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Code For Leasing Business Premises 2007

publication date: Aug 22, 2008
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The Code for Leasing Business Premises in England and Wales 2007 is the latest attempt at self regulation by the property industry, with the aim of achieving greater flexibility in commercial leasing. Commercial leases have been historically weighted in favour of landlords, and the Code may offer a better balance between landlord and tenant interests.

Eleanor Richardson, solicitor in the property department at KSB Law LLP, delves into the property industry’s new guidelines, offering insight into the changes and what advantages they could offer tenants. Eleanor outlines the implications and provides tenants with advice on how to handle landlord relations in light of these changes.

What is the Code?

The Code for Leasing Business Premises in England and Wales 2007 is the latest attempt at self regulation by the property industry. The aim of the Code is to achieve a fairer balance between landlords and tenants and provide greater flexibility in commercial lease terms without the need for government intervention into the operation of the commercial property market. Although the Code is voluntary, it is supported by the Government and key players in the property industry such as the British Retail Consortium, the British Property Federation (BPF), the British Council of Offices (BCO) and the CBI.

How does this affect agents?

The Code sets out provisions that it expects to see in leases (see below for more details). Agents need to be aware of these so that they can ask their landlord clients about their approach to the Code. If their landlord clients are interested in complying with the Code then new ways of approaching potential tenants may need to be thought through. Agents may be able to offer a “shopping list” to tenants, for example, different levels of rent based on how much of the lease code is incorporated into the Heads of Terms. For example a high initial rent may mean the Landlord is willing to offer an upwards and downwards rent review and a schedule of condition for the repairing covenant; a slightly lower level of rent may mean the Landlord is prepared to offer an RPI increase on rent review and a schedule of condition and a lower rent still would mean that an upwards only rent review is maintained and there is no concession on repairing covenants.

It would be also worthwhile taking the time to revise standard heads of terms with your client and their solicitors to clarify the approach that the client wishes to take to the Code and to, if necessary, update the standard form. For example, if a landlord decides that they always want to incorporate certain provisions, for example requiring consent to all tenant’s alterations, or always requiring an AGA on assignment, despite the provisions of the Code then the agents should ensure that their standard heads of terms for that client always specify these provisions to prevent arguments later on in the lease negotiations. This is particularly important before agreeing in heads of terms that all other conditions are to comply with the Code.

Agents should also be aware that an outright refusal to include a provision that all other terms will comply with the Code will probably indicate to a tenant’s agent that the landlord has a negative attitude towards the Code which may not be the case at all. It is therefore imperative that agents are very familiar with their client’s requirements and discuss heads of terms with not only their client, but their client’s lawyers before they are finalised so that the landlord’s interests are protected, but tenants are not frightened away!

Why is the Code needed?

There is a perception that commercial leases have historically been weighted in favour of landlords. Tenants, particularly small businesses who do not have equal bargaining power, have had little choice but to accept terms imposed on them by landlords, or perhaps seek out less convenient premises in secondary locations. In recent years changes in the law and market practice have improved the position for tenants. Since the abolition of privity in 1996, tenants are no longer automatically liable for paying the rent after they have assigned a lease. And the typical length of a lease has fallen from 25 years to around 10 to 15 years.

However, many institutional investors and owners have been reluctant to abandon terms such as upward-only rent reviews. The Code sets out advice for landlords and tenants on how to deal with these issues and provides a benchmark for a more even-handed approach to leasing.

What does the Code say?

Rent Reviews

One of the main criticisms of the take up of the previous Code was that landlords did not feel able to abandon upwards only rent reviews and therefore landlords were reluctant to state that they would comply with an obligation to offer upward and downward rent reviews. The Code specifies that alternatives to upward-only rent reviews (such as up/down reviews or reviews linked to RPI) should be available on request although this time the Code recognises that landlords may want to charge a higher initial rent in return for an alternative review mechanism.

In addition, some older leases allow the Landlord to choose when they initiate the rent review so that they can maximise the increase on review by, for example, postponing the rent review provisions if the market is in a downturn. Also, although the landlord may not be in a hurry to operate the rent review procedure, it is usually the case that once the rent has been decided the tenant has to pay the additional rent from the date that the rent review should have taken place until the next quarter day within a very short period of time and with interest. This means that the tenant may potentially be liable to pay quite a large amount of money on short notice without having any say in when the rent review should be held. Although most modern leases do not contain either provision, the Code seeks to avoid these instances by stating that either party should be able commence the rent review process.

Break Clauses

Traditionally tenant break clauses have had very stringent conditions attached to them so that the tenant can only exercise a break clause if they have complied with all of the tenant covenants of the Lease and they are not in breach both when they exercise the break notice and when they give up possession. Tenants will always, to a certain extent, be in breach of their repairing covenant and landlords have, in the past, sought to enforce the conditions of break clauses to prevent the Tenant from exercising the break, even where there is only a minor breach of covenant. Case law has now clarified the position, stating that minor breaches that do not affect the value of the reversion should not prevent a tenant from exercising their break option, but the Code takes this further. The exercise of any break clause should be conditional only on payment of the principal rent, giving up occupation and ending any subleases. Disputes about the state of the property or any goods left at the property should be settled later and not interfere with the operation of the break clause.

Assignments and Subletting

Even though, since 1996, privity has not applied to new leases, there is a perception that Landlords have continued to insist on authorised guaranteed agreements (AGA’s) on assignment whether or not it is reasonable in all the circumstances to do so, which, effectively, brings back a limited version of privity. The Code states that tenants should be able to assign the whole premises with the landlord’s consent, which should not be unreasonably withheld or delayed. The lease should not refer to any specific circumstances for refusing consent (except for assignments to group companies). Authorised guarantee agreements (AGAs) should not be required automatically. Subleases should be at the market rent rather than the greater of the market rent and the rent passing under the headlease. This last point can prevent tenants from subletting in a falling market.

Service Charges

The lease should comply with the Code of Practice on Service Charges in Commercial Property 2006

Alterations

The Code specifies that tenants should not need to obtain the landlord’s consent for non-structural internal alterations, unless they could affect the services or systems in the building, although details should be notified to the landlord. Tenants should not be required to remove permitted alterations at the end of the lease unless it is reasonable to do so. Landlords should notify tenants of their requirements at least six months before the end of the lease.

Repairs

The traditional obligation to “put and keep in good repair” can be operated unfairly against tenants, particularly if the building that the tenant is taking is not a new build or has seen better days. The Code states that tenant’s repairing obligations should be appropriate to the length of the term and tenants should only be required to hand back the premises in the same condition as they were in at the start of the lease.

Insurance

Most commercial leases include a rent suspension clause to protect the tenant where the property has been damaged by an insured risk, except where the damage has been caused by the tenant. However, the period of rent suspension is often limited to the landlord’s insurance for loss of rent. The Code states that landlords or tenants should be able to terminate the lease if the property has not been reinstated by the end of that period. If the property is damaged by an uninsured risk, the tenant should be able to terminate the lease unless the landlord agrees to reinstate at its own cost.

Will it work?

The bottom line is that if the Code is seen to be working then the government may just leave the industry to regulate itself and not impose stringent regulations that all tenancies have to comply with. The Code does recognise that negotiations between landlord and tenant are going to produce a variety of results based on the priorities of the parties. If the Code works well then all parties should benefit – the tenants should be able to negotiate terms which are flexible enough to meet their business needs, but which protect the landlord’s investment.