Tenants must face the fact that the lease is a legal document into which they are most probably tied for a number of years. That said, there are options available for businesses which need to dispose of their lease or renegotiate its terms.
These options may not provide a quick fix but the commercial reality of the current market has left both landlords and tenants feeling insecure, and if tenants consider their options early they may be able to reach a favourable solution.
Tenants should check to see if they have the right to assign or sublet the whole or part of the lease. Sometimes this is prohibited; particularly the right to deal with part only of a building. However, often assignment or subletting is permitted with the consent of the landlord.
By assigning the lease, the existing tenant would be released from their obligations in relation to the property, but they may be required to comply with certain pre-conditions. Subletting, although not disposing of the lease, may at least allow the tenant to recover some costs.
At the moment, assignment or subletting may prove difficult due to the general market reluctance to take on new leases. Also, as a precondition to assignment, existing tenants may be required to guarantee the performance of the lease by the incoming tenant.
In such an unstable commercial climate, providing guarantees as to the ability of another business to meet the demands of a lease which was too expensive for the guarantor in the first place may seem unwise. Assignment can also prove time-consuming and costly.
Breaking a lease
Many commercial leases allow the tenant to break the lease at a specified time during the term, or on the happening of certain specified events. This can be used as an exit route for struggling businesses. It is, however, essential that break options are exercised in accordance with their terms. Any pre-conditions must be strictly observed.
It is common for break options to require at least six months notice, and therefore early consideration of the possibility of exercising this right is essential. If the date by which the notice must be given passes, the right to break will be lost and the tenant must bear the cost of the lease at least until the next break opportunity, or alternatively look to other less certain ways of releasing their obligations.
Landlords are very unlikely to waive a tenant’s breach of a pre-condition to a break option. Tenants with good covenant strength who are willing to take on a new lease are few and far between, and with the abolition of empty rates relief landlords will be faced with full rates liability should their building stand empty for more than three months.
Options to break can also be used by tenants as a tool for renegotiation. If discussions start early enough, the threat of losing the tenant through the exercise of a break clause and being faced with an empty building may encourage landlords to renegotiate the lease onto terms more favourable for the tenant.
If the tenant’s problems are cash-flow related, the landlord may be willing to reduce the rent or alter the terms for payment, such as allowing payment of monthly rather than quarterly rents in advance.
In the event of a rent review or break option, tenants may find themselves in a strong position for renegotiation. Essentially, sooner or later the landlord will suffer if the tenant cannot remain profitable. It is certainly not in the landlord’s interest to see their tenant go under, and accordingly they may even be willing to agree payment plans for any rent which is in arrears to ease the pressure during the tough economic times.
Alternatively, landlords may be willing to share the risk of the market turbulence and renegotiate the rent to a percentage of the tenant’s turnover.
Recent high-profile discussions between some of the UK’s largest landlords and most influential tenants have highlighted the difficulties tenants face.
Recognition of the need for reductions in service charge, lease lengths and rent rises cannot come too soon for many tenants. Although the 2007 Code for Leasing Business Premises clearly sets out that landlords should accommodate commercial equality in leases, implementation of is recommendations is by no means universal.
Surrender of a lease
Despite the current weak market, in some circumstances it may be possible for tenants to negotiate a surrender of their lease. Surrender occurs when a tenant relinquishes their lease with the landlord’s consent. If the landlord agrees to surrender, the tenant is released from any future liability under the lease. It is important to note, however, that any breaches which occurred before the surrender remain enforceable by the landlord. Tenants should therefore ensure that they seek a release from all breaches.
Inevitably there will be casualties of the credit crunch. Even at a lower rent or using a different payment plan some tenants will be fighting a losing battle. But if a business goes bust can the tenant simply hand back the keys?
If a tenant gives up possession of their premises and hands back their keys to the landlord they may be able to prove that the landlord has agreed this as surrender of the lease. While surrender requires the agreement of both parties, if the landlord acts in a way to suggest agreement, such as re-letting the premises, the tenant will be released from their future liabilities under the lease.
But landlords are unlikely to accept the keys as surrender, in which case, the continuing liability of an insolvent tenant under their lease will depend on the nature of the insolvency.
Tenants hoping to rescue their business may enter into a company voluntary arrangement (CVA), which is a contractual arrangement with creditors supervised by a licensed insolvency practitioner. In this way tenants may avoid liquidation through the use of cost-effective arrangements with creditors (including landlords) regarding the payment of rents and debts. However, a CVA must be approved by 75% in value of creditors, and the procedure for implementing a CVA is cumbersome.
The CVA will set out a plan for the payment of any arrears, future rents and dilapidations liability in relation to the tenant’s leasehold property. If the tenant no longer requires the premises, the CVA can also set out a relevant method for determination of the lease.
The landlord’s ability to take legal action to recover any rents or the property will depend on the terms of the CVA.
Small tenant companies can also file for a moratorium which will prevent the landlord from taking any legal action without the court’s permission. However, the important thing to remember about a CVA is that it does not bind fixed charge holders. If the terms of the CVA are breached, then liquidation or administration are likely to follow.
If the tenant company goes into liquidation, the landlord can prove in the liquidation for arrears of rent up to the date of commencement of liquidation. Claims for rent due after commencement can only be made with court approval, but it is likely in any event that the liquidator will use his powers to “disclaim” the lease.
A disclaimer will have the effect of extinguishing any rights, interests or liabilities of the tenant. Landlords will have to look to previous tenants or guarantors, who will remain liable for any past and future breaches of covenant. However, the landlord will not be able to pursue any party if it takes back possession of the premises.
Administrations have become very popular since the Enterprise Act 2002 introduced a simplified out-of-court procedure. Administration allows for an attempt to be made at putting the tenant company back on its feet. At commencement of administration a statutory moratorium is placed on all proceedings against the tenant company during the period of administration. Also, the landlord is prevented from exercising any right of distraint or forfeiture.
This means that the landlord will be prevented from bringing any action to recover rent or the property without first obtaining the consent of the administrator or the court. The administrator cannot disclaim the lease like a liquidator; however, if the premises are surplus to the requirements of a business which is looking to continue trading, the administrator can assign the lease in the usual way.
For years the balance of power has been heavily weighted on the landlord’s side, but the market downturn is undoubtedly proving tough on both tenants and landlords. As a result, landlords are being forced to accept that when a tenant defaults on their legal obligations, the best option may be to open talks. Once a tenant goes bust, the landlord’s remedies are limited.
So for tenants and landlords alike, the idea of opening an early dialogue in pursuit of an amicable resolution is perhaps the only viable solution if they want to avoid becoming another statistic of the credit crunch.
This was first published in November 2009