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Monday, 27 June 2011

Lease Guarantees – Reserve Judgment!

Back in April I asked whether there would soon be clarity on the position of guarantors under leases in my post Lease Guarantees – It’s Time to Get Real!

To recap - the decision in last year’s Good Harvest case had confirmed what everyone had suspected, which is that when a tenant that has a guarantor assigns a lease, the outgoing tenant’s guarantor cannot give a guarantee for the incoming tenant – either directly or by way of an authorised guarantee agreement (AGA).

Nor can the original guarantor give repeat guarantees for successive tenants – which could potentially torpedo group reorganisations (or at least make them more difficult to structure).

Good Harvest also cast doubt on the validity of parallel or sub-guarantees – where the outgoing tenant gives an AGA for the incoming tenant and the outgoing tenant’s guarantor guarantees the AGA.

Good Harvest never made it to the Court of Appeal last year because the parties settled out of court.

The decision was later followed by the High Court in K/S Victoria Street v House of Fraser (Stores Management) Ltd (2010) PLSCS 278 but there was an appeal and, at the time of my April post, I was speculating on whether that appeal would go ahead, or whether, if the parties settled out of court in that case too, we would be left with uncertainty in the absence of any legislative clarity.

Well, the appeal in K/S Victoria Street has now been heard and we await the Court of Appeal’s decision on whether the controversial High Court decision in Good Harvest (which it was later compelled to follow at first instance in K/S Victoria Street) is correct.

For the time being the Court of Appeal has reserved judgment.

Watch this space...

Monday, 20 June 2011

Lease Break Clauses – Pretty Vacant

One thing you can be sure about in a time of economic grimness – there are a lot of tenants trying to get out of their lease obligations by exercising a break right, and there are a lot of landlords looking for an excuse to stop them.

As I've said before, if you are a tenant looking to take advantage of a break clause and you do not comply with the conditions set out in the lease for doing so, then the courts will not come to your rescue.

The latest example of this was provided only last week by the Court of Appeal in NYK Logistics (UK) Limited -v- Ibrend Estates BV [2011] EWCA Civ 683.

The case concerned a condition which is often found in break clauses (and which I advise tenants not to agree when negotiating new leases) – that vacant possession must be delivered up on the break date.

“Vacant possession” is not a phrase you tend to come across in normal life – it is a legal term and that’s why people often get caught out by it.

It is such a problematic term that the non-binding Code for Leasing Business Premises in England & Wales 2007 instead recommends that the only pre-conditions to a tenant’s break right should be the tenant giving up occupation of the property (which is less onerous); that there are no continuing subleases; and the basic rent is paid up to date.

But nevertheless leases often make “vacant possession” a condition that must be satisfied before the break is effective.

In my post Lease Break Clauses – What Can Possibly Go Wrong I looked at what “vacant possession” means in more detail. In short, you mustn’t leave anything (or anyone!) behind at the property; you must give the keys back (change the locks if you’ve lost them and give the landlord the new keys); if you’ve installed an alarm, give the landlord the code; get rid of any trespassers; and make sure all subtenants, licensees, franchisees or other sharers have all gone and that their agreements have all been lawfully ended.

The latest case, Ibrend, underlines the importance of getting everything done by the break date. You won’t be let off the hook if you are too late.

The tenant, NYK, served notice exercising their option to end their lease. The break clause contained a condition requiring vacant possession of the property to be delivered up. 

Unfortunately for NYK, by the time the break date arrived, they were still in the property carrying out the final dilapidation works and they were going to need a few more days to finish off those works. So NYK asked the landlord to confirm that they could carry out the works past the break date. 

The landlord gave no such confirmation, but nevertheless NYK continued with the works and entered the property after the break date. 

So had NYK given up vacant possession, as required by its break clause?

No, said the Court of Appeal.

The Court did not buy NYK’s argument that they were simply finishing off some outstanding works, which they could have stopped doing immediately if asked to do so and that they had not left any items at the property.

The Court of Appeal ruled that at the moment vacant possession is required to be given:

·         the property must be empty of people
·         the landlord must be able to assume and enjoy immediate and exclusive possession, occupation and control
·         the property must be empty of chattels

NYK had not handed the keys back, they had retained their security guards to control access to the building and had continued to carry out works to the property past the break date - so vacant possession had not been given.

