The market for on demand space, such as hot desks, is growing. Start-ups, especially technology-driven businesses tend to start small and need very little space while they incubate. After that initial phase, if they succeed they tend to grow explosively and need lots of space quickly. These two contrasting needs mean that these businesses require great flexibility. This need for flexibility is fuelling the growth of the on demand space market.
The right to occupy space can be granted either by lease or licence. Both can come in all shapes and sizes, and can regulate many aspects of the property owner’s and the occupying business’s relationship. While they are often used to achieve similar ends, legally, leases and licences are profoundly different documents. It is important the property owners use the right document in the right circumstance because getting it wrong can fundamentally erode the value of the underlying property and the owner’s ability to manage future occupation.
What are the legal and practical differences?
Unsurprisingly, leases create legal interests in land – they grant exclusive ownership over a period of time, beyond that even of the owner themselves in return for the payment of rent. They are governed by the Law of Property Act 1925 and unless short term or periodic, generally must be made by deed. For most UK companies, this means they still need a wet-ink signature by at least one director registered at Companies House in the presence of an independent witness. Additionally, depending on the length of the lease, when it starts and how much rent is payable, Stamp Duty Land Tax may be payable along with the relevant return and the lease may need to be registered at the Land Registry.
In contrast, licences do not create legal interests in land, instead they create contractual rights to occupy the property temporarily. As contracts, they can be entered into by people authorised by the occupying company in the same way as any other contract. They are not subject to Stamp Duty Land Tax and they do not need to be registered at the Land Registry.
Because leases create legal interests in the land itself, the lease must fix the location and extent of land that the occupier will be entitled to use. A licence only creates contractual rights, this means that the occupied area can be moved, extended, or reduced more easily.
Are licences better than leases for on demand space?
Considering all the points above, it is easy to believe that licences are better than leases. In short, licences are easier to put in place, are more flexible for the property owner and the occupier and don’t have the potential additional administrative issues. Licences do seem to lend themselves to on demand space. However, like so many legal questions, it is too simplistic to say that licences are better than leases; they are better at some things but worse for others.
Besides the need to ensure the details of any arrangement – whether lease or licence – are full and complete, licences carry a hidden risk – they can turn into leases: how?
English law doesn’t generally prescribe the words needed to create a given relationship, but looks for the parties’ intent and actions, as well as their words, so if a document appears to be one thing, but is treated like another, the law will look through the words and then treat the document accordingly. Often it’s a good thing … but not always.
So what are the risks if a licence turns out to be a lease?
Several issues can arise … for instance, from the owner’s perspective:
- If the owner’s interest is itself a long lease, as the building is part of a larger development with common parts, then they may be prohibited from granting an underlease at all or only with the freeholder’s consent – if so, a licence may be acceptable to the freeholder, but not if it were a lease; or
- If the owner has acquired the property with borrowed monies, there’s probably a mortgage on the building – again, licences may acceptable to the lender but a lease not,
It’s not impossible for such events to entitle the freeholder to forfeit the owner’s headlease or their lender ask for the loan to be repay instantly.
From the occupier’s perspective:
- If the occupation was to have run for longer than seven years, and declared to be a lease, then it should have been registered, to protect the occupier, but will not include necessary provisions to enable registration of title with the Land Registry; and
- At the end of the occupation period, a licence ends and the occupier walks away, whereas if it were declared a lease, then the arrangement may renew itself automatically and the occupier can find itself subject to business rates and other costs.
In relation to science parks it is also important to note the effect on the rental income from the property that automatic renewal has - the security of tenure provisions are complex, and if they apply, sections 24 to 28 of the Landlord and Tenant Act 1954 allow for the renewal process to be referred to court. We will be looking at the perils, pitfalls and benefits of the 1954 Act in one of our coming articles.
On such a court renewal, the landlord can seek to review the rent; however, if the tenant doesn’t like the proposed new rent they have the right to ask the court to determine the new rent. If so, the court will look at comparative rents in the local area. Science and innovation parks or incubators not only offer property space but space with reputation and goodwill and provide significant business support including accelerator programs, and expert business development advice.
Consequently, they are able to attract substantially higher rents. These additional programs are not taken into account by the court and therefore a court will likely propose a significantly lower rent for the renewal. That would also have implications for rent reviews on other leases on the science park, too.
What makes a licence into a lease in disguise?
The most basic element of a lease is that it grants a tenant the right to exclusive possession. A tenant can exclude anyone else from the property, including the landlord. A licence does not grant exclusive possession; the landlord can enter the property or require the tenant to use a different area. However, if the owner allows themselves to be “locked out” of the occupied area or treats itself as being excluded, then exclusive possession might be claimed from that behaviour.
Another way of inadvertently converting a licence into a lease is to use the wrong terminology – for instance, in later correspondence, referring to the “lease” or “rent”, or calling the parties “landlord” and “tenant” can all be taken into account. Loose language can inadvertently change the nature of the document.
From the owner’s perspective, especially a science park, the biggest risk is the renewal rights under the 1954 Act, as they may blight rents for years into the future. Some lawyers will try to mitigate this risk by including provisions excluding the licence from the Landlord and Tenant Act 1954. This requires serving a notice on the tenant and obtaining a declaration in response and words in the document to “contract out” of the 1954 Act. As the Landlord and Tenant Act does not apply to licences it is therefore not possible to comply with this statutory procedure, and we consider the inclusion of the provision could be evidence that the document was a lease disguised as a licence.
What are the solutions?
Though we began with the thought that a licence was perfect, and have seen that’s not necessarily so, the pitfalls arise when what actually happens on the ground don’t match the document. If you’re looking at hot-desking, with users taking the next free desk and moving from day to day, or if they really are sharing space, and not in one office for longer than six months, a licence could still be the right mechanism.
If not – for example it’s for twelve or twenty four months, and the occupier will have exclusive possession – then it should be a lease, together with full contracting-out for most science parks.
There’s also a widespread perception that it takes significantly more time to prepare a lease than a licence, and therefore it is not commercially practical to put leases in place. However, leases are often the best and most appropriate means of regulating occupation of property, even for short terms of six months or less, and while leases do take a little more time, they can be put in place in just a few hours.
The science park team at Wright Hassall work with our clients to streamline the lease process resulting in rapid turn-around from receipt of heads to delivery of signature-ready documents, using our own in-house-developed case management system and web portal services.
We are presently working with the Land Registry is explore the practicality of e-signatures for some property documents, including leases. While this will take some time to come into effect and there are a number of legal and practical issues that will still need to be addressed, once implemented, stepping away from “wet ink” requirements will further reduce the time to put even short leases in place.
If you are concerned about whether you are using the correct documentation, or if you would like to discuss how we can help you to get signature-ready leases to tenants faster please do not hesitate to contact us at [email protected] or call team leader, Barry Sankey, on 01926 884630.
There’ll be more on our science parks landing page soon about the many benefits and headaches surrounding the Landlord and Tenant Act 1954.