Following a difficult trading year, many businesses are considering whether and how they can reduce or exit their lease liabilities as soon as possible. This might be because of a need to adapt their business models or just to reduce overheads and preserve cash flow.
This might be an urgent if not business critical issue for a tenant’s survival.
The easiest and most inexpensive way of a tenant concluding its lease liabilities is to wait for the contractual term of the lease to expire (but even then the tenant may have some residual liabilities). However, there may be many years left to run meaning the contractual expiry date will be of little use. Indeed, it might be the opposite, and quite unhelpful for the tenant.
Following recent articles Commercial Landlords, Arrears and COVID-19 and COVID-19, Landlords, “CVAs” and forfeiture - what are a landlord’s options?, this article considers some of the means available to a tenant to bring its lease to an early end or to reduce its rent.
Some commercial leases, contain a “break” provision, under which a tenant can serve notice on the landlord, to determine its lease on a specific date.
The break provision arises as a matter of contract so unless it is specifically provided for within the lease, the tenant cannot make use of it. Therefore, when entering into leases, tenants should consider their medium to long term business plans and requirements for occupation of the premises and whether they want to negotiate a break provision. The flexibility that a break clause provides to the tenant will create uncertainty for the landlord, so the tenant should expect to pay something, one way or another, for the luxury (nothing comes for free, after all).
However, beware the break clause pre-conditions (for example, giving up “vacant possession”, or, ensuring all amounts under the lease are paid), and, the requirements for serving the break notice correctly. If these are not strictly complied with, then the lease will continue which could have disastrous consequences for an unwary tenant who had banked on being able to exit the premises.
It is therefore imperative that a tenant should seek early and specialised advice to ensure that the lease break mechanism is properly engaged. The tenant may also be entitled to an apportioned refund of any monies paid, for the period after the break date when the tenant is no longer in occupation.
The tenant could simply walk away from its lease and the premises and hope for the best.
However, unless the tenant is released from its contract with the landlord either by operation of law or agreement, then the tenant will remain “on the hook”.
As discussed in our previous article Commercial Landlords, Arrears and COVID-19 , although a landlord’s options to enforce a debt are currently restricted in terms of forfeiture, statutory demands and winding up petitions, a landlord can still bring a Court claim in respect of any amounts owing. The current restrictions will not last for ever (landlord’s hope), so tenants in default will be at increasing risk moving forwards.
It would be difficult for a tenant to defeat a landlord’s claim, particularly in relation to rent arrears, if the tenant has simply walked away.
Generally speaking, the 54 Act will apply to a lease if the statutory criteria are satisfied. These include that there must be a lease and that the tenant occupies for the purpose of business.
The parties can agree that the 54 Act will not apply, but in order to give that agreement effect, the parties must follow the correct and prescribed “contracting out” process.
Whether a lease is subject to the 54 Act is important, because a tenant with the benefit of the 54 Act will enjoy “security of tenure”. This means that (i) a tenant will generally be entitled to a new lease at the end of its current lease and (ii) a lease will automatically “hold over” (i.e. continue) on the same terms once the lease ends, unless the lease is determined in one of the prescribed ways under the 54 Act.
When a tenant is holding over under a lease which continues by virtue of the 54 Act, the tenant is not obliged to stay and could serve a notice under Section 27 of the 54 Act giving not less than three months’ notice to bring the lease to an end.
If they have not already, tenants who are seeking to get out of their leases should speak to their legal advisors regarding whether the contractual term of their lease has expired, and, whether there is scope to serve a notice under Section 27 of the 54 Act.
The parties are free to agree that the lease and the parties’ obligations will be brought to an early end, through the tenant “surrendering” the lease.
A surrender can come about through an operation of law (for example, through the tenant relinquishing and the landlord accepting the keys to the property) or under a written agreement.
However, as a pre-condition of any surrender, the tenant will likely be required to pay a premium to the landlord. The amount of the premium will often be calculated and negotiated by the parties’ surveyors, having regard to the remaining term, the value of the rent, the value of the early release and a sum in respect of the tenant’s liabilities regarding its lease repair and other covenants relating to the physical status of the premises.
At the least, the surrender agreement should provide that it is executed in full and final settlement of any and all claims under the lease, so that the tenant is not faced with uncertainty further down the line. To achieve this, together with ensuring that the agreement is legally binding, the tenant should seek specialist advice.
Many commercial leases will provide that a tenant may assign the benefit of its lease to a third party, subject to obtaining the landlord’s consent, and potentially, satisfying various other conditions.
In “new” leases made on or after 1 January 1996, a tenant will be automatically released from its lease obligations upon assignment, allowing the tenant to exit. This makes assignment an attractive prospect, unless the landlord or the lease requires the tenant to enter into an “authorised guarantee agreement” (aka an AGA), under which the tenant will guarantee the performance of the incoming tenant’s lease obligations. However, the tenant may be able to resist providing an AGA, even if the landlord or the lease requires it.
Alternatively, the tenant could apply for the landlord’s consent to underlet the premises. Whilst this would not allow the tenant to wholly exit the lease, it would at least put the majority of the tenant’s burden onto the sub-tenant, and the cost of the tenant’s interest in the premises would be subsidised.
Some landlords and tenants have already voluntarily negotiated rent concessions or deferments. This reflects the Government’s guidance in its Code of practice for the commercial property sector which asserts parties to leases should, but are not obliged to “… operate reasonably and responsibly, recognising the impact of COVID-19, in order to identify mutual solutions where they are most needed”.
A struggling tenant can approach its landlord asking for relief. However, strictly speaking, there is no obligation on the landlord to accommodate the tenant (unless provided for in the lease), although it might do so on a commercial basis.
Where an agreement cannot be reached, a tenant could argue that the conditions following the COVID-19 pandemic and lockdowns have resulted in the tenant being prevented from using the premises, in certain periods, for the purpose that was envisaged at the time the lease was entered into. Further, as a result, that the tenant should be released from its financial obligations under the lease, during any of those periods.
This is what the tenant Lillywhites Limited (owned by Mike Ashley’s Frasers Group Plc) argued in respect of its occupation of a 67,700 square foot, six floor department store in Piccadilly Circus, London. However, it would be fair to say that the landlord, Criterion Buildings Ltd, did not agree with Lillywhite’s position, as it has issued a claim against Lillywhites, seeking £3,226,207.19 of lease arrears plus interest.
This will likely be a closely watched test case of sorts, and it will be interesting to see how it progresses through the High Court and any appeals.
It is uncertain whether Lillywhite’s argument will succeed, particularly if the lease did not provide for a rent cessation in those circumstances. The starting point and following a long line of established legal decisions, is that the Court will have regard to the words of the lease, as the Court will be reluctant to amend that agreement, merely because it is prejudicial.
Even if Lillywhites is successful, it is likely that the Court’s decision will be of limited use to struggling tenants, as its reasoning will probably be fact and lease specific.
A similar argument that Lillywhites could have raised, but didn’t, is to assert that the lease was “frustrated” by COVID-19 i.e. that the market conditions prevented the tenant from substantially performing its lease obligations. However, the law in relation to frustration is complex, fact specific and not always consistent. It is also not guaranteed that the Courts will agree that a lease has been frustrated, which is perhaps why Lillywhites has not raised the issue (so far).
Knights’ Property Litigation specialists are well placed to assist either tenants or landlords, facing any such difficulties. For further information regarding the issues raised here, or for more specific advice, please contact a member of the Property Litigation team.