The new commercial lease code for the property industry (the Code) was launched in March 2007. Since then, there has been extensive press commentary on the provisions of the Code and its impact in the market place.
The Code has been promoted as a guide to best practice. Here we outline its principal considerations and set out the reasons why we consider that the tenets of the Code should be adopted.
Since the early 1990s there have been increasing concerns about the inequity of the bargaining strengths of the parties negotiating lease terms. Attempts by a combination of professional and industry bodies were made to regulate this issue with the introduction of the 1995 and 2002 lease codes. The intention was to avert the Government from legislating to address the concerns. However, these codes are widely regarded as having had very little practical impact on the market.
It appears from the opinions in the property and legal press that the Code is the last chance for the industry to attempt self-regulation on these matters. The Government has increased its profile this time with the Housing Minister launching the Code in March of this year and simultaneously setting up close monitoring of landlords' support to the latest proposals.
Although the Code is directed at all new leases in England and Wales, the ultimate aim of the various industry bodies behind its promotion is to have its impact extended throughout the UK. It is also anticipated that, where possible, parties will apply the principles of the Code to existing leases.
Summary of the Code
The Code is in three parts: -
1. The Landlord Code;
2. The Occupier Guide; and
3. Model Heads of Terms.
The combination of the Occupier Guide and the Heads of Terms is intended to ensure that prospective tenants are better informed and that the parties consider all salient points at the outset, which should lead to fairer negotiation of the terms of a lease. However, the design of the Code requires parties to adhere to all parts of the Code, including the Landlord Code, in order to have the measure of success that the property industry is seeking. For this reason, we will focus our comments on the Landlord Code.
The Landlord Code
The Code provides guidance in ten basic areas.
1. Lease Negotiations
It is recommended that the landlord commits its offer to lease in writing to the tenant. The offer should include the essential clauses of a lease namely the rent, duration (including any break rights), tenure, rent review clauses (if applicable), rights of disposal of the tenant's interest in the lease and the extent of the tenant's repairing obligation (i.e. address the matters in the model heads of terms). It is also recommended that the landlord states if the lease is to be Code compliant and if not, the particular areas that are not compliant and the reasons for this.
2. Rent Deposits and Guarantees
If the landlord intends to secure a rent deposit from the tenant the details of the amount, the duration and the payment of interest at a commercial rate is to be disclosed and agreed from the beginning of the transaction. In addition, the Code provides that the landlord should protect the tenant's deposit against landlords' insolvency by placing it in an appropriate account not connected with the landlord's assets. If a guarantee is required, the strict requirements of the guarantee should be available to the tenant from the outset including any conditions relating to the release of such a guarantee.
3. The Lease Term, Break Clauses and Renewal of Rights
The duration of the lease should be clearly documented. How this is dealt with is left to the parties and there is nothing prescriptive in the Code, maximising the flexibility between the negotiating parties. Break options and any rights of renewal should be clearly documented, and for the purposes of a break option it is recommended that the only pre-conditions would be that the rent is paid up to date, the tenant gives up occupation on the due termination date and there are no current sub-leases at that date. It may be that to balance the interests of landlords and tenants, landlords restrict any such right to the original tenant. In the event that the landlord is intending to exclude security of tenure for the tenant under the Landlord and Tenant Act 1954, the tenant should be made aware of this from the outset.
4. Rent Review
The recommendation is to move away from headline rent reviews. Instead, the Code requires landlords to keep up to date valuations of its properties for the purposes of rent review. It is also recommended that landlords consider requests from tenants for upwards/downwards rent reviews or other alternatives as well as the ability for either the landlord or the tenant to initiate a rent review. The landlord is expected to provide reasons for rejecting alternatives to the standard upwards only rent review and, unless clearly set out in the Heads of Terms, the basis of rent review will be the open market rent.
5. Assignment and Sub-Letting
Assignments of the whole should be permitted with landlord's consent (not to be unreasonably withheld). The Code however goes on to say that it is not recommended that a list of reasons for refusal be set out in the lease nor is it to be the case that an AGA (authorised guarantee agreement) ought to be requested as a matter of course.
This particular recommendation is probably more controversial given that the Landlord and Tenant (Covenants) Act 1995, which introduced AGA's, was to be an improvement on the concept of the former privacy of contract, whilst offering the landlord some protection on assignment. In practice AGA's are almost invariably requested and rarely refused.
The suggestion is that an AGA should only be required if the proposed assignee is of a lower financial standing than the assignor or is resident or registered overseas. In Scotland, the test of financial standing relates to the demonstration of an assignee's ability to meet the tenant's obligation under the lease. It may be that this approach is adopted in England in assessing whether an AGA should be requested. This seems more equitable than comparing the financial standing against the profitability of the outgoing tenants. In addition, for smaller tenants, a rent deposit is recommended in place of an AGA.
If subletting is permitted, the sublease rent should be the market rent rather than passing rent.
6. Service Charge
The Code refers to the RICS sponsored code of practice for service charges in commercial property, which applies to service charges created from 1 April 2007. The Code recommends that the provisions of leases follow the guiding principles of the service charge code, namely, "not for profit, not for loss".
