Heads of Terms – what are they, are they binding, are they the whole ‘deal’?
Heads of Terms (HoT) are the starting point for most transactions and are usually prepared by the landlord or their agent, detailing the ‘agreed’ position on a number of the key commercial points in a lease. The Royal Institution of Chartered Surveyors produce guidance on what should be included in a HoT. If things are missing then this can slow down negotiation of the lease.
HoT are usually marked ‘subject to contract’. This means that even if they are signed by the parties they will not be legally binding until a formal lease is signed and dated. However, landlords will often seek to use what was agreed in the HoT as the basis for any negotiation so it is recommended that tenants seek legal advice at the HoT stage.
The lease – some key points to be aware of
Extent of the property and rights included
It is vital that you understand what this is at the outset. A lease can either be of the whole or part of a building and this should be clearly spelled out in the HoT (preferably with a plan to show the floor layout). You should check this carefully and let your solicitor know immediately if you think there are any mistakes.
Equally important are any rights included in the lease. Is there parking provided or use of any third party facilities? Never assume something is included, simply because it appears on a plan – it may belong to another tenant or there may be an extra charge payable.
Remember that for commercial leases it is much more common for the tenant to pay rent quarterly in advance rather than monthly. This can have a significant cash flow effect so plan accordingly. Check also whether the rent will be subject to VAT or not. Property rent is not automatically subject to VAT but many landlords do charge VAT and/or will retain the ability to charge VAT if they need to. If VAT applies to the rent it will also apply to other costs which the landlord charges to the tenant.
Security of tenure
As a general rule tenants operating a business from property benefit from a form of security of tenure. This means that at the end of the lease term they can apply to the landlord for a new lease on substantially the same terms as their current one (subject to an uplift in rent). In some circumstances the landlord may be able to avoid granting a new lease but they may have to pay compensation in order to do so.
It is also possible to exclude this right to security of tenure (often called ‘contracting out’) provided certain steps are taken before the lease is entered into. In this case the tenant has no right to stay on, and even if the landlord decides to offer an extension, it can do so on any terms that it pleases, there are no statutory controls on this.
Unlike residential leases, most commercial tenants are responsible for the repair of their property and all the plant and machinery within it, with the repairing obligation potentially requiring the tenant to put the property into a better condition than it was at the start of the lease. However, this can depend on a couple of things:
The extent of the property included in the lease (see above). A lease of whole frequently includes the whole of the structure of the building, not just the interior. Leases of part are usually more limited, with the landlord responsible for maintaining the structure and recharging the cost via a service charge.
Whether the HoT have limited the tenant’s responsibility for repair (see below).
Most leases will prevent the tenant from doing any works to the property unless they have first obtained the landlord’s written consent and some cases may prohibit alterations completely. If you need to do work to the property to ‘fit out’ before operating then discuss these early on and make sure these are agreed at the outset. Usually the landlord will insist on a ‘licence for alterations’ which will set out which works are permitted and impose obligations to remove works before the end of the lease.
Tenants assume that once they have taken a lease it is theirs to deal with as they wish. That is rarely the case, and the lease will normally have lengthy clauses dealing with how and when the tenant can either sell (assign) or sublet the property. Expect that these will include the landlord being able to ‘vet’ the financial strength of the proposed buyer and to impose conditions on the assignment, including that you give a guarantee (sometimes called an ‘AGA’) that the buyer continues to comply with the lease obligations after the lease is sold.
It is common for a lease to contain a clause allowing the tenant, landlord or both parties to end the lease early (usually called a ‘break right’ or ‘break clause’).
As a tenant, a break right can be a particularly important should you need to change premises for any reason (i.e. expansion, need for a new location, financial difficulty) during the lease term.
A break right is almost always agreed at HoTs stage but if this is not in the HoTs and you want it to be raised, you should tell your solicitor this as soon as possible.
A building survey – why we recommend you get one
As a tenant, you will be responsible for keeping the property in repair (see above). It is therefore important to make sure that you understand the condition the property is in at the date you are planning to lease it, and arranging for a professional survey can help understand this.
