Structure and Content of a Lease

Property Practice - Chapter 6

Why do people think owning a freehold is better than owning a leasehold?

Because a freehold lasts forever - also cannot be evicted by a landlord

Why is leasehold common in commercial property despite being a depreciating asset?

Because leases offer flexibility

What are the key disadvantages for tenants in a leasehold arrangement?

The lease depreciates over time - the LL will likely retain control and therefore specify what the tenant can and cannot do.

Why might a landlord dislike granting a lease rather than selling the freehold?

The tenant may not pay rent/ take care of the premises

Why are leases necessary for buildings with multiple occupants?

Because positive covenants are enforceable in leaseholds against individual occupants

What is the purpose of prescribed clauses in a lease?

To summarise essential information required by the Land Registry for registration.

What does the interpretation section of a lease contain?

Definitions of key terms used in the lease to avoid repetition.

What is included in the grant of a lease?

The formal clause where the landlord grants the premises to the tenant for the term.

What are ancillary rights in a lease?

Rights given to tenants to use areas necessary for occupation

What are rights excepted and reserved?

Rights the landlord keeps over the leased property - they are in favour of the LL

What is a fixed-term lease?

A lease that lasts for a specified period and ends automatically without notice (‘expires’)

• longer leases will often have a ‘break clause’ - i.e. a right to terminate

What is a periodic tenancy?

A tenancy that continues from period to period (indefinitely) until notice is given by either party.

• Notice should be the length of one period of the lease - exception is a yearly tenancy can be terminated by six months notice.

What is a tenancy at will?

A tenancy that can be terminated at any time by either party - is indefinite and can last any amount of time

• Least security.

What is an absolute covenant?

A covenant preventing the tenant from taking the specified action in all circumstances - landlord has total discretion on the matter

What is a qualified covenant?

A covenant allowing the tenant to act only if they obtain the landlord’s consent.

What is a fully qualified covenant?

A covenant requiring landlord consent - the landlord will not be able to withhold consent unreasonably.

What is meant by an FRI (Full Repairing and Insuring) lease?

A Full Repairing and Insuring lease where the tenant covers repair and insurance costs - LL does not have to use rent to pay for repairs, maintenance and insurance.

Ensures:

• the building is kept in good repair

• the lease reserves a market rent throughout the term to ensure steady income (usually with ability to increase the rent)

• the investment is readily sellable if necessary, ie the lease must be acceptable to future buyers of the freehold.

When can a tenant be in breach of a repairing covenant?

Only when there is actual disrepair

What does a covenant to 'keep' property in repair require?

The tenant must put and keep the property in repair - even if that involves the tenant putting the building into a better state of repair than when they entered into the lease

Why is a covenant to keep property in good condition more onerous?

Because it may require work even when no physical disrepair exists.

Why does the landlord usually insure the building?

To protect their investment and ensure it can be reinstated after damage

What is meant by insuring to full reinstatement value? (what a property should be insured to)

Insurance that covers demolition

What is a rent suspension clause?

A clause that stops rent being payable when the premises are unusable due to insured risk causing damage.

• In the absence of an express term to the contrary, rent will continue to be payable even if the property is rendered unusable.

Why might a tenant want a right to terminate after damage?

To avoid paying rent if reinstatement takes too long or proves impossible.

What happens when damage is not covered by insurance?

The tenant must repair the damage under their repair covenant.

What is a rent review clause?

A clause which allows a LL to increase the annual rent in line with rises in rental value in the wider property market.

When is annual rent paid?

On a quarterly basis - (25th March, 24th June, 29th September, 25th December)

How has a covenant to repair been defined by case law?

• must be disrepair first - before the tenant can be in breach of covenant to repair.

• the property need not be kept in ‘perfect repair’ - reasonable repair

• works of renewal or improvement go beyond repair - repair is restoration by renewal or replacement of parts of a whole, not renewal or replacement of the whole

• can oblige a tenant to remedy an inherent defect (but not obliged to give back a property ‘wholly different.’)

What happens in a repair covenant if it includes the additional word ‘keep’?

A covenant to ‘keep’ a building in repair also means ‘put’ it into repair, even if that involves the tenant putting the building into a better state of repair than when they entered into the lease.

A covenant to ‘keep the property in good condition’ is more onerous than a plain covenant to keep it in repair. It can mean that the tenant is obliged to carry out some works, even though there is no actual disrepair

What happens if there is damage and the LL has complied with its covenants to insure the property to its full reinstatement value against the insured risks specified in the lease?

• LL should be able to reinstate the property using the insurance proceeds from the buildings insurance policy, the premium having already been recovered from the tenant as insurance rent.

• The landlord will not receive the rent from the tenant while reinstatement is taking place, but will receive an equivalent sum under the loss of rent insurance policy, also paid for by the tenant.

What will a T do whilst a property is being re-instated?

The tenant will be inconvenienced and may have to relocate on a temporary basis, but they will not be paying rent on the property

Once the rent becomes payable again they will probably be able to resume occupation of the property.

If they cannot occupy the property at that point, they may be able to break the lease; if they have no break clause, they will have to start paying rent again for a property they cannot use.