The service charge code is promoting communication, transparency of costs, and the right to challenge the propriety and fairness of expenditure. There are many of these provisions which at first glance are disincentives to landlords but in fact in practice regulate the performance of the managing agents. The Code also specifically discourages a fixed percentage management fee and recommends disclosure of insurance commissions.
The service charge code, like the Code, is voluntary and does not have legal status. There is scope for interpretation of the provisions which allows flexibility. Agents and professional advisors however are requested to interpret the provisions in such a way as would be consistent with the principles of the Code.
The impact of the service charge code is likely to be felt most keenly in the context of larger multi-let properties such as shopping centres. Were a service charge dispute to find its way to the Courts, they are likely to regard adherence to the service charge code as best practice. Accordingly, the onus will be on the landlord to explain why he has failed to comply with its requirements.
The Code sets a benchmark whereby the repair obligation of the tenant should be to hand back the premises in the same condition as when the lease was granted unless an alternative is clearly agreed in the Heads of Terms. This benchmark is contrary to the more usual obligation of keeping the premises in good and substantial condition and repair. It is most likely that the Code will be followed in the case of shorter leases (which is the current market trend) or leases with break options or of lower value. It is also currently the case that in such leases, tenants frequently have a survey carried out and a photographic record of condition is attached to the lease at the outset to provide a yardstick against which the tenant's repairing obligation is to be measured. The Code is setting the standard expected but allows scope for flexibility depending on the particular circumstances of the lease negotiation in question.
The Code does not preclude the landlord and tenant agreeing more onerous repairing obligations so long as this is reflected in the level of rent payable and the term of the lease.
8. Alterations and Change of Use
The Code recommends that landlords exercise control over alterations and changes of use only to the extent required to protect their investment. It is also suggested that internal non-structural alterations should be permitted without a need for consent unless they interfere with the buildings' services/systems.
If the landlord requires a tenant to reinstate alterations at the termination of the lease, at least six months' notice should be given to the tenant. This is in order for the tenant to have the opportunity to carry out the necessary works before the lease comes to an end.
The Code recommends that tenants have the right to walk away from a lease in the event of damage or destruction by uninsured risks as well as insured risks. It is also provided that rent suspension should apply during the period of damage in both cases. The recommendation then goes further. It suggests that in the event that suspension of rent is limited to the period in respect of which loss of rent has been insured against, both parties should be given the right to break at the end of that period if the premises have not been reinstated.
There is evidence in the market that parties are beginning to share the risks associated with uninsured losses.
10. Ongoing Management
It is recommended that the landlords respond constructively and speedily on all matters, provide costs estimates and act reasonably wherever possible. In particular, it is recommended that they request any additional information that may be required within five working days of receiving an application and that they consider at an early stage whether any other consents will be required (for example from a superior landlord or a mortgagee). Furthermore, landlords should deal with defaults promptly and in an open and constructive way.
Despite restricting the way in which landlords can conduct negotiations for the grant of the lease and indeed the terms of the lease itself, the Code does favour flexibility rather than require slavish adherence to a set of prescriptive principles. This approach is consistent with the fluid nature of the property market. Overall, the Code paves the way for better negotiations and relationships between landlords and their occupational tenants.
When market factors raise rents, tenants will be on the look out for deals that make business sense for them. The combination of the Code and the service charge code should operate to enhance communication between the parties leading to greater mutual respect and a better relationship during the term of the lease. Furthermore, if legislation is to be avoided, there will need to be empirical evidence from the market place that the principles of fairness and equity enshrined in the Code have been widely embraced by the property industry.
We actively seek to promote compliance with the Code and positively embrace the flexibility offered by it. The Code offers clear guidance but permits freedom in the market for individual occupiers and landlords to make commercial decisions based on their own professional experiences. Legislative intervention in such areas of market practice would, we believe, be unwelcome. There is a high likelihood that it would lead to more disputes being resolved in Courts rather than matters being addressed directly between the contracting parties.
The property industry has gone further than ever before in promoting the Code and the British Property Federation (BPF) has introduced a scheme of accreditation for commercial landlords who comply with its provisions. It is the intention of the BPF to seek as complete acceptance as possible of the Code within the property industry. Accreditation provides the ability to display the kitemark, showing your alliance with the scheme. Alliance with this scheme may give a landlord a competitive edge over another landlord who is not similarly accredited.
The rules of accreditation include
- the landlord informing any prospective tenant that they are members of the scheme
- providing prospective tenants with a copy of the Occupier Guide and model Heads of Terms
- agreeing to abide by the Landlord Code
- communicating to the tenant if there are any requirements of the Landlord Code that cannot be fulfilled, with reasons
- agreeing a written complaints procedure in relation to the negotiations in accordance with the Code.
This offers a greater security to tenants and will provide many with more information at the outset of the transaction than is currently the case. The benefit here for landlords is that they will be dealing with commercially aware tenants and this ought to lead to smoother lease negotiations.
Where landlords consider the restrictions of the Code impair their commercial interests, there is the ability to opt out of specific requirements provided that this is disclosed and justified. It is anticipated that such concessions will encourage landlords to comply in the main with the Code rather than regard it as contrary to their commercial best interests.