Sometimes it is possible to limit the repairing obligations by agreeing a ‘schedule of condition’ for the lease. This highlights the state of repair the property was in prior to your occupation and limits your obligation to repair the property to keeping it in no better condition than that shown in the schedule. Money spent on preparing a professional schedule of condition will pay dividends when it comes to finalising repair issues with the landlord at the end of the lease.
Insurance – who insures the property, what should I be aware of?
In most commercial leases, the landlord insures the building with the insurance premium being re-charged to the tenant either entirely (for a lease of whole), or a proportion (for a lease of part).
However, there are a number of considerations for tenants regarding insurance which should be discussed with your solicitor at an early stage including:
What is insured for – a commercial lease specifies various ‘risks’ which the landlord is obliged to insure against (subject to certain exceptions) such as flooding, fire and storm. However some risks (such as subsidence and terrorism) can often be excluded, meaning the cost of any damage caused by these risks may end up being the tenant’s responsibility. Discuss this point with your solicitor and remember that the landlord will only insure the property, not your fixtures and fittings nor any losses to your business if the property is damaged.
Ask to see a copy of the landlord’s insurance policy and make sure you are comfortable and familiar with its terms. The lease will exclude the landlord being responsible if the insurers refuse to pay because you have done something which invalidates the policy, so it’s important to understand what is required of you as tenant.
Outgoings – what will I have to pay as a tenant?
Remember that the rent will not be the only cost of ownership; you should budget to have to pay for the following:
The annual rent.
The landlord’s insurance premium/a fair proportion if a lease of part.
Any ordinary outgoings attributable to the premises such as business rates, water, gas, electricity.
Service charge if the property is on an estate or part of a larger building.
If you have any particular concerns about what you will be required to pay as a tenant, you should raise these with your solicitor early in the transaction.
Statutory compliance – things to think about
Being a tenant of a property comes with various responsibilities, two of the most common (but often forgotten) being:
The Control of Asbestos Regulations. If the building predates the early 2000s then it is important to understand that these Regulations require the tenant to have regular surveys for asbestos carried out and to have health and safety plans in place to protect staff and contractors from the risk of exposure to asbestos. Even if the landlord is able to provide a copy report for the property, it is important for the tenant to carry out its own survey and to keep this up to date.
The Fire Safety Order. Anyone with responsibility for commercial premises is required to carry out regular assessments of fire safety risks and ensure adequate plans are in place. Again, even if the landlord is able to provide a copy the tenant has a separate duty to maintain records and policy documents.
Stamp Duty Land Tax (SDLT) – what is it and how much will I have to pay?
Depending on the amount of annual rent payable and the length of the lease, the lease may be subject to SDLT, which currently is payable within 30 days of completing your lease. Your solicitor will assist you with preparing the return you need to submit, as well as letting you know the amount you need to pay.
For example – a lease with a term for 10 years at a rent of £30,000 a year will cost just under £1,000 in SDLT under the current SDLT rates.
If you are on a tight budget please ask your solicitor to carry out a rough SDLT calculation at the start of a transaction so you can factor this into the overall transaction budget.
Do I have to register my lease?
If your lease is for longer than seven years it needs to be registered at HM Land Registry. In many cases even leases of less than seven years need some sort of entry making at the Registry. Although your solicitor will deal with registration for you and explain the process in more detail after completion, you should be aware that it can take several months for the Registry to complete the application. It doesn’t affect the legality of the lease in the meantime but it can be a surprise when you receive the registration document months after the lease was completed!
How long does it take to negotiate a lease?
There is no set timescale for how long it takes from issue of HoT to completion of the lease and keys being handed over. However, we would usually expect a normal lease transaction (i.e. of a standard building such as an office with no unusual terms or third party consents required) to take a minimum of six weeks from the date we receive the HoT.
It is possible to complete leases in less time than this but usually this will mean that you may have to concede more points in the negotiation in order to meet the deadline. If you are working to a particular completion date it is important you let your solicitor know this as soon as possible so they can identify any relevant issues.
One key factor in timescales is third party consent. This can include a superior landlord’s consent (because your landlord is themselves a tenant) or where the landlord needs consent from its lender. These consents are out of your solicitor’s hands and can often make timescales very unpredictable so do not make arrangements (like booking works to be done) until your solicitor can confirm a fixed date for completion.
Reproduced from the Lexology newsfeed.