What happens if damage occurs and it is not covered by the insurance policy? (e.g. through agreement or high premiums)

The tenant will be liable to repair the property under the repairing covenant.

What does s.3 of the LTA state regarding improvements?

A tenant of business premises can use the provisions of s 3 Landlord and Tenant Act 1927 to enable it to carry out ‘improvements’, even where the lease contains an absolute prohibition.

• Under s 3, a tenant who wants to carry out improvements can serve a notice on the landlord detailing its proposals.

• The landlord has three months within which to object and if it does, the tenant has the right to apply to the court for authorisation to carry out the improvements

• The court can authorise the improvements if they add to the letting value of the property, are reasonable and suitable to the character of the property and do not diminish the value of any other property of the landlord.

Can a LL offer to carry out the works themselves?

YES - in return for a reasonable increase in the rent - a tenant is under no obligation to accept an offer by the landlord to carry out the works and may withdraw its notice

• If the tenant rejects the landlord’s offer, the court cannot give the tenant authority to do the works itself.

What happens in the absence of an alterations covenant in a lease

The tenant is free to make any alterations it wishes subject only to general law

Why do landlords distinguish between different types of alterations in the lease

So they can impose different levels of control on structural non structural service media and partitioning works

What are non structural internal alterations

Changes inside the property that do not affect the structure such as reconfiguring internal finishes or layouts

What is an absolute covenant against alterations

An obligation that completely prohibits the tenant from carrying out the specified alterations

In practice to which type of works is an absolute alterations covenant commonly applied

To structural and external alterations to protect the fabric and appearance of the building

What statutory provision can help a business tenant overcome an absolute prohibition on improvements

Section 3 of the Landlord and Tenant Act 1927

What can a business tenant do under section 3 of the Landlord and Tenant Act 1927

Serve notice on the landlord describing proposed improvements and seek authority to carry them out

On what grounds can a court authorise tenant improvements under section 3

If they add to the letting value are reasonable and suitable to the property and do not diminish the value of any other property of the landlord

What alternative does a landlord have instead of consenting or objecting to tenant improvements

It can offer to carry out the works itself in return for a reasonable increase in rent

What happens if a tenant rejects a landlord offer to do the works under section 3

The tenant may withdraw the notice and then the landlord cannot do the works or increase the rent and the court cannot authorise the tenant to do the works

When may a tenant lawfully carry out improvements despite an absolute prohibition

If the landlord fails to object within three months or the court authorises the works under section 3

What is a qualified covenant against alterations

One that prohibits alterations unless the landlord gives prior consent

What key rule does section 19 subsection 2 of the Landlord and Tenant Act 1927 imply into a qualified covenant on improvements

That the landlord cannot unreasonably withhold consent to tenant improvements

How has case law defined improvements for the purposes of section 19 subsection 2

Works that increase the value or usefulness of the property to the tenant even if they reduce the value of the landlord reversion

Why would a tenant prefer a fully qualified covenant for alterations

Because it clearly prevents the landlord unreasonably withholding consent for alterations whether or not they are improvements

What is a fully qualified covenant against alterations

A covenant requiring landlord consent and stating that consent must not be unreasonably withheld

Why is planning permission likely to be needed for changing the shop front

Because it is an external structural change that affects the appearance of the building

What is compensation for improvements under section 1 of the Landlord and Tenant Act 1927

A right for a tenant to claim money at the end of the term for authorised improvements that add to the letting value

When can a tenant usually claim compensation for improvements

Only if it used the section 3 procedure to get prior authorisation and if it claims within statutory time limits

How can the user clause make use of the Use Classes Order 1987

By permitting use within a wider use class such as Class E rather than a single named use

How can a landlord add more control to a user covenant

By making it qualified so that any change of use within the class needs landlord written approval

Is there a statutory implication that landlord consent to change of user covenants cannot be unreasonably withheld

No - there is no such statutory implication for user covenants

What does section 19 subsection 3 of the Landlord and Tenant Act 1927 prevent regarding user consents

It prevents the landlord charging a fine or increased rent for consenting to a change of user where no structural alterations are involved

Why must planning law be considered when changing user of premises

Because a planning permission or lawful development consent may be required for a material change of use

How might a landlord retain control over planning applications by the tenant

By including a covenant that the tenant must not apply for planning permission without landlord consent

What is alienation in the context of leases

A broad term covering ways a tenant creates interests in the property for third parties

What happens if there is no restriction on alienation in a lease

The tenant can dispose of its leasehold interest in any way it chooses

What typical absolute alienation clause might be found in a lease

One that prohibits assignment underletting charging sharing occupation or parting with possession except as expressly allowed elsewhere in the lease

What is assignment of a lease

A transfer of the whole of the tenant leasehold interest to a new tenant

What is underletting

The grant of a new lease out of the tenant interest usually of the whole or part for a term shorter than the headlease

What is charging or mortgaging of a lease

Using the leasehold interest as security for a loan from a lender

What is sharing occupation

Allowing another party to use the premises while the tenant remains in occupation such as through a licence or concession

What is parting with possession

Allowing another to take over control and possession of the premises so the tenant no longer has physical control

What is a headlease

The original lease between the freehold owner and the tenant out of which an underlease may later be granted

What is an underlease or sublease

A lease granted out of an existing lease creating a landlord and tenant relationship between the headtenant and undertenant

What is required for a lease to count as an underlease rather than an assignment

The term of the underlease must be shorter than the remaining term of the headlease even if only by one day

In alienation terminology who is the assignor

The current tenant who transfers its leasehold interest

In alienation terminology who is the assignee

The incoming tenant who acquires the unexpired term of the lease

Why do most leases prohibit charging?

