Representative bodies in the property industry for both landlords and tenants have worked together with the Government to introduce a new Code in relation to commercial leases. As is the case with the recent Code in relation to service charges in leases, the new Code for commercial leases does not have legal status. However, the property industry does recommend that compliance with the Code becomes an industry standard. Any divergence from the Code may require an explanation, either if so requested by the tenant at the time of negotiations, or as justification of action if a dispute is brought before the courts.
The Code is in place for new leases in England and Wales but it is the desire of the various industry bodies instigating the promulgation of the Code, to have its impact extended throughout the United Kingdom. In addition, it is expected that the Code will also be applied to consent to sub-letting of existing leases in relation to the level of rent payable under a permitted sub-lease, i.e. it should be market rent rather than the passing rent.
The main aim of the Code is to ensure that all parties to a lease understand the commitment they are making and that the documentation incorporates both parties' clear intentions. The expectation is for preliminary negotiations to be simpler and more transparent to ensure the lease is a fair representation.
Heads of terms
The Code provides a model set of heads of terms setting out the likely covenants of a lease contract. More regular and extensive use of heads of terms documents is recommended. A clearer understanding of the issues involved should allow the intentions of the parties to evolve at the preliminary stages of negotiations. Clarity at this stage should lead to both parties' intentions properly being reflected in the lease.
The Occupier's Guide
The Code encompasses a guide for tenants intending to lease business premises. The guide provides useful background information to the landlord and tenant relationship, to assist the tenant in making informed decisions in negotiations. It is not meant to supersede advice from surveyors and legal advisers but it does offer to the tenant a benchmark against which to measure the level of compliance by a prospective landlord with the new Code.
The Landlord's Code
This part of the Code sets out the recommendations for landlords in relation to the level of disclosure of lease terms they require to agree from the outset. It also promotes flexibility in discussions with prospective tenants and overtly states that the landlord should justify any divergence from the recommendations of the Code.
So what are the side effects?
Conflict will arise where the principles of the Code do not easily accord with current market practices. Conflict may also occur since the Code applies generally to landlord and tenant relationships. In many cases this may require more than one regime to be operating within the same estate or may lead to extensive negotiations where the level of rent or the term of the lease does not merit this. There is also the obvious conflict where the landlord is himself a tenant and the restriction of the superior lease will dictate the extent to which negotiations can take place, but this is anticipated. The onus is on the landlord to state which parts of the Code he is unable to comply with and to provide reasons. It is in respect of the current market practices that most issues are likely to arise.
The Code will require landlords to keep up to date valuations of its properties for the purposes of rent reviews as it recommends dispensing with the use of headline rents. It also recommends that landlords consider requests from tenants for upwards/downwards rent reviews or alternatives such as tenant only break options, the landlords having to provide reasons for rejecting any such alternatives. Open market rent is to be the marker if the basis for review is not apparent.
The Code again sets a benchmark whereby the repair obligation should be to yield up the premises in the same condition that they were at the commencement of the lease, unless an alternative is clearly agreed at the heads of term stage of negotiations. This is contrary to the more usual obligation to keep the premises in good and substantial condition and repair and may impact on the negotiations as to the level of rent. It may also lead to an increase in the number of detailed and photographic schedules of conditions attached to leases. Who will be responsible for the additional costs?
The Code suggests that an AGA (Authorised Guarantee Agreement) ought not to be requested from an outgoing tenant as a matter of course. The Landlord and Tenant (Covenants) Act 1995 introduced AGAs to improve on the concept of privity of contract while offering the landlord some protection on assignment. The Act has not improved flexibility on assignment due to the many ways found to avoid shifting the balance in favour of the tenant. The Code attempts to overcome this by suggesting that a proposed assignee should be of a lower financial standing in order to justify a request for an AGA from an outgoing tenant.
Landlords or their agents are to be required under the Code to disclose all commissions earned on insurance. This may lead to tenants seeking a reduction in the premia paid by them, possibly affecting an element of landlords' profits.
The Code recommends that tenants have the right to walk away from a lease in the event of damage or destruction of the whole of the premises by an uninsured risk unless the landlord rebuilds at its sole cost. In addition, it is suggested that if loss of rent for insured risks is restricted to a period of insurance, both parties should be given the right to break if at the end of that period the premises have not been rebuilt.
The ongoing management is generally left to the tenant and the landlord may choose to rely on the covenants in the lease. The Code states that the landlord should serve a schedule at least six months before the end of the lease and also a subsequent schedule if more works arise. There is also the principle that the landlord ought not to require the tenant to remove alterations installed during the lease, at the end of the lease unless it is reasonable to require this. Landlords may find it difficult to be specific on this at the commencement of the lease given the difficulty in foreseeing circumstances that may exist at the end of the lease.
It is anticipated that many landlords and tenants will endeavour to comply with the Code and it is for agents and legal advisers to promote this. It is also anticipated that what has become the standard institutionally acceptable lease will require to be modified. The banks and other lenders are being encouraged to review their conditions of borrowing to ensure that leases that are Code compliant meet their requirements. It is likely however that market forces will still, to a great extent, dictate which lease terms are open to negotiation and determine which recommendations of the Code one or other party may seek to exclude from time to time.
It must be considered a possibility that in light of market forces, the recommendations of the Code may lead to more negotiations and more legal drafting rather than simpler proceedings to reach an agreed form of lease. It is hoped however, that the Code operates to set up more equitable relations between a landlord and tenant from the outset of a lease rather than operate to resolve disputes between the parties when the relationship has broken down.
The intention is for the new Code is to achieve a balance between landlords and tenants by encouraging all parties to endeavour to follow the guidance provided. If the Code is not adhered to and the outcome is that the Code becomes no more than a measure for resolving disputes, it may be the case that the Government does not keep their involvement to an advisory capacity. We may find ourselves presented with more legislation as the ultimate cure.