Local Government - March 2009
Landlord and tenant update
In this update we:
- Investigate the pros and cons of adopting the Code for
Leasing Business Premises 2007
- Offer some thoughts on dealing with tenants and
landlords who are in financial difficulty
- Consider two cases on enforcing oral three year tenancy
agreements.
The Code for Leasing Business Premises 2007
The British Property Foundation Code for Leasing Business
Premises was launched on 28 March 2007. It was the result of
a pan-industry discussion between representatives of all manner of
Landlords and Tenants and the Government.
The Code says its aim is to be used as a check
list for negotiations on both new Leases and Lease renewals.
To what extent, if at all, has this happened? How many Landlords
have adopted the Code? There is no doubt the code is Tenant
friendly. Is it the case that Landlords are scared of
adopting the Code as they think they will be offering their Tenants
too favourable terms which may impact upon their investment?
The Code is voluntary, and for the reasons set
out below, it is easy to see why a Landlord may avoid adopting
it. Even so, a large number of property companies, investors
and advisers have signed up to support the Code. Adoption of
the code by growing numbers in the property industry may ultimately
lead to an accreditation scheme or a kite mark arrangement for
compliant Landlords which could then be displayed on letting boards
or with the agents’ particulars. It is hoped that this would
give comfort to potential Tenants that a Landlord with this
accreditation is reasonable and one to deal with. The market
at the moment is a volatile place. Tenants are looking to
break their leases if they can and find more competitive and
flexible lease terms. Companies, following consolidation
exercises, are looking to minimise their exposure under their
current leasing arrangements. Tenant perception is one very
good reason why Landlords should be looking to implement the Code’s
recommendations. If a Landlord can actively market itself as
one employing the Code, a properly advised tenant may be more
likely to let premises from them.
Below are some of the main points in the Code
which are likely to trouble some Landlords, if they adopt the Code,
consider how they draft their leases and how they manage their
properties during the lease term. The changes are, in some
instances, considerable departures from the institutional lease
which is the norm and is widely understood
The code contains draft Heads of Terms.
These are very thorough and because of their detail, potential
issues with the letting should be brought to the fore early on in
the transaction.
The Code recommends limited break clause
preconditions. It states that as long as the Principle (not
Insurance or Service Charge) rent is up to date and vacant
possession is given, the Tenant should have the right to break. The
reason for the lack of extensive conditions to the Tenants ability
to break is that a Tenant should have this right notwithstanding
breaches of covenants during the lease term; these should and can
be dealt with after the lease has been broken
The Code says Authorised Guarantee Agreements
(“AGA”) from existing tenants looking to assign should only be a
requirement on future assignments if the proposed tenant is either
of a lesser financial standing than the current tenant or the new
tenant is based overseas. This represents a large risk to
Landlords as by not asking for an AGA they are reducing the avenues
of recovery in the event of tenant default.
In another departure from the institutional
lease terms, Section 5 of the Code says underlettings are to be
permitted at the market rent at the time of the proposed underlease
and not the passing rent under the head lease. The Industry
norm has been to insist the underlease rent is the greater of
either the market rent or the passing rent. If adopted, this
would give more flexibility to tenants, who may be able to under
let premises in circumstances where they were previously prevented
from doing by the restrictive underletting provisions in the
headlease relating to rent.
The Code recommends that the dilapidations
should be served six months before the end of the Lease. How that
is going to work in practice is difficult to say, especially in the
case of damage caused during the last six months of the term,
after the schedule has been prepared
Upon any application for consent under the
lease (assignment, underletting, alterations) the Landlord should
ask for any additional information within five days of the initial
request and then give an answer within 15 days of the full
information being provided. This should include an estimate
for costs. At the moment the timescales which dictate if a
Landlord is unreasonably delaying giving consent is based in case
law. The Code could give an aggrieved Tenant something to
hang any application to the Court on, should they seek a
declaration that a Landlord is unreasonably delaying consent.
If the Tenant could point to the fact the Landlord has adopted the
Code, the Court may use these timescales to make their decision
There is certainly a growing awareness of the
Code but not, as yet, a positive shift towards compliance with
it. In addition to attitudes of Landlords and Tenants
generally towards adopting the Code, it is difficult to insert Code
compliant leases into buildings or estates with existing
non-compliant leases throughout. Existing Tenants will
no doubt ask why should they not receive the same preferable lease
terms?