So, if you want to end your lease and your break clause requires vacant possession, make sure you agree the scope of any works that need doing to the property as soon as possible, and then set yourself a timetable for doing those works so that they are completed in advance of the break date.

Then, on the break date make sure the property is empty, both of people and things (and that all subleases and other sharing arrangements have been legally ended); hand back the keys; if there is an alarm, hand over the code; and terminate any security arrangements.

Do all that, and you have a fighting chance of saying goodbye to the lease.

Fail to do so, and you could be left with costly ongoing liabilities for a property you no longer need or want.

Thursday, 16 June 2011

Lease Break Clauses – This Time it’s Personal!

And so to another story of break clause woe – I know you love them!

This time I’m looking at what happens when a break clause is only for the personal benefit of one tenant, not anyone taking an assignment of the lease in the future (assignees).

Personal break clauses are usually given to the original tenant, but sometimes they can be introduced into a lease when an assignment takes place at a later date, when they might be added to the lease for the benefit of the one assignee only.

Either way – they are a personal benefit, as opposed to more standard break clauses that can be operated by whoever happens to be the tenant at the relevant time.

A recent case, involving a personal break right, concerned three leases which, by anyone’s standards, were an expensive proposition – Norwich Union v Linpac MouldingsLtd [2009]EWHC 1602 (Ch) and again Linpac Mouldings Ltd v Aviva [2010] EWCA Civ395.

The leases were of three industrial units for terms of 99 years from 1971 which, very unusually for commercial leases of such duration, imposed a full market rent reviewable upwards only every 7 years (it’s more usual for a 99 year lease to be granted at a premium and then reserve a nominal ground rent instead). By 2010 the rents had ballooned to approximately £600,000 per annum and the leases stretched on over the horizon to the jet-packed future of 2070!

L was not the original tenant. The leases were assigned to L in 1986 and the licence to assign added a right, that was not in the original leases, for L to break the leases in 2010 – but that right was only personal to L. L subsequently assigned the leases to an associated company, which later ceased to be associated with L and went into administration, unable to pay the rents.

When it had taken on the leases, L had given the landlord a standard obligation to observe the tenant’s obligations throughout the terms of the leases, so now its assignee had gone bust, L was back in the frame.

In 2009 L wanted to operate the break clause to get out of this mess, and together with the assignee asked the landlord if the leases could be assigned back to L to enable it then to operate its break clause (which could not be operated by the administrators of the assignee because it was personal to L).

So here are the questions that came before the court – and the answers it gave.

1.    Is a landlord entitled to refuse consent to an assignment back to a tenant when that tenant has a personal break option?

Yes – it is a reasonable ground for refusing consent (even when you take into account the answer to question 3 below).

2.    Can a former tenant who was granted a personal break right exercise that right after it has assigned the lease to someone else?

No – the break right can only be exercised when the tenant is in possession, unless there is a clear contractual provision to the contrary (which there wasn’t in this case). After an appeal, the court said it made no difference that the break right had been included in a licence to assign rather than in the original lease.

3.    If the lease were assigned back to the tenant who was granted the personal break right, would its right to break be revived?

No. A personal right to break cannot be revived by reassignment as it would create great uncertainty for the landlord. In this case the administrators had reassigned the lease without landlord’s consent, but it didn’t help them.

This is yet another example of the importance of break clauses and how vital it is to structure deals very carefully.

If you are going to enter into such an onerous lease or leases, and the pain is sweetened by the offer of a personal break clause, remember that your liability may extend beyond a future assignment of the lease (in a new lease probably under an authorised guarantee agreement), which means if your assignee goes bust, you are back on the hook.

So if you have a personal break right, rather than assigning your lease, think about subletting the premises instead.

That way, your personal break right is preserved (and you can agree in the sublease to limit the circumstances in which it will be exercised so as not to disturb your subtenant whilst it is solvent).

You can even give the same break right to your subtenant (just make sure it corresponds with your own break right in such a way that you can end your lease if the subtenant ends the sublease).

Otherwise...well, I’ll give the last word to Lord Justice Sedley in Linpac:

“The result is [L] remain liable until 2070 for an annual rack rent on premises which they neither occupy nor have any use for.”

