The global pandemic has undoubtedly had an impact on commercial leasehold premises of all kinds and in all sectors. We have seen some businesses accelerating their plans for their real estate whilst for others their entire premises strategy will have been re-written.
This could mean a business reducing their real estate portfolio, co-locating their operations or taking more space. Any of these objectives will involve a commercial tenant carefully considering its exit options. Landlords too will need to be ready to react to tenant requests and understand how best they can protect their investment. Most exit options available require landlord consent or agreement. Understanding what the landlord can and cannot ask for will be key.
There are a variety of points to consider, and not all of the options will be available to all occupiers but understanding them is key to helping businesses formulate their next steps. If you are looking to reduce or increase the property footprint of your business or move to new premises, you will find the key points below.
Typically, tenants will have one of four options to consider:
• exercising a break clause;
• assigning their lease to another tenant;
• surrendering the lease.
Exercising a Break Clause
This is usually the only way a tenant can unilaterally terminate their lease without the consent or agreement of the landlord.
A tenant should check its lease carefully to see if they have a break date in the near future. It is important to know how much prior notice needs to be given to the landlord to exercise the break; six months is common, but it can be longer. Tenants should be wary of any conditions attached to a break right, these are very strictly construed – not complying with a condition can mean a tenant’s break is not valid, with the result that the tenant has to stay in the premises paying the rent until the end of the lease (or the next break date).
From the landlord’s perspective, they should carefully review the lease to understand whether a break notice has been served correctly and what the break conditions are. This could be the difference between having tenanted premises and an empty unit.
Assigning a lease
If the tenant can find someone to take on the lease, then they will almost certainly need their landlord’s prior written consent to the assignment. The lease will normally say that the landlord cannot unreasonably withhold or delay giving its consent, will set out the circumstances when consent can be withheld and will list the conditions the landlord can impose on the assignment.
It is important for landlords to understand the conditions, for example they may have the right to ask for a guarantor or a rent deposit. It will be crucial for a landlord to carry out referencing on the incoming tenant and a review of its accounts. This will help the landlord form a view whether the tenant will be able to pay the rent and help protect the value of the landlord’s investment.
Where the landlord is entitled to refuse its consent to assign the lease, or to impose conditions that the new tenant cannot accept, it may still be possible to grant a lease to a third party that “sits underneath” the tenant’s own lease, known as an underlease. Landlords are often less able to refuse their consent to an underlease. The tenant will not be released from its obligations in its own lease. The tenant will however be able to pass down some or all of its own obligations to the undertenant in the underlease (payment of rent, repair liabilities and so on).
The landlord’s consent will most likely be required before underletting and the lease will set out the conditions that apply to the underletting. Landlords will be concerned that, despite the tenant still being primarily responsible for the premises under their lease, the underlease rent is appropriate, the undertenant is using the premises for an acceptable use, the undertenant is a responsible occupier and the underlease is in an appropriate form. In some circumstances the undertenant can become the landlord’s direct tenant and therefore there is a legal as well as management imperative behind the landlord wanting to keep a close eye on underletting.
One advantage of underletting is that leases will sometimes allow a tenant to underlet part only of their premises. This can be particularly useful for tenants who want to retain some but not all of their space, allowing them to mitigate part payment of the rent and reconfigure their space to suit the changing needs of their business.
Landlords will need to ensure that their leases correctly control such underlettings. Too many underleases may affect the marketability of the building.
If a tenant is unable to break its lease unilaterally, or find an assignee or undertenant, then a tenant could look to agree the “surrender” of its lease with a landlord. Many landlords may not be willing to accept a surrender, particularly where the premises would be difficult to re-let – it would leave them with an empty unit and they will be liable for business rates. Often a tenant will need to pay an incentive to the landlord to accept the surrender in such circumstances.
However, some landlords may be willing to engage – they might have development plans or perhaps another tenant lined up. If a tenant is very lucky, the landlord may even be willing to make a payment to their tenant in such circumstances.
A surrender will normally give both parties a clean break from their lease obligations. It is important for the surrender deed to clearly set out these arrangements to ensure that all required payments are made, and neither party retains any unintended liability after the surrender, or releases liability that they intended to remain.
The lease is the rulebook that governs a tenant’s exit options and sets out what a landlord is entitled to ask for in response, so it is the place to start for a tenant considering its premises strategy or a landlord faced with an application for consent or other proposal from its tenant.
A well negotiated lease can help support the landlord and tenant’s immediate requirements and protect them against the uncertainty of the future. We are here to help both landlords and tenants secure the best possible outcomes.
Ben Price and Tom Watkins are both Partners in our Real Estate Team, both advise commercial landlords and tenants in all sectors. They are part of a real estate team which is known for “First rate legal minds. Highly efficient and organised in their dealings. Immensely personable” (Legal 500, 2022)