How to re-gear a lease

In the aftermath of the last economic recession, many tenants and landlords opted to renegotiate their lease terms to improve or consolidate their respective positions. Economic hardship had resulted in some lease provisions becoming too onerous for tenants, while many landlords were happy to make their leases more tenant-friendly to prevent properties from becoming vacant; empty premises was a key landlord concern, especially in view of empty business rates liability. High-profile re-gears in 2017 involving tenants such as Time Inc UK and Warner Bros Entertainment demonstrate that re-gearing remains a popular practice. This article explains the concept of lease re-gearing; its advantages from both a landlord and a tenant perspective; how to document a lease re-gear; tips to avoid the common pitfalls when engaging in a re-gear; and how legislative changes and market developments can affect re-gearing. What is re-gearing? Lease re-gearing involves a landlord and a tenant changing a term or terms of their lease. Examples include changes in rent, replacing open-market rent review with RPI-linked rent review, term extensions, increasing or decreasing the demise, removing a break clause and/or variations to alienation or alterations provisions. A compromise is usually reached: a landlord may offer its tenant a rent-free period in exchange for the deletion of the tenant’s break right or may agree to pay a capital sum to refurbish the premises in return for the tenant accepting an extended lease term. How to document – and potential pitfalls ■ Deed of Variation: completing a deed of variation is arguably the most straightforward way to effect a re-gear, for example, to revise the rent or remove a break clause. If the lease is registered, an application should be made to the Land Registry to register the deed of variation. If the landlord’s title is registered and the lease is noted on the landlord’s title, an application should also be made to note the deed on the landlord’s title. It is, however, important to be aware of the legal consequences of documenting certain variations by way of a deed of variation: following Jenkin R Lewis & Son Ltd v Kerman [1970] 215 EG 817, if the deed varies the lease to extend the term or increase the area let, the effect is that the lease is surrendered and a new lease is created, known as a “surrender and re-grant.” This could have significant implications if the lease is excluded from the security of tenure provisions of the Landlord and Tenant Act 1954, as the deed of variation will inadvertently grant a tenant security of tenure under the new lease unless the contracting-out procedures are followed. There may also be stamp duty land tax (SDLT) implications for a tenant that would be liable to SDLT on the grant of a new lease, although overlap relief may be available. Note that if the lease is guaranteed and the guarantor is not a party to the deed of variation, the guarantor will be released from its obligations, which can significantly degrade the tenant’s covenant strength. These risks mean that using a deed of variation to extend a lease term or extend the area let is generally inadvisable. ■ Surrender and new lease: a further alternative to document a re-gear is by way of surrender of the existing lease and the grant of a new lease. On surrender of the existing lease, both parties are released from their obligations under that lease; the parties do therefore need to consider whether any liability needs to be preserved in the new lease, for example, a right for the landlord to recover balancing service charge owed by the tenant after the annual reconciliation has been carried out. While agreeing to base the form of the new lease largely on the existing lease should limit negotiations, parties should resist reproducing the existing lease without considering whether new terms will be more suitable or beneficial; after all, some of the terms will be amended in any event to reflect the terms of the re-gear. SDLT may be payable on the new lease and overlap relief may be available to reduce the amount of SDLT payable. ■ Grant of further lease: variation to extend the term or increase the area let should be dealt with by way of the grant of a further reversionary lease or a supplemental lease. The new document may also make variations to the original lease, for example the revision of break rights or reduction in rent. If the term of the new lease does not start until some time after its completion (ie a reversionary lease), watch out for the trap that the term must commence within 21 years of the date of its grant, otherwise it will be void. Notwithstanding the length of the new lease, a reversionary lease must be registered at Land Registry if the term commences more than three months after the date of the lease. If the tenant will have two separate leasehold interests (the original lease and the new lease for the term extension or additional space), provision needs to be made to ensure that neither lease can be assigned without the other so that both leases are held by the same tenant at all times. It is also important to ensure that if the landlord forfeits one lease, for example on the tenant’s default or insolvency, the other lease will also determine automatically. Do remember that SDLT will be payable within 30 days of the grant of the lease, not from the date on which the term commences. Other points to remember for a consecutive lease of the same premises include: Alterations: the landlord will want the tenant to be under an obligation at the end of the new lease to remove any alterations carried out by the tenant during the term of the first lease (as well as during the further or new lease) and to reinstate the premises. The tenant will want to ensure that those alterations are disregarded on an open market rent review, otherwise works that the tenant has paid for will be rentalised. Rent review: if rent review under the new lease is to be fixed or index-linked, consideration should be given to whether a requirement that any underleases must be at an open market rent should be revised. Decoration: the tenant’s decoration obligations may need to be amended in the new lease to ensure that the period between decoration is appropriate. Legislative context and market practice When agreeing the new lease, both parties need to examine whether the existing lease needs updating to reflect any changes in legislation or market practice developments since the existing lease was granted, including, for example: Land Registry-prescribed clauses; Land Registry plan requirements; energy performance certificates; Minimum Energy Efficiency Standards; RICS Code of Practice on service charges; fire safety regulation changes; CDM regulations; and changes to privity of contract following the Landlord and Tenant (Covenants) Act 1995. Tread carefully Clearly, lease re-gearing can be of great benefit to both landlords and tenants. However, parties do need to ensure that lease variations are drafted correctly so as to sidestep any traps and unfavourable consequences. Fiona Smith is a senior associate and Sophie Handler is an associate at CMS