And here’s a link to my other posts on break clauses if you want to read more.


Tuesday, 14 June 2011

Down the Drain – Private Sewers to be Taken Over

A quiet revolution appears to be taking place in the subterranean world of private sewers.

The government has decided that the automatic transfer of private sewers and lateral drains connected to the public sewerage system in England & Wales to the statutory water and sewerage companies will go ahead on 1 October 2011, with pumping stations to follow progressively up to 1 October 2016.

For drains, this is basically the part of the pipe running from the boundary of the property to the public sewer.

If, as a property owner, you want to retain control over these assets, you need to think carefully about how they will be affected and get ready to submit an appeal.

This briefing note from Clifford Chance provides helpful guidance.

This will lead to a big change of responsibility for sewerage services and lead to the transfer of thousands of sewers and drains, and eventually approximately 33,000 pumping stations.

What’s surprising about this is the timing – it all seems a bit hasty, to say the least.

The regulations dealing with this have been laid before parliament, but are not expected to come into force until 1 July 2011. In order to meet the October deadline, the water and sewerage companies will need to serve notices of the proposed transfer during July, giving the sewer owners only 2 months to appeal against their assets being included in the transfer.

So, during the period when many property owners might be digging sandcastles and water channels in the Mediterranean sand, they are going to have to get to grips with analysing the extent of their assets that might be affected by the transfer, see if it’s going to cause a problem and, if necessary, lodge an appeal.

As Clifford Chance points out, this might not be easy as the notices will not come with a plan; will be served on customers (who might not be the actual owner); and with complex sites, ownership might be difficult to establish.

Drainage assets will only be transferred if they are outside the site’s “curtilage”. That part of the sewer that is within your site’s “curtilage” and which serves only your property will be unaffected and will remain your responsibility. Sewers and drains leading to cesspits and watercourses will also not be included in the transfer. There are other exceptions, which are detailed in the legislation.

“Curtilage” is not defined in the legislation – the government decided, following consultation, that it was too difficult to define – so the courts will be left to settle any disputes. There are no comprehensive records of where private sewers are located (or what condition they are in).

Defra accepts that with complex sites this might be a tricky issue to resolve, but has not yet provided a solution. Clifford Chance understands that draft guidance might be available by the end of June – which again makes things challenging from a timing perspective.

Here is a link to the government’s response to the consultation, issued in March 2011.

If you think you might be affected, have a look at the Clifford Chance list of recommendations – the gist of which is to assess your drainage situation now; make sure the water company has your details for serving the notice; and if in doubt, lodge an appeal.

Appeals will be to OFWAT and must be made within 2 months of the notice. The grounds for appeal are expected to be (1) that the proposed transfer does not satisfy the relevant criteria and (2) that adoption of the assets would be "seriously detrimental" to the owner.

You might have negotiated drainage easements with so-called "lift and shift" provisions, which might allow you to move the drains in connection with future development. If those provisions are not going to be preserved by the transfer, I wonder whether that will be an accepted basis for appeal?

Defra says the costs of transfer will be met by an increase in the sewerage element of bills across the nine sewerage companies currently estimated to be around 6 pence to 27 pence a week.

A lot about this remains unclear – the guidelines to be published by Defra will be key to helping property owners and their advisors decide what, if anything, they need to do.

The upside is that if the transfer goes ahead, you are no longer responsible for the upkeep of the drain – responsibility will pass to the water company.

But if you do want to keep control of these assets, don’t let them get flushed away by accident.

Monday, 13 June 2011

What is a Building Lease? Why is it treated differently?



“Building leases” have, for a long time, been treated differently from other leases when it comes to how much control a landlord has over assignment and subletting.

What is a “building lease”?

It's a lease granted for more than 40 years where the consideration for its grant is or includes:-

·         constructing a new building; or
·         making substantial improvements, additions or alterations to an existing building.

What rules apply will depend on when the lease was granted – was it before or after 1 January 1996? I’ll call pre-1996 leases “old” leases and the later ones “new” leases.

Old leases

If your building lease permits you to assign or sublet, but only after getting your landlord’s consent then, despite what the lease says, if you want to assign your lease or sublet before the last 7 years of the term the law says you do not need to get your landlord’s consent to do so. You just need to give your landlord notice of the transaction within 6 months of it being made. In the last 7 years, you would need consent.

