6 min read
It is understandable that complex lease transactions require complex documents, however the majority are fairly straightforward, yet some are unnecessarily complex and difficult to conclude. The property and legal industry often make the process of granting a lease and agreeing lease terms overly complicated, is this to justify their need and fees? 95% of leases are straightforward, and whilst all have different terms, the basics should be much the same. Good, clear drafting in plain English means both parties can easily understand their obligations. Poor ambiguous drafting results in disputes and we all know what that leads to.
Landlords often maintain the status quo to protect and create value, whilst Tenants do not get a strong enough representation in the industry and are ineffective in driving change.
Here are 5 key issues when it comes to agreeing a lease (the next 5 are in a further article).
The Heads of Agreement is the document that details all the commercial terms, it should be neither a 6-bullet point email nor a 50 page document, but instead a document that is concise, written in plain English and clearly sets out the commercial terms.
The Heads should include the key commercial terms including what the Parties are obligated to do and what the parties are not. Being silent on an obligations does not mean you don’t have to perform that obligation, and it may result in the lawyers adding it back in because they are not aware of its specific exclusion. Sometimes ambiguity is good as it gives flexibility but it can also lead to disputes. The documentation stage with the lawyers is exactly that, documenting the agreed commercial terms and putting some flesh around it. It shouldn’t be a renegotiation of commercial terms because of poor Heads.
We have a general rule that if we find a lease clause ambiguous and not clear then the client will definitely find it ambiguous. Ambiguity in a lease document is from poor drafting, it leads to disputes and potentially the engagement of property and/or legal practitioners. If you need to engage a lawyer to interpret a lease clause, then the other party will probably be able to engage a lawyer to take an opposing view on its interpretation.
It is very refreshing when we see a clearly written lease in plain English that leaves no doubt in the readers mind as to what the lease obligations are.
Outgoings are the recovery of costs that the landlord incurs in managing the building, it includes items such as cleaning, maintenance, insurance, land tax and management fees etc. It is not a revenue source for the landlord, it is cost recovery! Some larger landlords manage the property in house via a management company, which acts as a separate entity to the fund. The management company charges the fund for their services and they in turn recover the cost from the tenant. These charges must be the reasonable cost of managing the building. It should not include Asset Management costs such as the negotiation of lease renewals, market rent reviews or leasing of vacant suites or super profits. There needs to be greater transparency with Outgoing cost recoveries.
If Outgoings are ‘above market’ because of high management fees then the fund loses out because at market review the rents are assessed on a gross basis meaning the net rental income is less and the fund loses income, but when the fund manager is essentially the same organisation as the property manager nothing is ever done to rectify.
Some may argue that the Outgoings are audited,so they are transparent, the audit is to confirm the costs were incurred, it does not confirm whether they are allowed to be recovered under the lease or whether they are reasonable.
The term ‘gross rent’ is when the rent paid contains both a rent and outgoing component, outgoings are not separately charged. If the gross rent escalates by 4% each year then the outgoing component also escalates by 4%. If Outgoings increase by only 3.5% then the landlord has gained. If the Outgoings increase by 4.5% then the tenant has gained. This seems fair and provides the tenant with a degree of certainty. Generally gross rent escalations are higher than CPI so the landlord should generally be better off. When there is a clause that allows the landlord to recover the increase in outgoings over a base year then the landlord gets the annual escalation as well as the outgoing escalation.That’s double dipping. Even annually adjusting the base year amount by the fixed rent escalation results in a bit of a heads I win, tails you lose situation for the landlord.
There should be a rental structure where if it is a gross rent, then there is only a fixed annual percentage escalation,this provides certainty of cost for the tenant and a greater incentive to manage outgoings efficiently by the landlord. Alternatively, a net rent plus outgoings with robust drafting to ensure the outgoings remain a pure cost recovery. No double dipping or heads I win tails you lose. Keep it simple.
Alienation rights are the rights of a tenant to either assign or sublet their lease. Privity of Contract means if you assign the lease and the assignee defaults on their lease then the landlord can revert to the original tenant for the recovery of rent debt. Landlord’s are reluctant to let the original tenant be released from this potential future liability.
It is beneficial for a landlord to have an established, financially strong tenant; even to the extent that they give stronger companies preferential terms. A property has a higher value where there is a AAA rated tenant, when compared to a property full of C rated tenants.
Under Privity of Contract law, the landlord basically gets a new tenant with the original tenant as guarantor. Surely if the incoming tenant is of equal or greater financial strength than the original tenant then the original tenant should be given a full release. Should the landlord be put in a more secure position from an assignment?
Some leases state that you can only assign to a tenant who is financially equal to, or better than the original tenant. This means if government is the original tenant they will never be able to assign a lease and if a new financially weak startup wants to assign they can assign to anyone. When dealing with assignments, landlords should apply two tests. Firstly, is the assignee financially strong enough to pay the rent and meet the lease obligations, does the bank guarantee need to increase to give the landlord the same security? Secondly is the incoming tenant of equal or greater financial strength to allow a release under Privity of Contract.
Property Beyond can provide specialist advice with regard to negotiating leases,interpreting leases and lease disputes. If you are a tenant seeking to minimise risk and cost then please contact Property Beyond on 02 8094 1999.
