The commercial property market has seen dramatic changes in recent years and these changes are no more evident than in the commercial lease terms that landlords are agreeing with prospective tenants. In addition to shorter lease terms, lower rents and greater rent concessions, the dramatic reversal of the negotiating position of commercial tenants is evidenced in the lease negotiations, with tenants requiring greater flexibility and 'tenant-friendly' lease covenants.
Commercial tenants are insisting upon far less onerous repair and yield-up obligations to ensure that they do not risk the imposition of significant exit costs at the end of the lease. The traditional 'full repair' obligations are being diluted by reference to detailed schedules of condition, the incorporation of 'fair wear and tear' exclusions, with the removal of the tenant's fit-out being at the discretion of the tenant, not the landlord.
In a typical lease term of ten years, tenants will most likely enjoy a break option during the term (e.g. at the expiry of the fifth year) and tenants are highly sensitive to dilapidation costs that would arise on foot of their repair obligations. In addition to the dilution of the core tenant repair/yield up covenants, tenants of multi-unit buildings are seeking to exclude any contribution towards capital expenditure incurred by the landlord, that heretofore would have been recovered by the landlord via the service charge. Tenants view such capital expenditure as being a cost to the landlord of maintaining the investment value of the building and should not be recoverable from the occupational tenants that are in occupation for periods of ten years or less.
Tenants are very sensitive to the additional costs associated with their demise, especially commercial rates and service charge. While commercial rates are somewhat outside the control of the landlord, tenants require clear visibility on the cost of the services provided and will insist upon a detailed service charge budget, if not audited accounts of the management company. In certain circumstances, tenants are insisting that landlords renegotiate with their managing agents and third-party contractors to ensure that the services to the premises are being provided at the most competitive rates in the market. In addition to applying pressure on the landlord to renegotiate the services, tenants are inserting express exclusions in the service charge provisions of the lease to achieve this goal. Examples of these clauses are as follows:
- Managing agent fees capped at 10% of the annual service charge;
- Exclusion of any contribution towards a sinking fund; and
- Exclusion of any liability for capital expenditure incurred by the landlord during the term.
Cessation of Essential Services
In the current economic climate, tenants are particularly concerned with the landlord's financial standing and their ability to procure the delivery of the essential services to the building, especially where the landlord has significant service charge voids due to parts of the building being vacant. More and more, we are seeing tenants requesting specific provisions dealing with a set-off of their rent, service charge and insurance in circumstances where a breakdown or cessation of essential services arises during the term. Furthermore, tenants are often requesting an option to terminate the lease if the breakdown in these essential services continues for a sustained period.
In the absence of collateral warranties, or where the warranting parties are no longer of good financial standing, tenants are requiring the landlord to expressly covenant to repair any structural, electrical or mechanical defects arising in the building, often for the duration of the lease term. This is particularly true where the premises has been vacant or partially vacant since construction. In these circumstances, tenants are concerned that the relevant services (e.g. the heating and air conditioning systems) have not been fully tested and defects may only be identified when they are operating at greater capacity.
Traditionally, landlords insisted upon their commercial tenants providing "vacant possession" and being in full compliance with the lease covenants, as a pre-condition to successfully exercising the tenant break-option.
Recent UK case law has provided guidance on the interpretation of the term "vacant possession". In accordance with this case law, vacant possession cannot be delivered in circumstances where the tenant has left the premises in such a condition to materially prevent or interfere with the ability of the landlord to subsequently
re-let the premises to a third party. The premises should therefore be "empty" and any objects, possessions or chattels of the tenant that constitute a "substantial impediment" to the use of the premises must be removed.
Given the reversal in negotiating position, tenants now seek to exclude any pre-conditions or impediments to the exercise of their break-option, save for service of the requisite notice. In circumstances where a landlord accepts this position, it may prove difficult for the landlord to procure vacant possession of the premises as of the
break-date. This outcome would of course put the landlord in the invidious position of chasing the outgoing tenant to remove its equipment and possessions from the premises, while at the same time attempting to let the premises to a third party.
Landlord Banking Issues
Where the landlord and tenant have finally agreed the terms of the commercial lease, the landlord's financial institution will invariably require their advisors to separately review the final form of the lease and to report to the institution, prior to formally approving the lease and accompanying documents. In certain circumstances, the lending institution will insist upon the renegotiation of certain covenants or concessions and this can add significant delays to the completion of the transaction. These potential delays should be borne in mind by prospective tenants, especially where they are under commercial time pressure to take possession of the premises.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.