When negotiating a commercial property lease, it may be tempting to focus only on the rent and assume everything else is a relatively minor issue. That mistake is the result of not appreciating three points:
- commercial property leases do not have to be fair. This is not a consumer document.
- risks in commercial property leases involve relatively large numbers
- the commercial property lease can affect evert aspect of your business
- certain words and phrases in legal documents may appear to have one meaning but actually have a very different meaning in court.
- Solving problems is more expensive than doing it correctly in the first place, as I mentioned here.
Trap 1: “Simplicity before understanding is simplistic; simplicity after understanding is simple” (Edward de Bono)
It is often said that the contract must be interpreted according to the original intention of the parties.
This is simplistic.
In fact, the contract must be interpreted according to the original intention of the parties by reference to the language in the contract.
In other words: making sure that the commercial property lease really does reflect the deal you want, needs very precise wording.
Only then is it simple.
As someone who has been both a partner in a law firm and an in-house lawyer at a large property company, I can assure you that commercial property leases can be kept fast and simple. I wrote a blog on that topic here.
Trap 2: A simplistic commercial property lease favours the Landlord (in practise)
There are rules about contract interpretation that might seem to be favour the Tenant. For example, any ambiguity in the wording is deemed to go against the party who drafted those words. That is not what happens in practise. Consider, a very short commercial property lease did not describe the premises except to mention the address and the floor. This simplicity is simplistic and it is actually a trap for Tenants. When this happens, the Tenant often thinks they are only responsible for the wallpaper, the floor covering and not much else. However, the landlord argued that the Tenant is actually responsible for the walls and the suspended ceiling including any pipes and wires in the walls and above the suspended ceiling – all items that the Tenant assumed to be service charge issues. The Tenant then got a large bill for repairs.
The result is that the Tenant pays the invoice because the Tenant knows that the legal dispute will be even more expensive. However, it gets worse:
- in accepting the Landlord’s position, the Tenant has agreed to be liable to have all those parts of the building in perfect condition at the end of the lease, which is very expensive indeed.
- the Tenant still does not know exactly which parts of the building are included in their lease. For example, it may include the floor slab or not. If the Landlord decides the premises do include the floor slab, it might rip up the whole floor after the end of the lease and then charge the rent to the Tenant for the time it takes them to do those repairs.
A simple commercial property lease would have included a much longer description of what the property actually is. The contract would be longer but it would be simple.
Trap 3: Meaning depends on Context
You may only understand some of the words in a lease after thorough due diligence. That may sound strange but consider:
- There have been no repairs to the building in the last 5 years. This may mean that the building is in great condition and well-constructed. However, it may be that there is no professional management and no-one will know about any maintenance issues until they are already very serious.
- The building is brand new. You may take this to imply that the service charge will be low for a long time because it is unlikely that any repairs will be needed. You would all too frequently be wrong and the bill would be huge. The construction contract does not have to pay fair and many Landlords now do somewhat shaky contracts because they intend that the Tenants will be liable for all the repairs – including faults in construction. This would be hidden in layers of clauses that sound right but often add up to nothing. I have had two of these cases in central London in the last 6 months alone: in one case, the construction contract only gave warranties for 12 months (commercial property does not have to be fair) and in the other case, the Landlord did not even know if the contractors had any insurance!
- The services are provided during business hours. This was an office lease in a new City of London office tower. They wanted a week’s notice and costs up front to switch the lift back on after 6pm!
Trap 4: “The only constant is change” (Heraclitus)
As Tenants may buy or sell subsidiaries, open new divisions of their business or themselves become take-over targets, it is important that the commercial property lease remains flexible enough for the Tenant to change its business strategy. An unfavourable lease may give all control of the Tenant’s business strategy to the Landlord!
Consider:
- Longevity. Does the commercial property lease ensure that at the end of the term, the Tenant can choose to take a new lease and remain in the premises or would there be a lengthy discussion about the new rent level and open competition from any new potential Tenants? For a Tenant, that prospect may not only be worrisome from a financial perspective but also the time perspective: the process of carefully selecting new premises and moving into them is very time consuming. The impact on an office can be considerable but the impact on a shop can be even worse. A commercial property lease can manage this in many ways.
- Expansion. If there is further space available in the building, would it be prudent for the Tenant to reserve that space for 6 – 12 months?
- Equipment. Might the Tenant need specialised telecom and data cabling installed in the building? That might be expensive, slow and even forbidden if the office lease is a listed building and if, as so often happens in London, the Landlord also needs consent from one or more Superior Landlords. Such issues can be addressed in the office lease at the outset, to avoid unpleasant and expensive problems in the future.
- Networking. Does the Landlord facilitate contact between the Tenants? This does not take much effort for a Landlord but clearly, is better discussed at the outset if it might be important. A simple gathering of the Tenants twice a year could facilitate new business relationships or a strategy to green the building. Those are both items which can be simple and cheap but are quite impossible if the Tenants do not talk and that is hard to achieve if the Landlord does not facilitate it.
- Advertising. Many commercial property leases will prevent or control advertising and any kind of sign in the windows and anything visible from outside the premises
- Online Sales. Shop leases often require a percentage of the turnover to be paid to the Landlord as rent. In an unfavourable shop lease, the turnover rent clause may include a percentage of internet sales and that may depend on where you or your team sit when you make the internet sale. In a very unfavourable shop lease, the turnover rent clause may include a percentage of internet sales from your entire business – so even if you or your team are in a different commercial property!
- Expansion. In an unfavourable shop lease, the turnover rent clause may include a percentage of sales made at any other (current or future) branches of your business!
- Appearance. Restricting any change of colour, design, equipment, layout or logo. Your office or shop can be your strongest marketing tool so the ability to change it is vital. I have gone into more detail on that here.
- New Products. An unfavourable shop lease will be very restrictive about what the Tenant is allowed to sell in the shop. This is especially common in shopping centres but is also common on the high street if the Landlord owns a number of other retail units in the same area.
Trap 5: The End is not your Friend
The end of the lease must be prepared well in advance. There are many different scenarios for the end of the lease. Unless the Tenant is staying on at the same property with the same landlord for a further lease term (and a renewal lease is signed), the Tenant needs to get ready:
- If the Tenant wants to stay and has a right to demand a new lease under the Landlord and Tenant Act 1954:
- Certain legal notices must be served and there is a number of strategic considerations to weigh up about what you do and when.
- If the Landlord refuses a new lease or if the Landlord demands that the Tenant agrees to new obligations in the next lease, this can end up in court – and it does so quite frequently ( I must say that has never happened to me).
- If the Tenant is leaving at the end of the lease term, they need to carefully work out what steps to take, when and in what order. An unfavourable lease and no careful preparation, will leave the Tenant very much at the mercy of the Landlord – and then the costs of the dilapidations can easily double. I described that in more detail here.
- If the Tenant is leaving early by using a break clause, this also needs the same careful planning as if it is the end of the lease – but with an added problem. An unfavourable lease will have conditions attached to the break clause that make it extremely difficult in practise to make it work.
The problem is that the words seem reasonable until you understand what actually happens in practise. Getting this wrong or not leaving yourself enough time will allow the Landlord to refuse to allow the early termination and then the Tenant’s business strategy is in ruins.
This was an actual problem that I had to solve earlier this year. if the lease had been done properly, it would have been a minor consultation, but the unfavourable wording of the lease made it quite a minefield.
At EM Law, we are experts in all types of commercial property transactions. Should you require assistance in leasing, financing, acquiring or disposing of an interest in a commercial property, contact me, James Williamson.
