First 2007 saw negative property returns for the first time in 15 years and the continuing negative economic outlook for 2008 is putting pressure on all sectors of the property market to secure rental income to offset falls in capital value. The legal process is a key part of this and asset managers and lawyers are coming under ever greater scrutiny to make sure they deliver maximum value. Against this background there are two fundamental legal areas for asset managers to look at, first streamlining the letting process and second minimising the damage on tenant default and insolvency.
Asset managers, lawyers and letting agents need to work together to do everything we can to secure deals as quickly as possible and each stage of the letting process needs to be examined in detail to make sure that it supports this, rather than putting obstacles in its way.
At the outset, make sure that you have an agreed deal with the proposed occupier that meets both parties' expectations and leaves no grey areas that might cause delay. It is crucial to have some basic heads of terms and, if there are any thorny issues, that these are agreed up front. We are now seeing more and more attempts to renegotiate terms during the legal stage, even on basics such as rent, and the longer the negotiation period is the more likely this will happen or, worse still, hand your occupier the perfect excuse to walk away from the deal. Your heads should cover:
- rent calculation and review
- term and breaks and conditions to their operation
- service charge and any limits or caps
- repair and exclusions
It also helps to impose some structure on the negotiation by including milestone timings. The parties can, for example, agree to fixed dates for the issue of papers, occupier review, amendment and then exchange. This can also include a fixed date for a round table meeting or conference call to iron out any final issues and close down the negotiation. The rent free period can be used to push the timing as well if it’s agreed that the clock starts running when the lawyers issue a first draft lease. This fixes the process in everyone's mind and, as the rent free expires, will quickly bring the negotiation to focus on only the truly commercial points.
If possible, avoid deferring the more contentious issues to the legal stage as this is unlikely to be the quickest way to resolve matters and each parties specific requirements need to be explained (and agreed to) as soon as possible. This would include, for example, a staggered rent free where there is a covenant or trading concern or certain management requirements such as the provision of turnover information, which can be very useful to pre-empt a default situation, but which an occupier is likely to consider an unnecessary and unreasonable infringement of business privacy unless confidentiality can be agreed.
Another issue which can cause delay is pre-emption and your right to step into a proposed assignment or, less commonly, underletting. It can be extremely important that you have the opportunity to adjust the lease terms or, in retail properties, alter the tenant mix but this must not be an obstacle to the occupier’s alienation rights and the pre-emption must not cause delay or uncertainty. The occupier needs to maximise its position, know that you will act quickly in deciding to step in and that you can only do so on sensible market terms.
On a practical level, and to cut down on the time spent on the legal negotiation, it is also worth making sure that your lawyers have the occupiers’ packs ready well in advance and that these are maintained in a "ready to let" state. Consider using web based disclosure for title, searches etc and have full demise plans (to scale, showing a north point and with identifiable features such as roads marked) prepared before the letting. Gather service charge information, VAT and insurance information well in advance and work up a balanced lease with your lawyers with a considered approach to likely occupier amendments. If there is a genuinely balanced lease, a deal can be struck at heads of terms stage that the document is taken by occupiers without negotiation. On shorter leases and lower rents this approach can suit both parties and should bring both time and legal costs down.
If you are using a traditional longer form lease, it goes without saying that occupiers who find your lawyers inflexible on minor points of little commercial significance will not be impressed. On a shaky deal this could be fatal so make sure your lawyers understand your approach to this and that you decide what they can agree on major points on your behalf. Pre agreeing the approach can significantly speed up the negotiation. The alternative to this is to consider using a shorter form contracted out lease with a term of less than five years, no review and an inclusive rent. We would, however, counsel against very short term (six month) leases as occupiers will often remain in occupation after the end date and serious security of tenure issues can arise. The form of lease can be particularly relevant to the speed of the negotiation so this is worth spending some time getting right.
TENANT DEFAULT AND INSOLVENCY
Of course, even if you employ very best practice to new letting transactions, or when you are looking at an existing arrangement, your occupiers’ business conditions might worsen and, over the foreseeable future, it has to be assumed that occupier defaults and insolvencies will become more frequent. Asset managers need to think in advance about their options as this can be critical to reaching the most effective outcome. There are some practical things that can be done if the need for action can be identified soon enough and the parties are willing to negotiate You may be offer or be asked to agree to temporary concessionary arrangements, for example monthly rent payments or the suspension or reduction of the rent to allow an occupier some breathing space if it gets into difficulties. In most circumstances, it would be better to have an occupier in the premises and operating, even if only the rates, service charge and insurance rent are covered, than to have the premises empty with the lights off. Such an arrangement will need to be documented carefully so as to avoid prejudicing your position and to ensure that your lenders are in agreement, if necessary. That said, taking an active approach to rent collection has much to recommend it.
Ensuring rents are paid on time, and taking prompt enforcement action where necessary to achieve this, helps maintain rental income streams, may give advanced warning of occupiers meeting financial difficulties and minimises your exposure in the event of occupier insolvency. Occupiers may also, individually or in groups and possibly through tenant associations, approach you with a request to downsize their demises and reduce their rents. If several occupiers wish to do this, the combined offer might be more attractive for you where there is scope for a wider ranging reorganisation of the premises to meet other occupiers’ needs. It helps to have a strategy in place for such requests with an established tenant mix policy (if relevant) and an awareness of which demises can be divided up without substantial time consuming works being undertaken, all before any such requests are received.
It is inevitable, however, that some occupier insolvencies can not be avoided. Insolvency law is a complex area and each process has different ramifications, so advice should be taken to assess your options on a case by case basis but one of the situations you are most likely to face in the current climate is administration. Companies in administration enjoy a moratorium against enforcement action by you unless you have Court permission.
If the premises are being used for the purposes of the administration you may, depending on the circumstances, be in a position to take action to obtain payment of the rent (with the Court’s permission). If not, you will need to consider whether to take the premises back or leave the lease in place to avoid, or at least minimise, liability for void rates. If the property is to be taken back, unlike liquidators, administrators do not have the power to disclaim a lease and in the absence of an occupier’s break clause, the administrators will need to surrender the lease to you. They will often try to do this by handing the keys back and surrendering by operation of law. It may seem like a good idea to take the property back without a deed of surrender and legal due diligence (and costs) but this might prejudice the arrears position and the occupier may have encumbered its title or registered its lease against your own title. These issues should be dealt with before the surrender takes place.
Trying to deal with them later can cause significant delays that could prejudice a new letting.
Finally, if a property is valuable to the administrators, they may attempt to carry on trading and make an application to you to assign which, where consent is not to be unreasonably withheld or delayed, will need dealing with promptly. In these circumstances you must make sure that you are not accepting rent from unauthorised occupiers and acquiescing to the breach of the lease by the unauthorised occupancy or, in certain circumstances, effecting a surrender and re-grant in favour of a new occupier.
The current imperative to increase rentals and maximise occupancy remains. The strong message that Nabarro are getting from the market is that lawyers need to be talking to landlords about these sorts of practical matters now and make sure that they take every opportunity to streamline the process and maximise the asset value for their clients.
- Structure heads of terms fully and clearly
- Do not park difficult issues
- Impose timing milestones
- Consider more novel lease terms
- Be fully prepared on the legal documents
- Keep the communication lines open and share information with occupiers
- Act early if problems arise but not with haste