There is definitely an interest in the Lease
Code but the reality is that until Landlords and their advisers use
a lease that is Code compliant as a starting point, little progress
will be made towards the goal of national compliance. Despite
everything we have said before, the ability in the current market
for Tenants to negotiate more favourable lease terms will only go
so far and tenant power on its own will not change the market; that
will ultimately require a shift in attitude by Landlords
Dealing with tenant default and the insolvent landlord
In today’s current financial climate thousands
of businesses are struggling to keep afloat as the “credit crunch”
shows no signs of ending. Every day, news comes of more
individuals and companies facing insolvency proceedings.
Nowhere is this more evident than in the commercial property field
and one area where this is having a major impact is that of
commercial lettings.
Not only are landlords finding that tenants
can no longer pay the rent for premises or, worse still, disappear
without trace leaving behind substantial rent arrears and
dilapidations, but tenants are also facing uncertainty and
vulnerability as many landlords are themselves struggling to
weather these financial storms. So where does this leave landlords
and tenants and what can they do to try and protect their
position?
The Struggling
Tenant
The most notable sign that tenants are in
financial difficulties is the failure to pay rent or service charge
contributions. In considering the options available to them
the landlord will need to assess their aims and objectives and then
choose the most appropriate course of action in the circumstances
from a range of options available to them. The first question
that the landlord will need to consider is whether they want to
keep the tenant on the hook for the rent or try and end the
tenancy. The answer will depend on whether there are other
potential tenants available to take a new lease of the premises or
whether the landlord wants to take over the premises
themselves.
In the current market the landlord may be
unable to find suitable, alternative tenants. Similarly, they
may not wish to take new tenants if the current lease has many
years left to run and has favourable terms to the landlord, which
they would now be unable to negotiate with any new tenant. If
that is the case then the landlord will need to look for the best
way of recovering the arrears. Does the tenant have valuable
assets against which the landlord could seek to distrain for the
outstanding rent by seizing or taking walking possession of
items? If so, the landlord will need to be aware of the
limits on distress and be aware that this remedy is soon to be
abolished and be replaced with a new statutory scheme for the
recovery of commercial rent arrears which will reduce the powers
available to landlords.
If the tenant has other property then the
landlord may choose to seek a county court money judgement against
the tenant and seek to enforce it by a charging order over that
property. There may be guarantors or sureties that could be
pursued by the landlord for the arrears, rent deposits may be
capable of being used or arrears pursued from sub-tenants – subject
to compliance with the relevant contractual or statutory
procedures. It may also be possible to look back to former
tenants to recover arrears, although landlords need to be aware of
certain restrictions that may apply, particularly on more recent
leases. However, if the assignment to the current tenant was
unlawful or there is an authorised guarantee agreement (AGA) in
place then recovering arrears from former tenants may be an option
available to the landlord.
If the aim of the landlord is to retake the
premises, for example if the tenant has absconded and no details
are known as to their current whereabouts, then forfeiture or
acceptance of a surrender by operation of law may be options that
the landlord would want to consider. Forfeiture by peaceable
re-entry may be attractive as a fairly quick and cost effective
means of recovering possession, so that the landlord can limit
their loss although, again, care should be taken by the landlord to
ensure they comply with all necessary requirements.
However, the inability to pay rent or service
charge may be a sign of a more serious situation and the tenant may
in fact by facing insolvency because of their inability to pay
creditors. Indeed the landlord themselves may want to consider
taking insolvency proceedings themselves in respect of the unpaid
arrears. If such action is taken then the landlord’s options
to recover any arrears or take further legal action for other
breaches of the lease, such as failure to repair, are likely to be
greatly restricted.
If a tenant company is placed into
Administration a moratorium will exist preventing any form of legal
action against the tenant without the consent of the insolvency
practitioner or permission of the Court. This can place the
landlord in a difficult position as the tenant may have the benefit
of the premises even though no rent is being paid. Landlords
may find that they are being forced to apply to Court and incur the
time and cost of such an application to try and secure consent to
forfeit, etc. particularly as there is no guarantee that consent
will be granted. However, a recent case has suggested that in
the case of an administration, the unpaid rent should be paid as an
expense of the administration, where the premises have been used
during the administration for the continued needs of the business.
