What are heads of terms?
Heads of terms (HOTs) are used to outline the key commercial property terms of a proposed transaction.
They are issued prior to solicitors being instructed and form the basis of the terms to be included in the legal documents.
A well-drafted set of Heads of Terms will:
- Help the transaction run smoothly;
- Avoid unnecessary delays caused by protracted negotiations; and
- Keep legal costs down.
Carry on reading for our top ten tips for improving your Heads of Terms when entering into a commercial lease.
1. Plan
The property being demised should be described in detail and, if possible, identified by reference to a Land Registry compliant plan.
Preparing a plan at the Heads of Terms stage will allow the tenant's solicitor to instruct searches at the outset and avoid delays.
It also enables the landlord's solicitor to more easily identify the rights and reservations that will be required so that those rights can be incorporated into the first draft of the lease.
2. Break conditions
If there will be a break clause, the break date(s), the length of notice required and any pre-conditions to exercise the break should be set out in the Heads of Terms.
If the pre-conditions are not set out in the Heads of Terms, it will be for the solicitors to negotiate what the break conditions will be.
As the parties are likely to have very different ideas about what, if any, conditions there should be, this can lead to delays.
3. Rent reviews
The Heads of Terms should specify the type of review (e.g. market rent, fixed increases, index-linked) and how often the reviews are to occur.
Suppose the review is to be a market rent review.
In that case, it is helpful to set out any unusual assumptions and disregard them at the Heads of Terms stage to limit negotiation between solicitors later.
4. Assignments
The landlord should set out any conditions it is entitled to impose when giving consent to an assignment and any circumstances in which it can refuse consent.
In particular, it should be made clear whether the landlord will be able to insist on the tenant giving an authorised guarantee agreement (AGA) in respect of a new tenant or whether an AGA can only be requested where reasonable to request it.
It is also helpful if the Heads of Terms specify whether the landlord will be entitled to require a guarantee from a third party and a rent deposit deed on all assignments or only where it is reasonable to request such security in the circumstances.
5. Underletting
If underletting of the part will be allowed, the Heads of Terms should specify the part(s) of the property that can be underlet and whether there is a maximum number of under lettings permitted at any time.
The Heads of Terms should also specify whether the underlease rent will be calculated by reference to the open market rent or the passing rent under the lease (or the higher of the two).
6. Repair
The usual position is that responsibility for repairs will rest on the tenant.
Unless otherwise agreed, it is generally assumed that the tenant's obligation to repair is in the institutionally acceptable form "to keep the property in good and substantial repair and condition".
If it is intended that the tenant's repairing obligation will be limited by reference to a schedule of condition or by carving out latent defects or existing contamination, this should be set out in the Heads of Terms.
7. Insurance
Heads of Terms will usually only specify that the landlord insures and recovers the premium from the tenant.
It is useful for the parties to agree early on whether any risks won't be insured risks (e.g. terrorism or flood) and what will happen in the event of damage by insured or uninsured risks, i.e. will there be a mutual break clause?
8. Green lease clauses
There is a growing trend towards ESG considerations amongst property owners, and green leases are becoming more popular.
A green lease is a lease which includes provisions aimed at managing and improving the environmental performance of a building.
Green leases can range from "light green" to "dark green".
Light green lease clauses impose less responsibility on the parties, such as an agreement to discuss improving environmental performance.
Dark green leases contain more specific clauses, which are legally binding and require a more significant level of commitment to environmental issues.
The parties should discuss their requirements regarding green lease clauses early so that the agreed position can be recorded in the heads of terms.
9. Third-party consents
The requirement for consent from a third party, whether a mortgage lender or superior landlord, is a common cause of delay in property transactions.
As such, it is worth identifying any third-party consents required in the Heads of Terms, so that consent(s) can be obtained early.
You may also want to specify whether it will be the landlord or the tenant who is responsible for paying any costs associated with obtaining that third-party consent.
10. ECTEA 2022 registration
Overseas entities that own property in the UK must be registered on the Register of Overseas Entities at Companies House.
This includes companies that own a leasehold interest for 7 years or more.
If relevant to the transaction, it is good practice to include details of the relevant party's Overseas Entities number in the heads of terms to make the registration status clear from the start.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