However, if the lease bans you from assigning or subletting altogether, then you can’t do it.

New leases

Assignment and subletting are now treated separately and differently from each other.

Assignment of a new building lease is treated in the same way as any other lease, regardless of how long the term has to run and the identity of the landlord.  If the lease says you have to get your landlord’s consent to assignment, you must obtain it in the normal way. The lease may also impose assignment tests, like the ones I mention in this earlier post.

But, if you want to sublet, then the old rules still apply – so despite what the lease says, unless there is a total ban on subletting, you don’t need to get your landlord’s consent until the last 7 years of the term. You just need to give the landlord notice within 6 months.

These special rules for old and new leases don’t just apply to dealings with the lease, but also to dealings with subleases out of the lease. Also, charging and parting with possession in other ways, are treated the same way as subletting.

Exceptions

But, there are exceptions.

The special rules do not apply where the landlord is:-

·         a government department; or
·         a local or public authority; or
·         a statutory or public utility company.


Why?

What's the rationale for any of this? Are many people even aware that building leases are treated differently?

Incredibly, although the law on building leases, before the 1996 changes, dates back to 1927, there's only been one case on the matter before the courts.

The relevant law is specifically sub-section (1)(b) of section 19 of the Landlord and Tenant Act 1927.

One prominent law firm, Eversheds (in an article by Bruce Dear and Elizabeth Chapple in the Estates Gazette on 12 March 2011 (£)), has been calling for the abolition of the law – after all, when it was disapplied to assignments in 1996 no-one seemed to care, so why do we still have special rules for subletting of building leases?

The rules themselves beg all sorts of questions.

·         When is it relevant? What does “in consideration” mean – when a tenant carries out the work, or reimburses the landlord the whole cost of doing so?
·         Why are government departments etc excluded? How do you define them anyway – for example what are quangos and other non-departmental bodies? A tricky one when public functions are increasingly delivered by private organisations.
·         Who is the relevant landlord? The one who granted the lease in the first place or whoever is the landlord from time to time? So if the original landlord was a government department, which later sells to a private company, does that alter the tenant’s freedom of action?

I agree with Eversheds. Either people don’t know about the law, or it’s unnecessary.

Time to abolish this law and let freedom of contract prevail.

Update 6/3/13 -  A strident way to finish a post! I was clearly in a campaigning, or complaining, mood at the time. This post is nearly two years old now, but is still attracting a lot of hits on this blog. I've not seen anything in the intervening time on this subject, nor have I had to deal with a building lease myself in that time. 

I'm not surprised this hasn't been at the top of the reform agenda though - there are more than enough more pressing things for people to worry about (to strike another note of stridency).

However, if anyone has any interesting comments to make on the subject of building leases, I'd be delighted, as ever, to hear from them.

Friday, 10 June 2011

Law Commission Blows the Cobwebs Out of Land Law

The Law Commission published a report on 8 June 2011 called Making Land Work: Easements, Covenants and Profits a Prendre.

The proposals amount to a radical shake up of ancient rules, many based on centuries of common law dating back to 1189, which are often difficult to understand, never mind explain in plain English.

The reforms are contained in a draft Law of Property Bill and are designed to simplify the law on rights over someone else’s property, make conveyancing easier and help prevent neighbour disputes.

The Law Commission recognises that these rights are essential to the effective use of land and are relied upon by a significant proportion of property owners – land can be worthless without access, or with inadequate service media. Obligations can protect the character of land and enhance its amenity or financial value.

However, it has concluded that “parts of the current law are ancient, contradictory and unfit for modern society” and are therefore ripe for an overhaul.

I don’t want to go into this in too much detail as I’d end up writing a (not very good) text book. There’s a useful commentary in the Solicitors Journal and a very helpful executive summary of the reforms by the Law Commission itself. And, if you’re very keen, the full 257 page report is here!

