At a time when heads of terms for leasing transactions are taking longer and longer to get into an agreed format, and less time is left for putting a contract in place, how can you ensure that delays don’t occur because of commercial points which you perceived as agreed?
There are four key areas where time spent at the heads of terms stage could save valuable time when the contract is being negotiated.
Index-linked review clauses
Index linked review clauses are becoming increasingly common, partly as a result of their popularity with the active players in the market, cash rich funds and supermarket operators. Heads of terms often state "5 yearly uplifts, index-linked, cap and collar of 3%/ 5%", but what exactly does this mean? Do both parties think it means the same thing? Differences of opinion on some of the essentials will yield different results, and could necessitate a further round of approvals, further consideration of incentives, not to mention a fresh round of negotiation:
- which index should be used? Retail Prices Index? Consumer Prices Index? Producer Price Index? Another?
- is the increase to be compounded year on year?
- should the cap and collar be applied each year (if it is a compound increase) or only in the year of review? While an extreme example, if the calculation produced a figure of 10% one year, 5% the next, 1% the next etc, capping and collaring each year would produce quite a different figure, than if the cap/ collar was only being applied at year 5.
Uninsured risks
Enshrined within the Code for Leasing Business Premises in England and Wales (2007), the concept of damage by an uninsured risk (something that is either uninsurable, or something which can’t be insured under normal conditions in the UK) remaining with the landlord, is now considered institutionally acceptable in Scotland. While the code is not mandatory in England (and we have no equivalent in Scotland), it is endorsed by various groups, such as the British Property Federation.
The Leasing Code provides that, if there is damage or destruction caused by an uninsured risk, then the tenant is given an abatement of rent, and the landlord makes good the damage or destruction caused by the uninsured risk. It doesn’t place the tenant in exactly the same position as if the damage had been insured, as the landlord isn’t automatically obliged to rebuild. Instead, the general approach is that the landlord is given a period of around six months to a year to decide if they want to rebuild. If they don’t, the lease automatically terminates. This gives the landlord a window to determine if rebuilding is financially viable, and time to obtain funding. Damage or destruction caused by a terrorist attack, or something specific to a particular building, for example flooding, are the main concerns for a landlord. It is worth agreeing the approach on uninsured risks at the heads of terms stage, as any well advised tenant will bring it up once documentation is issued. This will only waste time as the point is debated back and forth. Terrorism insurance is currently available, and it is generally accepted that the government will be the insurer of last resort.
Your decision may be building specific or tenant specific, and may depend on the other occupational leases already in place. You might take a different view if a coffee shop wanted to open up next to Edinburgh Castle, compared to a hairdresser taking a shop in Wick.
Compliance with the Service Charge Code
It is no surprise that a survey on occupiers’ satisfaction, carried out in 2011, concluded that service charge is the most contentious issue between landlord and tenant. This has been the case for many years. The RICS sought to address this by issuing an RICS code of practice on service charge, the Second Edition of which came into force on 1 October 2011. The First Edition of the Service Charge Code set out the expectations for the standards and management required in commercial property, and a key aim of the Second edition is enhanced engagement with the legal profession. The Code has the status of a guidance note, and cannot over-write existing leases, but it is hoped that drafting will be included in new leases or lease variations. In light of this, the City of London Law Society have produced wording that can be included in new leases or variations to existing leases. Rather than leaving this to be debated once the heads of terms have been issued, this should be addressed at heads of terms stage. In practice, many of the big landlords do insist that their managing agents adhere to the Service Charge Code, but are reluctant to confirm this within the lease, due to concerns that this could limit marketability of the investment. As a result, tenants are still taking comfort from service charge caps or specific exclusions.
Monthly rent concession
Initially requested as a temporary measure to ease cash flow, an increasing proportion of tenants are looking for monthly rental payments as standard throughout the term. Rather than a blanket agreement, it will save time if the following are considered, and dealt with in the heads of terms:
- should you consider an administration fee? Managing agents will have to send out 12 invoices a year, rather than four and a lender may charge an additional fee;
- should this concession be personal to that particular tenant and should it be binding on successor landlords?
- What is the sanction in the event of rental default? Should payment revert back to quarterly?
Conclusion
Agreement on the commercial points at heads of terms stage can save valuable time in documenting what the parties have agreed, and can keep down the costs of the negotiation. It is also easier to deal with an issue at the stage when all commercial points are being debated, rather than it becoming the last issue, dependent on who is willing to concede.