical lease term is equal to the unexpirable residue to the actual lease perhaps with a minimum term to cover for the situation where the actual lease is very close to expiry date The House of Lords in United Scientific Holdings Ltd v Burnley Borough Council [1977] 2 All ER 62 held that, in the absence of any contrary indications in the express wording of the clause, or in the interrelation of the rent review clause with other clauses in the lease, there is a presumption that time is not of the essence of the clause, and that the review can still be implemented and pursued even though specific dates have passed

The rent review process Level of rent – upwards only or upwards downwards Tenant would prefer the latter which reflects reality of the market and doesn’t leave them paying a high rent in a falling market however landlords aren’t keen on this (especially institutional landlords who want a predictable yield and will therefore push for an upward review. Frequency of review – review is typically set at 3-5 years on anniversary of the lease Instigating the review – - traditional method was agreement was reached by formal service of notice and counter notice by the parties – would bring them to eventual, agreement but in practice this often causes in disputes over the validity of service and fairness. - informal – negation – more common – parties will negotiate and usually reach agreement Should the parties fail to reach an agreement regardless of method, the lease should make provision for the matter to be referred to an independent third party, usually appointed by the Royal Institute of Chartered Surveyors, either as an arbitrator or an expert.

Situations where a head landlord may come into a direct relationship with an undertenant: If the headlease is surrendered - A surrender is subject to the rights of undertenants (and other third parties) and it does not extinguish an underlease Mellor v Watkins (1873-74) L.R. 9 Q.B. 400 even if the underlease was granted in breach of covenant Parker v Jones [1910] 2 KB 32 If the headlease is forfeited and the undertenant successfully applies for relief against forfeiture. An undertenant has a right to apply for relief from forfeiture under section 146(4) of the LPA 1925 and the court has a wide discretion as to the terms on which it may grant relief to an undertenant. If the headlease is disclaimed in the event of the tenant's insolvency. Following disclaimer of the headlease, the undertenant can remain in possession of the property for the term of the underlease provided that the undertenant complies with the covenants in the headlease, including payment of the headlease rent. The Landlord and Tenant Act 1988 (LTA 1988) imposes certain duties in relation to consents for underlettings. Where a tenant covenants not to underlet the property without the landlord's consent, and that consent is not to be unreasonably withheld, the LTA 1988 imposes the following statutory duties on the landlord: - To give consent, except where it is reasonable not to do so. - To give consent within a reasonable time. - To give the tenant written notice of the decision. If consent is given subject to any conditions, the landlord must specify those conditions. If consent is refused, the landlord must give the reasons for the refusal

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To pass on the application to anyone else whose consent is needed under the lease.

Unless the lease contains an express provision allowing the landlord to charge for giving a consent, section 144 of the LPA 1925 will apply and the landlord will not be able to charge for its consent to the underletting. Section 144 of the LPA 1925 does not prevent the landlord recovering its reasonable legal and other expenses when giving consent. Practical Law Property standard document leases do not expressly require the landlord not to unreasonably "delay" consent. A failure by a landlord to give consent within a reasonable time would constitute an unreasonable withholding of consent under the LTA 1988. It is, therefore, not necessary to include an express obligation in the lease as this is already imposed by statute. However, as the lease will be used and read by the parties themselves who may not know this, the parties' legal advisors may wish to amend the clause to state this expressly. A landlord is proposing to let some office premises to a well-known and profitable recruitment agency, whose business has been established for some time. The landlord is concerned that its rental stream is protected against any adverse fluctuations in the property market.

Your firm acts for Malt Holdings PLC (“Malt Holdings”), the current landlord of the lease of premises at 110-112 Cross Street, London WC1B 2JY. The lease to Bottega Limited (“Bottega”) was granted three years ago for a term of 10 years commencing on the date of grant and reserves an initial rent of £115,000 per annum, subject to review every five years. The relevant part of the lease appears on the following pages of this Student Guide. Assume that Bottega is still the current tenant under the lease and that instead of assigning the lease (as in Workshop 8), Bottega wants to underlet the property to Rosebud Chocolates and Gifts Limited (“Rosebud”). 1. Explain why Malt Holdings would want information about Rosebud as a company in the con...