Lease negotiations: Consider the detail carefully

In the second of his series of three articles exploring what retailers can do in the current market to improve their position when entering into a lease, Guy Whitehead examines the provisions in the lease. Specific provisions in a lease can make a real difference to the operation and viability of a store. The provisions are generally designed to protect a retailer’s ability to trade, to prevent competition from temporary trading positions in the vicinity of a store and to prevent landlords being able to pass on costs that should ultimately be borne by them. Retailers and their advisers typically rely on lease specification documents to cover standard provisions (such as user clauses) that a retailer will either insist on or attempt to incorporate when entering into a lease. The document should be kept under constant review to ensure that the implementation of new legislation and operational changes by the retailer (such as the creation of a new store concept) are covered. See also: Initiating the discussion The purpose of the specification document is to ensure that retailers achieve (as far as possible) uniformity of lease terms across their estate so that they can be assured that their requirements will be reflected as and when new leases are completed. As with any lease transaction, it is crucial that retailers carry out due diligence on the store before entering into the lease to ensure that the landlord has a clean title to the premises, there is nothing revealed by the usual searches and enquiries that could be problematic, and the retailer has full transparency on what the overall costs will be to operate from the store.  What to bear in mind Provisions that should be considered for each lease include: Scaffolding protection provisions The provisions (which usually qualify a right that is reserved to a landlord to erect scaffolding) are designed to ensure that no scaffolding (except in an emergency) is erected by a landlord during key trading periods (such as Christmas). The provisions should include obligations on the landlord to ensure that access to a premises is maintained at all times and any scaffolding is removed as soon as reasonably possible, with the tenant being able to erect temporary signage. Exclusion zones The provisions prevent the landlord allowing temporary trading positions (such as stalls and moveable kiosks) selling the same products as the retailer within a defined area in the vicinity of the tenant’s premises. The obligation is generally couched on terms that the exclusion applies during such time as the lease is vested in the retailer, the retailer remains in actual occupation and the predominant use remains as a retail shop for a specified use. Repayment provisions It is important that landlords should be under an obligation to refund certain payments that have been made by tenants during the life of the lease. Situations where this is appropriate include: (a) where payment of the rent has been suspended following damage by an insured or uninsured risk; the premises are unfit for occupation and use, and payments of rent and service charge have been made in respect of the period after the date of the rent suspension; (b) where an option to break has been exercised and payments have been made by the tenant for the period after the break date; and (c) at the end of the lease itself, specifically where the tenant has made payments of service charge on account. Each clause should specify when the refund has to be made by the landlord and the payments covered. Break clauses The clauses should reflect the heads of terms but ideally any options to break should be unconditional. If this is not the case, then retailers should be advised to limit the conditions to payment of the principal rent and if necessary give up occupation (rather than vacant possession, which shouldn’t be accepted under any circumstances).  Uninsured risks It is generally accepted by landlords that damage to premises caused by uninsured risks should be carved out from a tenant’s repairing obligations. The provisions are usually drafted so that a landlord can either elect to reinstate the premises within a certain period (at the cost of the landlord) or terminate the lease with a statement confirming that the landlord will not seek to include in the service charge any costs flowing from damage by an uninsured risk. Environmental performance The introduction of the Minimum Energy Efficiency Standard has resulted in landlords seeking to pass on any improvement costs that are required for the premises to tenants. This should be resisted by retailers by removing the ability for a landlord to pass on any costs that are incurred by the landlord including the cost of obtaining an EPC (which is contrary to the new service charge professional statement). Payment of rent Retailers should push (at the heads of terms stage) to be allowed to pay the rent on a monthly rather than quarterly basis (to assist with cash flow) and to stipulate their preferred method of payment (such as by BACS transfer). Landlords generally accept these provisions, although they may prefer for them to be couched in terms that it is a personal concession to the tenant and documented in a side letter. Shop front It is critical for a retailer to have the ability to alter or change the shop front fascia and signage to ensure that a store bears the usual corporate branding. The lease should allow such alterations and internal non-structural alterations with the qualified consent of the landlord. Alienation The assignment provisions should be amended so that a landlord is only able to obtain an authorised guarantee agreement (AGA) where it is reasonable in the circumstances. This gives the tenant scope to argue that an AGA isn’t necessary in circumstances where the incoming tenant has a greater covenant strength than the outgoing tenant. Retailers should push for any AGA to be limited to the duration of the contractual term (to avoid giving an open-ended guarantee if the lease continues under the 1954 Act) with underlettings being at open market rent and not passing rent. Rent suspension If the premises are damaged or destroyed by an insured or uninsured risk so as to make the premises unfit for occupation and use, then the rent suspension provisions should apply to both the principal rent and service charge. If the damage or destruction applies during a rent-free period this should be allowed once the rent suspension period ceases to apply. Service charge exclusions Exclusions from expenditure should be considered on each transaction and will depend on whether the premises are located in a new development or established shopping centre. Exclusions to consider include the initial capital cost of constructing the centre, equipping and fitting out (for new developments); the cost of remedying latent/inherent defects (for new developments); damage by insured and uninsured risks; replacement of plant and machinery (except where beyond economic repair); costs where the landlord is entitled to be reimbursed from another source; and chancel repair costs (where relevant). Rights granted or reserved The rights should always be approved by the instructing surveyor and depend on the type of premises to be demised. Rights must include adequate rights of access/servicing to the premises and passage of utilities. Consideration should be given as to whether the tenant requires the ability to install air-conditioning equipment or to operate a Wi-Fi network within the store for its customers. Retailers should tightly restrict any landlords’ right of entry and development rights to ensure they don’t interfere with trade and use of common areas. Keep open It is common for leases within shopping centres to include keep open provisions (the justification being that such leases usually have turnover rent provisions so the landlord wants to ensure that the tenant maximises revenue from the store). Such provisions should be resisted by retailers of high street stores. Side letters The use of side letters by landlords to offer personal concessions to tenants is becoming increasingly common and can cover myriad scenarios, from monthly rather than quarterly payments of rent to waivers in respect of plate glass insurance. From a retailer’s perspective, the most important point is that the letter must bind a landlord’s successors in title so that if a landlord sells the freehold reversion to a shopping centre, the buyer is bound to comply with the concession. Coming up Next week we look at the life of the lease and lease end. Although the articles are primarily written from the perspective of retail tenants and the difficulties they face both on the high street and beyond, they should provide landlords (who themselves are having to contend with unprecedented market conditions) with food for thought on how best to strike a balance between protecting their investments and giving tenants scope to run a profitable business. Guy Whitehead is a senior associate at Irwin Mitchell