Here we look at some of the key things to be aware of with regards to heads of terms (HoTs) in commercial lease transactions, such as taking new office space or granting a lease of space in a stadium, and why HOTs are so important.
Why are HoTs used?
There are a number of reasons which include:
- Clarity of terms – well drafted HoTs provide a framework of the main terms agreed in principle between the parties and establish how the transaction will be structured.
- Identify material issues early – the aim is to agree in outline the important terms before legal costs are incurred in carrying out due diligence and drafting and negotiating the legal documents.
- Time and cost saving – they help speed up the drafting of the legal documentation and avoid negotiating headline terms during the transaction.
- Timetable – they will outline the timetable for completion of the transaction and the obligations of the parties during the negotiations.
Who prepares them?
A landlord’s agent or surveyor will often prepare them. However, it is not uncommon for a landlord themselves to do this. As lawyers, we are often asked by both landlord and tenant clients to review and input into draft HoTs before they are agreed between the parties.
What form do they take?
HoTs can take many different forms and vary from transaction to transaction depending on who prepares them.
They can be a well-structured, detailed and carefully drafted document prepared by professional advisers, they could be a one sided scribble by the landlord on a piece of paper or they could simply be set out in an email or given verbally by a landlord over the telephone.
Whoever prepares them should always remember that they need to accurately reflect what has been agreed and contain sufficient detail to ensure protracted negotiations are avoided. The last thing any party wants is to be renegotiating HoTs midway through a transaction as this will just lead to frustration, delays and additional costs for all concerned.
Keys terms agreed
The principle terms you tend to see in HoTs will vary depending on the form they take and the nature of the deal. Broadly, they should cover the following:
- Parties – they should identify the landlord, the tenant and any other party to the lease such as a tenant’s guarantor.
- Demise – they need to accurately identify the property being let. It is important that both parties are clear on this as it will have a significant bearing on other lease terms (such as repair and service charge responsibilities).
- Term – they need to identify how long the lease is being granted for and whether it will have the protection of the security of tenure provisions in the Landlord and Tenant Act 1954 (meaning the tenant will have a statutory right to renew the lease at the end of the term subject to statutory grounds of objection). If the parties have agreed to a break clause, the conditions of the break and how much notice is required should be set out.
- Main financial terms – how much is the rent, is it a known sum or is to be determined (e.g. linked to turnover or linked to measurement following practical completion of works), when is it is due and is there any rent free period? If the rent is subject to review, when and what type of rent review clause is being used (fixed, open market review, in line with RPI or another index)?
Is the tenant required to pay a service charge? If so, is it subject to a cap or any specific service cost exclusions? Is the tenant required to contribute towards the cost of insurance?
- Scope of the key tenant covenants and rights – this should include provisions around repair, the ability to assign, underlet or share occupation, restrictions on use and carrying out alterations to the property.
- Rights granted / reserved – details of any specific rights being granted to the tenant (such as rights of access, car parking rights, rights relating to plant, loading and unloading) or rights being reserved by the landlord over the property should be set out.
- Conditions – is the grant of the lease conditional on anything? This could be the completion of agreed landlord works and/or the grant of satisfactory planning permission for works or change of use. It could be the grant of superior landlord’s consent (if the landlord itself has a leasehold interest). An agreement for lease may be required to set out the parties’ obligations in relation to the satisfaction of the conditions.
- Other transactional documents – is the tenant required to pay a rent deposit and enter into a rent deposit deed? Is the tenant intending to carry out fit-out works at the property which require a licence for alterations? Has the landlord agreed to make a contribution towards to the cost of the tenant’s fit out?
- Timetable – timing may be important in a transaction, so a reference to any particular timetable agreed between the parties is usually found.
- Costs – is each party to be responsible for their own costs in the transaction?
Are head of terms binding?
In most cases, the intention of the parties will be that the HoTs are not legally binding. It is therefore key to avoid creating a document which could be construed otherwise.
Particular care is therefore needed to ensure that HoTs are not treated as a legally binding contract under section 2 of the Law of Property (Miscellaneous) Provisions Act 1989. There are drafting techniques which can be used to protect against such risk.
If there are pre-contract matters which the parties do want to be legally binding (such as confidentiality, exclusivity or break fee arrangements), these are better kept separate from the HoTs.
Whilst HoTs may not be legally binding, they do evidence intent and parties will often regard them as morally binding. If a particular disagreement arises during a transaction which can be answered by reference to the HoTs a party that seeks to renege from the position stated in the HoTs may find itself in a weak negotiating position.
Key take away points
HoTs can help determine the way a transaction progresses so it is important that they are given careful consideration at the outset. If drafted inappropriately, particularly without legal advice, they can lead to ambiguity and uncertainty over the intentions of the parties and the deal agreed and will cause problems down the line.
As with any commercial transaction, the terms often will depend on the bargaining position of the parties. However, it is advisable to seek legal advice before agreeing them. Lewis Silkin has advised many clients in the preparation and negotiation of HoTs in commercial lease transactions so please contact us if you require any assistance.