Here are the main points covered in the reforms:

·         They will simplify the law relating to the creation of easements (which are rights over someone else’s land), sweeping away the many and complex ways in which these can arise without being created expressly. For example it will no longer be possible to acquire these rights by casual trespass

·         The introduction of a new way to attach obligations to land, replacing (for the future) the law relating to restrictive covenants and enabling positive as well as negative obligations to be directly enforceable against successors in title. This will make it easier to deal with responsibility for maintenance of and contributions towards things like shared driveways or fences.

·         “Covenants” will be replaced by the more modern sounding “land obligations”. And, unlike with covenants, the original parties to a land obligation will be free from any future liability once they have sold their land.

·         It will be easier for developers to establish the webs of rights and obligations that allow modern estates to function – which will do away with the need to use complex devices like rent charges or leases to achieve straightforward objectives.

·         It will be easier to create easements that allow a substantial use of land by someone else (for example, rights to park a car).

·         “Profits” (for example grazing or mining rights) will only be acquired by express contract – not by prescription or implication. This seems sensible because these things are largely commercial enterprises.

·         All the rights will be shown on the registers maintained by Land Registry – so buyers will be able to identify clearly the relevant rights before buying.

·         The jurisdiction of the Lands Chamber of the Upper Tribunal will be expanded to allow for the discharge and modification of easements and profits created in future.

The validity and enforceability of existing rights won’t be affected – so unfortunately we’ll still need to know the old law for a good while to come.

The report has already attracted much comment from legal experts – here is a flavour on the Estates Gazette blog.

Some have expressed disappointment that the reforms do not specifically deal with rights of light (although there may be implications for light in the general reforms on prescription and compensation). Whilst rights to light might benefit from a separate review, it seems that is likely to be some years off. Here are some of my recent posts on rights to light issues.

But the proposed reforms are long overdue and a welcome attempt to bring this area of law into the 21st century.

I hope the proposed reforms become law.

Thursday, 9 June 2011

Rent Review – The Only Way is Up

One of the most important parts of a commercial lease is the rent review clause – there will nearly always be one where the lease is for a term of more than 5 years, and there may even be one where the term is shorter.

When I started out back in the 80’s - when we went to work on horseback and the only items on your desk (apart from mountains of paper) were a ‘phone, a dictating machine jammed with mangled tape and a pile of “while you were out” messages of varying vintage – the norm was the 25 year lease with upwards only open market rent reviews every 5 years; a classic investment model.

The crucial thing about an upwards only rent review clause is that – like it says on the tin – the rent can’t go down, even if the open market value of the rent is lower than the existing rent (which these days is very often the case), in which case the existing rent will just stay the same.

Rent reviews were originally introduced to combat the high levels of inflation after World War II. They also underpin investment value because they protect the owner against fluctuations in the market.

The typical clause will set out a procedure for the parties to follow to try to reach agreement, but if they can’t, the clause will provide a way for resolving disputes, usually requiring an independent valuer or arbitrator to assess the rent on the basis of a hypothetical lease and certain assumptions and disregards.

Fast forward to the second decade of the 21st century and the most common form of rent review clause (now available for viewing on your iPhone) is still the upwards only open market kind.

Average lease term lengths however have reduced considerably. BPF/IPD figures published by the RICS showed the average term in 1999 at 14.3 years, but by 2009/10 this had come down to only 5 years – and so in many new leases there may well be no rent review at all. What is more, roughly 30% of new leases contain tenant break clauses.

Does this mean the open market rent review might be on the way out?

A survey carried out at the end of 2010 by DLA Piper for the IPF suggests not yet, although practice varies according to sector.

The UK is unusual in adopting upwards only open market rent review as the norm. In Europe, it is more common to find index linked reviews – where the rent is adjusted on the review date in accordance with the movement of an index, in the UK usually the Retail Prices Index.

The Republic of Ireland has even banned upwards only open market reviews for leases entered into after 28 February 2010 - delighting occupiers, but dismaying investors.

The UK government tried to encourage more variation in rent review methods in the non-binding Code for Leasing Business Premises in England and Wales 2007, where parties were urged to consider upwards and downwards reviews, as well as alternatives like index linking, but by and large the market wasn’t interested, although alternative methods have developed in certain sectors.

Of the various reviewing methods used, the survey found that the following ones tended to apply by sector:-

Open market upwards only – still widely used in office lets, especially in the City and West End of London where market durability makes fund managers more confident of long term performance. Tenants will often be willing to agree to this in return for other concessions. Also still widely seen in retail warehouse leases.