The LL will be concerned that if the borrower defaults on the mortgage, the lender may take possession of the property or exercise its power of sale

Why do commercial leases usually allow assignment of whole but not of part

Because splitting legal ownership of parts of a building can create management and legal complications

What does section 19 subsection 1(a) of the Landlord and Tenant Act 1927 do?

It implies into a qualified covenant against assignment that landlord consent cannot be unreasonably withheld thereby turning it into a fully qualified covenant

What does section 19 subsection 1A of the Landlord and Tenant Act 1927 allow parties to do

Agree in advance conditions and circumstances in which the landlord may reasonably refuse consent to assignment

Give examples of pre agreed reasonable conditions for assignment

Requiring an authorised guarantee agreement (AGA) from the assignor and or a suitable guarantor from the assignee

Give examples of pre agreed reasonable circumstances to refuse assignment

• Where rent is unpaid

• Where there is a material breach

• Where the assignee is not of sufficient financial standing

What duty does section 1 of the Landlord and Tenant Act 1988 impose on landlords

To respond to written applications for consent within a reasonable time (except in a case where it is reasonable not to give consent) and give written reasons or conditions for any refusal or conditional consent

What is the main purpose of a fully qualified covenant against assignment

To protect the landlord from undesirable tenants or uses while allowing reasonable dealings with the lease

Give examples where refusal of consent to assignment has been held reasonable

• Unsatisfactory references

• Serious un-repaired disrepair

• Risk of competition

• Reduction in reversion value

• Conflict with tenant mix

• Intended purpose for the property after it has been assigned

Give examples where refusal of consent to assignment has been held unreasonable

• Seeking an unrelated advantage - not entitled to refuse assignment based on grounds which have nothing to do with the T/LL relationship in regard to the subject matter of the lease.

• Relying on minor breaches

• Causing extreme prejudice to the tenant compared with limited landlord harm

What issue did Ashworth Frazer v Gloucester City Council address

Wether it is reasonable for a landlord to refuse consent to assignment because it anticipates a breach of the user covenant by the assignee

What was the general principle from Ashworth Frazer on anticipated user breach

It is usually reasonable to refuse consent if the proposed assignee intends to use the premises in breach of the lease but each case depends on its facts - consider what the reasonable LL would do when asked to consent in the particular circumstances.

How does the Equality Act 2010 affect landlord decisions on consent to assignment

The landlord must not discriminate on grounds such as race sex or disability when deciding whether to give consent

What is an underlease in simple terms

A lease granted by a tenant to someone else out of its own lease

Why must an underlease be for a shorter term than the headlease

Because otherwise it would amount to an assignment of the headlease rather than the creation of a new underlease

Why might a tenant underlet if premises are surplus to requirements

To recoup part or all of the rent and pass on costs like insurance and repair to an undertenant

How might a tenant profit from an underletting in a strong market

By underletting at a higher rent than it pays under the headlease - tenant can make a profit.

Why might underletting be preferable to assignment for a tenant that wants the premises back later

Because the tenant can recover the property at the end of the underlease term while keeping the headlease

Why might a tenant choose underletting instead of assignment when worried about an assignee default

Because as headlandlord it retains more control over the undertenant and avoids or manages liability under an authorised guarantee agreement

Why might underletting be used in a falling rental market

Because no one will take an assignment at the high headlease rent but someone might take an underlease at a lower rent reducing the tenant losses

What is one main landlord concern about underletting

That it may end up with the undertenant as direct tenant for example after forfeiture or expiration combined with statutory renewal rights

What is another main landlord concern about underletting

That the undertenant in occupation controls the property day to day while the landlord has to act through the headtenant

How can a landlord protect itself against underletting risks

By imposing strict controls or prohibitions on underletting in the alienation clauses - not uncommon for a lease to contain an absolute prohibition on underletting

Why do many landlords prohibit underletting of part

Because the property may not be suitable for subdivision and multiple tenants complicate estate management

What statutory rules apply to qualified covenants on underletting

Section 19 subsection 1(a) implying reasonableness and section 1 of the Landlord and Tenant Act 1988 imposing duties to respond (give consent unless unreasonable and written reasons of refusal in a reasonable time)

Why is compliance with underletting conditions important for the tenant

Because breach may justify forfeiture of the headlease and loss of the underlease

Why might a landlord require that an underlease mirrors the headlease covenants

To ensure covenants are not weakened and the undertenant is bound by similar obligations

Why might a landlord require underlease rent to match or exceed headlease rent and have linked rent reviews

To maintain rental levels and income if the headlease falls away and to preserve investment value (no loss in income)