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Meeting the issues head on: Tips to improve your Lease Heads of Terms

14 March 2023
Lawyers working in commercial property are in a unique position - we see a wide range of Heads of Terms from a multitude of sources and we witness the common issues which arise when negotiating a lease. This article sets out some practical guidance to improve Lease Heads of Terms and secure a quicker completion. 

Heads of Terms vary significantly in detail: from a bare skeleton which confirms little more than the term and rent, to a thesis which isn't far off writing the lease itself. There is a balance to be had (and practically this should lean closer to a short summary of the key terms) however, there are some points which come up in nearly every lease negotiation which, if dealt with in the Heads of Terms, can get the parties to completion quicker.

Key tips for improving Heads of Terms

1. Include the break conditions

It is not uncommon for a set of Heads of Terms to state something like:

"Tenant only break on the fifth anniversary of lease commencement. Break exercisable on six months' notice."

The problem with this is that there is no reference to the break conditions. This leaves the respective solicitors to negotiate what the break conditions will be (and there can be wildly differing positions on this). As a result, setting out the break conditions in the Heads of Terms (or stating that the break will simply be unconditional) can save several turns of the draft lease. 

In my experience, an acceptable set of tenant break conditions in the current market are:

  • that the tenant vacates the property and returns it to the landlord free from any occupier or third party right to occupation or possession; 
  • that the tenant pays all annual rents which were due to have been paid on or before the break date; and
  • that the tenant pays all other sums due and demanded at least 10 working days prior to the break date.

2. Be clear on assignment

Provided they are fairly standard, conditions on assignment (such as provision of an Authorised Guarantee Agreement ("AGA"), third party guarantor and/or payment of a rent deposit) are rarely negotiated. However, a well-advised tenant will seek to ensure that an AGA can only be required where it is reasonable to do so.

The tenant's argument here is that, if the proposed assignee's covenant strength is sufficient to comply with the lease covenants, a guarantee from the outgoing tenant should not be required. However, a landlord may argue that they should be entitled to rely on the covenant strength of the original tenant (given that they agreed to let the property to the original tenant) and so an AGA should be required in all cases.

The final position will depend on the bargaining strength of the respective parties however, I tend to find that a common compromise is:

  • that an AGA be provided on any assignment; but
  • that a third party guarantor and/or rent deposit may only be required where reasonable.

A simple line in the Heads of Terms stating that "an AGA is to be provided on any assignment" can save a lot of time discussing this.

3. Underlease rents

Commercial leases tend to place a number of requirements on any underletting. These normally include a condition regarding the underlease rent. This will either be:

  • that the underlease rent is to be the open market rent for the premises being underlet; or
  • that the underlease rent is to be the passing rent under the lease.

This can also be seen as a combination of the two (i.e. the higher of a. or b.)

The issue for the landlord is that the open market rent may reduce between the grant of the lease and the grant of the underlease (meaning that the underlease rent is lower than the lease rent). If the landlord then goes on to inherit the underlease, there will be a shortfall in the rent that they expected to receive.

On the other hand, a requirement to underlet at the passing rent may make underletting practically impossible for the tenant in a falling market where the passing rent is higher than the market rent. This could also have unintended consequences for a landlord if the rent review is on an open market basis as the tenant could argue for a discount at review if an underletting may be difficult to achieve. 

In the current market, the most common position is that the underlease rent is the open market rental value for the premises (but this is not always the case/desire for the parties). Making the position clear in the Heads of Terms avoids the need to discuss the issue further. It will be interesting to see if the market position changes going forwards as landlords seek to move to index linked rent reviews in the current higher inflationary environment.

4. Repair

Unless otherwise agreed, it is usually assumed that the tenant's repairing obligation will be in the standard institutional form – "the tenant shall keep the property in good and substantial repair and condition". 

It is possible to vary this repairing obligation (by including a schedule of condition or carving out existing contamination and/or latent defects) however, such variations should only be included where relevant to the circumstances of the particular deal. Despite this, it is not uncommon for a tenant's solicitor to seek to vary the repairing obligation anyway. Where this has not been agreed previously, it can cause significant delay whilst the parties seek to agree the position.

It is worth stating the precise nature of the repairing obligation clearly in the Heads of Terms in order to make the position clear before the matter is referred to solicitors.

5. Rates

Unless an inclusive rent is agreed, it is standard for a commercial tenant to be responsible for business rates payable in respect of the premises. If the tenant vacates the premises during the term, they may claim relief from business rates whilst the property is empty. The issue for the landlord is that, if the tenant has already claimed the relief, the relief may not be available to the landlord at the end of the lease term. As a result, it is common for a commercial lease to include a provision requiring the tenant to indemnify the landlord against any rates relief which the landlord cannot claim because the tenant has already done so.

A well advised tenant will seek to resist the indemnity. Their position here is straightforward – the landlord was not willing to contribute to the rates during the term so, if the tenant can claim any relief and reduce their liability, they should be free to do so without repercussions. The landlord on the other hand won't want to miss out on a potential rates saving just because the tenant decided not to occupy a property which they effectively agreed to occupy by taking a lease.

If the parties can agree the position at the outset, there is no need for protracted debate around the issue.

6. Include the lease plan

Letting all of the parties have sight of the lease plan early on gets the deal moving quickly because:

  • the tenant's solicitor can commission searches on day one; and
  • the landlord's solicitor can identify any peculiarities with the proposed demise and deal with them in the first draft of the lease.

Having the lease plan early also avoids delays issuing engrossments when the documents are agreed but a lease plan is not available.

It is important to remember that (where a lease is registerable at HM Land Registry) the plan needs to comply with HM Land Registry's requirements. Details of those requirements can be found here. 

7. Third party consents

The requirement for a third party consent is one of the most common causes for delay to a transaction. If you know a third party consent is going to be required (e.g. from a superior landlord or lender) it is worth flagging this in the Heads of Terms to ensure it is being dealt with as early as possible.

It is also worth agreeing who will be paying the costs for the consent in the Heads of Terms so there is no risk of dispute/ shock for either party when the funds are requested.

8. ECTEA registration

Overseas entities that own property in the UK are now required to be registered on the Register of Overseas Entities at Companies House. This includes companies which own a leasehold interest for a term of 7 years or more.

If relevant, it will be good practice going forward to include details of the relevant party's OE number in the Heads of Terms to make the registration status clear at the outset.

For further details regarding ECTEA Registration, please see this article by Jenn Berritt.

Hopefully the above tips provide some food for thought and demonstrate how the addition of just a few words in a set of Heads of Terms can save time in the long run.

To find out more about the points raised in this article please contact our experts.

Further Reading