That provides some comfort – providing there is money realised into
the Administration.
Conversely, if the premises are seen as a
burden on the struggling tenant and are no longer required or
necessary for the business then a decision may be taken to disclaim
the lease leaving the landlord with empty premises that they cannot
let in the current market. Landlords should be aware that if a
lease is disclaimed then guarantors may not be released from
liability and they may be able to force the guarantor to take an
overriding lease of the premises in the event of disclaimer, in
accordance with the terms of the lease.
The Insolvent
Landlord
Whereas a landlord will be alert from quite
an early stage that a tenant is in financial difficulties, owing to
the non-payment of rent, the position may not be as clear for
insolvent landlords and the tenant may only become aware of the
situation once the landlord has become the subject of formal
insolvency proceedings. However, there may be signs that the
landlord is struggling financially by their failure to comply with
their obligations under the lease. An example may be the
landlords’ failure to comply with their obligations to insure the
premises and the tenant may be well advised to take steps to
arrange their own insurance to protect themselves against the risk
of fire or flood damage, etc. Another example may be the landlord’s
failure to maintain the common / retained parts of the premises,
such as a properly functioning lift, or to ensure certain services
are provided, such as security cover. This may have a
detrimental effect on the tenant’s business and they may want to
consider taking action to address these issues themselves.
Whilst the tenant may want to consider
carrying out any necessary repairs, for which the landlord is
liable, the tenant will need to ensure they have the right to take
such action. In addition, recovering the costs of such works
from the landlord is likely to be difficult if the landlord does
not have sufficient funds to pay. As indicated above, there
may also be limits on the legal action that can be taken if the
landlord is the subject of insolvency proceedings. If the tenant is
keen to end the Lease then the default of the landlord may give the
tenant an ability to end the tenancy in limited circumstances.
Where a landlord has entered into some form of
insolvency procedure then confusion can arise for the tenant as to
whom they should pay the rent for the premises. Should the
rent be paid to the landlord, an appointed insolvency practitioner
or a superior landlord who may be demanding that payment be made
direct to them? Tenants will need to ensure that they are
fully aware of the landlord’s position by making enquiries,
carrying out company searches and ascertaining who may have been
appointed to manage the landlord’s assets. The tenant needs
to be clear as to whom the rent should be paid to avoid remaining
liable for rent by inadvertently paying the wrong party.
The tenant’s rent deposit or sinking fund
contributions may also be at risk as such funds could form part of
the assets to be distributed amongst the landlord’s creditors.
These may be protected if they are being held on trust by the
landlord or if there are provisions in the lease that stipulate
that such funds are to be applied strictly in accordance with the
terms of the lease e.g. towards repair and maintenance costs, etc.
However, again tenants should try and safeguard these funds.
Where a landlord company enters into
Liquidation then the Liquidator appointed may decide to disclaim
the landlord’s superior lease. If this happens then the
tenant’s lease will also be brought to an end. Whilst the
tenant will have the right to apply for a vesting order for the
superior lease to be vested in them, allowing them to remain in the
premises, the tenant would only be entitled to take over the
superior lease rather than the previous underlease, the terms of
which may have been more favourable. Similarly, a superior
landlord may be entitled to forfeit the superior lease in the event
of insolvency and, if they opt to do so, then the tenant’s lease
will end albeit they will have a right to apply for relief from
forfeiture and a vesting order to take over the superior lease.
What action should landlords and
tenants take?
In light of the many problems that can
arise once the insolvency procedure commences, landlords and
tenants should ensure that they look out for signs that their
landlord or tenant may be in financial difficulties and to make
sure they keep the situation under review. If any signs of
problems come to light then enquiries should be made to confirm
their financial position as far as possible and if necessary steps
taken to secure payment of any arrears or recovery of premises (for
landlords), or securing their continued occupation / negotiating a
surrender (for tenants) before any formal insolvency process
commences and their ability to take action is restricted. If the
insolvency process occurs however then steps should be taken to
liaise with the appointed insolvency practitioner as soon as
possible to ascertain their intentions with regards to the
premises. This will enable plans to be put in place as soon
as possible to deal with the effect of the proposed course of
action by the insolvency practitioner. However, landlords
should be careful not to waive any right to forfeit in liaising or
negotiating with the insolvency practitioner.
