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Service Charges: Tenant Power!

publication date: Nov 11, 2009
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WestfieldThe news that Westfield, the shopping centre owner, has managed to cut the service charge at its prestigious new development at Shepherd’s Bush following a campaign from unhappy retailers has been seen as a minor victory for retailers unhappy at paying what was perceived as being over the odds for their service charges.

The action taken at Westfield is a tangible example of what retailers can do, especially in the current market, if a concerted effort is made by all the occupiers to make a landlord bow to commercial pressures. It may be that the action by the tenants at Westfield was borne purely out of the present economic climate, but are tenants able to rely on the provisions of their leases to force their landlords into obtaining best value for the services they are obliged to provide?

The argument isn’t new. The classic example is the ground floor tenant who states, “I don’t use the lift so why should I pay for it.” Contract being king in the context of purely commercial properties, landlords have historically had to make the drafting of their leases broad and in some cases, ambiguous in order to claim for everything they want to, using sweeper clauses should a tenant expose a gap in what the landlord can charge for. Case law has chipped away at the ability of landlords to charge what they like by way of service charge during the term of a lease. These cases have made landlords think more carefully about not only the drafting of their leases but also the methodology of calculating the amounts charged to tenants which sit behind them.

Further advances have been made with the British Property Foundation’s Code for Leasing Business Premises and the RICS 2006 Code of Practice on Service Charge in Commercial Premises although the extent to which these have been adopted is questionable. It appears tenants, driven on by financial pressures, are more willing to take up issues with their landlords. The case of Boots UK Ltd v Trafford Centre Ltd last year is a good example of tenants challenging the ability of a landlord to charge for items, in that case promotion, which they see as being outside what the landlord can properly charge for.

It must be remembered that in commercial premises, the contract is still ‘sacred’ and should a dispute ever get that far, a court would look at the bargain and the terms of a lease between the parties to govern their relationship. It may take a lot for a court to infer anything else. The Westfield case has shown that landlords do respond to commercial pressures imposed by the tenants. The difficulties come when interpreting what is already in a lease and trying to unravel or amend an agreement which has already been struck. Below are some pointers for tenants who are looking at what they already have, and what they may be able to negotiate:

Rent: Will the landlord accept rent payable monthly in advance? Would this assist cash flow?

Rent reviews: There is some merit towards moving towards fi xed uplifts and treating the lease more like a bond rather than a traditional market reviewed rent. We may even see the introduction of downward reviews.

Repairing obligations: Tenants are now are insisting on more reasonable repairing obligations. Generally a tenant should not sign up to renewal or rebuilding covenants and should only commit to more onerous repairing obligations if warranties or guarantees are available. Landlords should not expect, although some still do, a tenant in a secondhand space to sign up for a full repairing lease unless of course any potential dilapidations claim is rentalised or there is some other concession made for the state of the premises.

Break clauses: These give the tenant greater fl exibility but leave the landlord with an uncertainty over it being income stream. This again can be incentivised by rent free periods if tenants do not exercise breaks, or by penalties if they do.

Assignment: This is a diffi cult balancing act for the landlord. They want to exercise reasonable control over the assignment of the lease, however, if the assignment provisions are too onerous this affects the ability to assign and thus the value of the lease.

Sub-lettings: A tenant will want the ability to sub-let at the market rent not the passing rent and be able to offer terms outside the lease. This ensures surplus accommodation can be sub-let and at the moment tenants are looking at the property that they own with a view to sub-letting and mitigating their exposure. Obviously they are not able to do that if the sub-letting provisions are particularly tight. From the landlord’s perspective if the balancing act is done correctly the tenant is encouraged to make better us of the space and is therefore more likely to stay and renew.

Alterations: The landlord should be prepared to take a more relaxed view on alterations including structural and external alterations depending on the configuration and nature of the building. It is obviously not unreasonable to insist on landlord’s consent for any structural alterations. An institutional landlord should not have any problem in any alteration so long as the obligation to reinstate at the end of the term exists and it is clear and specifically set out exactly what the alterations comprise so there is no argument over what the tenant should reinstate at the end of the term. Any licence to alter should include both before and after drawings to assist in the reinstatement and also, if applicable, this should assist in rent review negotiations.

Rent review: The lease needs to include clear hypothetical lease assumptions and disregards within the review clause and reflect the reality of the lease and the nature and peculiarities of the building.

After Westfield, will landlords be more willing to take a flexible approach on service charge items and the other substantive terms of the leases they grant? Potentially yes, especially in a recession. Institutional landlords will have to get used to the prospect of shorter lease terms, realistic and accountable service charge provisions and the fact they will not be able to pass on all costs to prospective tenants. In the past the value of an investment was primarily governed by the strength of the covenant that exists under the lease. This has resulted in the over pricing of poor or physically obsolete stock. The market will always tend to adapt to change in circumstances as the property market has always been very dynamic.

What landlords really need to do on an acquisition is to look beyond the current leasing structure and focus more realistically on the re-letting prospect of the building once the current lease expires. In essence, does a landlord want an occupied building, albeit on slightly less favourable terms than they would like, or an empty building for which they are going to be responsible? It may be that tenants ask for shorter lease terms and these are the norm but given the current trend for consolidation both landlords and tenants may show more loyalty to the buildings they are in, which means we may find situations like Westfield recurring.

Written by Matthew Williamson, associate in Weightmans’ commercial property team.