What are the most problematic/overlooked elements of negotiating a commercial lease?

Harry Wilshaw, Solicitor at Lewis Denley, looks at the process of negotiating a commercial lease and highlights some of the components that tend to cause the most problems or get overlooked entirely.

Related topics:  Landlords,  Tenants,  Law,  Commercial
Harry Wilshaw | Lewis Denley
13th October 2023
"When negotiating rent, tenants should strongly consider the chosen method for determining future reviews with the landlord. If the tenant is not careful they can end up entering into a lease where a rent review can be really unfavourable."
- Harry Willshaw - Lewis Denley

When a tenant taking on a new lease negotiates the heads of terms with the landlords there are always points that they fail to consider at the outset which can result in further negotiation or problems arising down the line.

Here is a list of certain points which every tenant should consider when negotiating the heads of terms of their new lease:

1. Renewal Options/Break clauses

Tenants often overlook the importance of securing the right to renew their lease or having a break clause. Without having renewal rights in place, tenants risk having to relocate despite the business building goodwill or having to re-enter onto new unfavourable terms with the existing landlord.

Break clauses can provide flexibility to a tenant should they encounter an unforeseen change in their circumstance. For example, should another opportunity to relocate arise or should the business simply not work out the tenant has an exit strategy.

Unfortunately, many tenants neglect this when negotiating the heads of terms and can end up locked into a lease for a significant amount of time with no exit in sight.

2. Rent escalation clauses

When negotiating rent, tenants should strongly consider the chosen method for determining future reviews with the landlord. If the tenant is not careful they can end up entering into a lease where a rent review can be really unfavourable.

For example, the landlord may want the provision to be ‘upward only’ which solely benefits the landlord since if the market rent falls below what is currently being paid under the lease the rent will remain the same. However, should the rent increase it will do so.

The tenant therefore needs to carefully consider how this is to be determined including how it is being calculated based on factors such as the retail price index, consumer price index or solely at the open market rent which could be more favourable in these current times we find ourselves in.

3. Maintenance and repair

You must ensure that they define maintenance responsibilities clearly and negotiate a balance between their obligations as well as the landlords within the heads of terms. Landlords will usually push for full repairing and insuring obligations on you as the tenant. Therefore, you should seek to negotiate a fair balance, specifying what you are responsible for and what falls under the landlord’s domain.

Tenants also forget to establish a clear protocol for reporting and addressing maintenance issues. The lease would need to outline response times and procedures for reporting such issues to ensure that there are no disputes occurring later down the line which could impact both parties’ relationship going forward.

Using a Schedule of Condition to document the property's initial state can protect against unwarranted repair costs later.

4. Use and Restrictions

Ensure the lease permits your intended property use. You do not wish to be in breach of your lease should you find out after the fact that your intended use for the property is not permitted. Such consequences can include the landlord having the right to exercise forfeiture which can result in your eviction from the property thereby impacting your business.

Subsequently, it is key that any restrictions pertaining to the use of the lease will not prohibit the tenants’ operations and have the appropriate flexibility required should the tenant need it.

5. Security Deposits and Personal Guarantees

Landlords usually insist on having a security deposit. You should negotiate an appropriate sum to avoid having an excessive amount being tied up in the security deposit. The tenant should also consider the conditions under which the landlord can draw upon the deposit and ensure it is fair and appropriate including who receives any interest generated.

With regards to personal guarantees, tenants sometimes will be asked for an individual to be a personal guarantor to guarantee the lease. Tenants should be cautious with personal guarantees, as they expose individuals to liability in case of a lease default.

6. Subletting and assignment

Tenants usually do not foresee the importance of having the right to sublet or assign the lease as originally, they intend to remain at the premises during the entire term. However, that does not mean they should not consider an ‘exit strategy’ should something unforeseeable occur during the lease term.

Should the lease become a significant financial burden to the tenant, the opportunity or possibility to assign or sub-let to another suitable tenant can be a financially astute strategy to exit the lease.

The restrictions around the tenant's right to assign or sub-let therefore need to be strongly considered and negotiated to ensure that they can exercise this right reasonably without being at the landlord’s mercy.

7. Improvements and Alterations

You should determine your responsibility for funding and overseeing any necessary improvements or alterations. The tenant needs to consider the flexibility given under the lease for certain works to be carried out to ensure that they will comply with the landlord’s requirements and their obligations under the lease.

A second point tenants do not often consider is negotiating and agreeing on the process for changes being approved to the property as many leases require the landlord’s consent.

Does consent need to be given in writing?

Can the landlord withhold their consent at their sole discretion?

Another way to avoid these types of issues occurring is to have an agreement in place for such alterations to be carried out prior to the lease term commencing. This is known as a licence for alterations whereby everything is agreed upon and set out between the landlord and tenant to ensure the property meets the tenant's needs.

8. Insurance

It can be common for landlords to be responsible for insuring the property, however, the tenant needs to ensure this is confirmed within the heads of terms. If the landlord is insuring the property you to ensure it is clear what your contributions are going to be towards any insurance premiums if requested by the landlord.

9. Default/Forfeiture Event

As expected within a lease there are consequences should either the landlord or tenant breach the agreed terms. You should therefore consider under what specific circumstances may result in a breach that is clearly outlined within the lease that can result in default. Examples of such circumstances can include non-payment of rent, bankruptcy or failing to adhere to any of the obligations/covenants made to the landlord.

However, many tenants fail to consider negotiating a ‘grace/cure period’ whereby they can rectify any breaches before facing any severe consequences.

Allowing the tenant to address the issues or breach can prevent unnecessary and harmful action from being taken by the landlord which can result in financial penalties or the landlord to re-enter the property. This should be considered when negotiating the heads of terms.

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