Enforceability of short term oral tenancy agreements
Landlords increasingly face problems caused by
oral three year tenancy agreements. Three cases this year,
two of which were decided in the Court of Appeal, have tackled the
issues and provide much needed clarification. With landlords facing
the current recession and its consequential financial restraints,
there are likely to be many similar cases and it is easy to see
why.
A three year agreement can be utilised by
landlords as a useful gap filler since it enables the occupation of
empty space until something more suitable comes along. It
also provides a tenant with the necessary means to trade whilst
they consider longer term options which may include sourcing
alternative premises. Also, the absence of any written
agreement facilitates a prompt and inexpensive transaction.
However, parties must remain alert to
inevitable expensive litigation when disputes arise based on the
lack of any written tenancy agreement as the following cases
highlight. In each case the focal point to be determined was
whether the absence of writing to evidence the tenancy agreements
defeated their validity. In summary, each tenancy had a three
year term and was dependent upon an oral agreement that was certain
as to its terms.
In the first case, Fitzkriston LLP –v-
Panayi [2008] EWCA Civ 283, the landlord contended that
the tenancy was not binding. However, in the second case,
Looe Fuels –v- Looe Harbour Commissioners [2008]
EWCA Civ 414, the Landlord asserted to the contrary that the
tenancy was binding. By contrast in the third case
Hutchinson –v- B&DF Limited [2008] EWHC 2286, the tenant was
the party seeking to uphold the agreement. It is evident from
these cases that the implications can be of benefit to either
party.
In Fitzkriston, the Court held the agreement
was not binding, but in the other two cases the Court decided
otherwise. It therefore engages the question, how can the
Courts decide differently on what appears to be the same
facts? To answer this, the following must be
contemplated;
For an agreement to create an interest in land
(a tenancy), it will be void unless in writing and signed,
irrespective of the parties intentions that the agreement be
binding - Section 2 of the Law of Property (Miscellaneous
Provisions) Act 1989. The exception to this being Section
2(5), if a resulting, implied or constructive trust could be
established. However, Lord Scott in Cobbe –v- Yeomans
Row Management Limited [2008] UKHL 55, severely prohibited
the application of estoppel as a route to advance any such
exception arguments.
If the agreement itself creates a tenancy,
instead of it being an agreement that a tenancy will be created at
some time in the future, Section 2 of the above Act will not apply
and the agreement will not need to be in writing. The
exception to that being, if the tenancy is for a term of more than
three years, it must not only be in writing but also be made by
deed - Section 52 of the Law of Property Act 1925. Finally,
tenancies of three years or less require written agreements if they
do not comply with certain requirements - Section 54(2) of the 1925
Act (the “best rent” principle).
These cases concerned agreements for terms of
three years or less, thus overcoming the first three
considerations. The difference in outcome is therefore
explained by the final consideration of “best rent”. Section
54(2) requires the tenancy should take effect in possession (so
reversionary leases where the term begins later than the date the
lease is completed, are excluded) and that it should be at the best
rent that can be reasonably obtained for those premises.
In Firtzkriston, the Court
held, albeit with only limited valuation evidence, the rent payable
was not the best rent for the property and the agreement was
therefore unenforceable in those circumstances. Conversely,
without any real reference to market valuation in the judgements,
in the other two cases the rent payable was held to be the best
rent reasonably available and so created enforceable
agreements.
Where the prescribed requirements are not
observed, landlords looking to argue that informal arrangements
have not given rise to a periodic tenancy which has security of
tenure should gather evidence of market rents in the area. It
will be easier for the landlord to make its case where the "rent"
being paid by the occupier is nominal only.
Those involved in such transactions should be
alert to the legal consequences attached to agreements for short
terms. Although lack of formality obviously has its
advantages, it is no good if the failure to observe the
ground rules allows one party to the transaction being able to
escape its obligations altogether.