Open market upwards or downwards – this is a “true” open market clause, as it allows the rent to be reduced if the market is on the slide at the time of review. Very rarely seen!

Index Linked – although popular in Europe, in the UK it tends to be favoured more in new properties where there may not be enough comparable properties to assist a valuer on an open market review.

Fixed increases (set out in the lease) – becoming popular in long retail and leisure leases where the high initial fit out costs encourage tenants to seek long term commitments.

Turnover based rents – more common than they used to be, but limited to the retail and leisure sectors. The turnover rent is not reviewed as such, but it will vary from year to year depending on the tenant’s turnover at the premises. Often they have a base minimum rent, which must be paid regardless of turnover, and the base rent itself is often subject to review.

Might rent review in general be on the way out?

It is probably an exaggeration to say that, but if terms are getting shorter and break clauses becoming more widespread, then the relevance of rent review must to some extent be diminishing.

I can’t see the investment market abandoning the rent review model that easily though. If tenants want flexibility, then perhaps it’s more likely to be provided in a break clause.

And if that’s the case – tenants, make sure that if you want to operate your break clause, you do it properly. Failure to get that right can prove disastrous – which is an excuse for me to plug these posts on break clauses again!

Wednesday, 1 June 2011

Lease Break Clauses – More Food for Thought for Landlords

For a landlord’s break right to be effective, the lease really needs to be contracted out of the Landlord and Tenant Act 1954 (1954 Act).

I wrote about this in my post Lease Break Clauses – When is a Landlord’s Break Clause Effective?, where I explained what “contracting out” means and also how a landlord’s break clause may still be of some use even if the lease has not been contracted out.

As that post is currently riding high in the poptastic Digging the Dirt Popular Posts chart (!), I thought it worth mentioning a recent case where the landlord had a break right but the lease was not contracted out.

Crossco No.4 Unltd & Ors v Jolan Ltd & Ors [2011] EWHC 803 (Ch) is a case of fiendish complexity concerning the demerger of a group of companies. The trial lasted several weeks and dealt with meaty and wide ranging legal issues relating to rectification, estoppel and constructive trusts.

I don’t want to tie myself up in knots trying to unpick the bones of that case – and see you bouncing off to the racier regions of the internet – so I’ll confine myself to a few brief points relevant to break clauses. If you want to read more, there is however a useful summary by Wragge & Co; the full case report is not yet on Bailii.

There are two main points from the case worth bearing in mind:

1.    A landlord can be “estopped” from operating a break clause. For that to happen, the landlord must have made a clear representation to the tenant that it would not be terminating the lease; the tenant would have relied on that representation; and as a result of that reliance, the tenant would have suffered detriment.

The representation must be clearly made by the landlord, which does not seem to have happened in this case, so the tenant did not succeed on this point.

2.    A landlord cannot operate a break clause in relation to only part of a building where a lease has not been contracted out.

Where a lease has not been contracted out, if the landlord has a break clause then at the same time as serving its contractual break notice, it also has to serve a statutory notice under the 1954 Act, called a “section 25 notice” – which is where the landlord will try to oppose lease renewal on a statutory ground (such as that it wants to redevelop the property or reoccupy it itself). I wrote a bit more about these grounds in my earlier post, and compensation is payable to the tenant if the landlord relies on a statutory ground.

The law does not allow you to serve a section 25 notice in relation to part of a property as opposed to the whole. So you either have to bring the whole lease to an end or not at all.

For more commentary on relying on statutory grounds, here is a useful article by Osborne Clarke.

The statutory ground of redevelopment was also a matter at issue in the Crossco case. A landlord needs to prove it had an intention to redevelop – and the availability of planning permission and funding are key elements in proving that intention. Showing a fixed and settled desire to redevelop can be more tricky.

The Crossco case therefore gives some food for thought where you are considering a landlord’s break clause.

Where you are trying to operate break clauses in leases that have not been contracted out, you need to think carefully and take advice.

The main message I have been trying to get across in these blog posts on landlords' break clauses is that if you are a landlord, when you are granting a new lease and you want a landlord’s break clause to be effective, make sure the lease is contracted out of the 1954 Act.