Changing Gears – How landlords and tenants can work together to mutual advantage during the coronavirus crisis
No-one can have failed to notice that the Government’s advice to exercise social distancing and not visit restaurants, bars and other leisure venues, has had an immediate economic impact for those businesses which are affected.
In this article Commercial Property Partner Daniel Woodcock looks at the ways in which commercial landlords and tenants can collaboratively work together to re-gear their existing lease arrangements, helping tenants survive the short-term economic impact caused by the coronavirus outbreak.
Although aimed at landlords and tenants in the retail, restaurant, pubs and bars, hotel, travel, leisure and sports and other public venue sectors, where the impact of the crisis has hit hardest and fastest, this article is of relevance to all commercial landlords and tenants in England and Wales.
Why should this happen now?
In line with the recently unveiled package of financial measures announced by the Government to sure up the economy against the impact of coronavirus, landlords and tenants now need to start talking. They will need to work together exploring strategies that will enable normally good quality tenants to weather the short term storm, giving them the chance to get back on their feet and back to normal trading again once the effect of the current pandemic has passed.
What is Lease Re-gearing?
As the name suggests, this is the process by which landlords and their occupational business tenants re-negotiate some of the terms of their existing tenancy agreements mid-way through the lifetime of a lease.
Re-gearing is usually considered when economic circumstances require the parties to re-balance and re-structure a lease’s underlying commercial terms. Commonly, a tenant may be granted short-term economic concessions, such as a rent payment holiday or reduced rent for a defined period, and, in return, a landlord may seek to improve the investment value of its lease by, for example, the removal of an upcoming right for the tenant to break the lease.
Why might tenants wish to do this?
In times of short-term economic turmoil, such as that presently being faced by businesses in the sectors referred to above, normally solvent tenants may need to be afforded an economic lifeline by their landlords to enable them to survive the immediate crisis and then return to profitable trading again. Examples of concessions which might be sought by tenants under such circumstances may include:
- The creation of a new rent free period during which tenants may not have to pay any rent for a period of time.
- An agreement that the tenant only needs to pay a proportion of the usual rent for a period of time.
- An agreement that service charges may be waived or capped for a period of time, even if the lease does not normally permit this.
- An agreement by a landlord to either postpone, or not exercise at all, a forthcoming upward-only rent review.
- An agreement that the landlord may agree to waive or delay its right to recover certain rent arrears or agree a longer term repayment plan in respect of those arrears.
- Amending the alienation provisions of the lease to enable the tenant to have more freedom to underlet or assign its lease more flexibly.
- An agreement to widen the permitted user clause of a lease or to permit the carrying out of a wider range of alterations to premises to permit more diverse business uses to be able to operate from the premises giving tenants more flexibility and make the lease more marketable.
The benefit to landlords
Following the onset of a period of short term, unexpected economic uncertainty, such as that caused by the present pandemic, landlords may quickly find that previously model tenants find themselves in a difficult trading environment, causing them to experience a temporary reduction in their cashflow and unable to pay their rent or other charges associated with their lease.
By providing a lifeline to such tenants, landlords can help them to survive this short term economic impact and have a breathing space within which to get their businesses back on their feet and trading profitably again. In doing so, landlords can prevent forcing tenants out of business and thus avoid unoccupied voids which would see the landlord’s rental income decrease, potentially making them liable for paying empty business rates and negatively impacting on the value of their investments.
Examples of concessions which a landlord may seek as a quid pro quo can include:
- Removing a contractual right for the tenant to break their early lease early at a future time, so as to guarantee that the lease can run for its entire contractual term.
- Reviewing the rent review provisions of a lease in the landlord’s favour. This could include for example more regular stepped pre-agreed increases in future rent in return for the current reduced rent or rental payment holiday granted to a tenant.
- Revising leases so as to align them with the landlord’s standard, current form of lease and to remove any clauses which have previously been a cause of concern for landlords.
- The creation of improved security for landlords, by, for example, a third-party agreeing to guarantee the tenant’s payment of rent under the lease or the observance and performance of the tenant’s covenants.
Are there any risks for the tenant when re-gearing their lease?
Whilst the re-gearing of leases can create considerable advantages for tenants who find themselves in temporary difficulties, great care needs to be taken in how these are documented by tenant’s solicitors so as to avoid the following potential adverse effects:
- Variations which extend the contractual term of the lease, result in additional property being added to the let premises or additional property being substituted for property removed from the let premises can lead to an unintended deemed surrender and re-grant by operation of law.
- A variation which gives rise to a deemed surrender and re-grant is classed as a disposal and acquisition for Stamp Duty Land Tax (“SDLT”) purposes (in England) or Land Transaction Tax (“LTT”) purposes (in Wales). Relief may be available, but if a transaction does not qualify for such a relief, a tenant may incur a liability to pay SDLT or LTT which could be a considerable sum. A tenant may be entitled to overlap relief only if certain conditions are satisfied.
- Any unintentionally re-granted lease may be compulsory registerable at the Land Registry. A delay in registering, or not registering at all, can cause problems for both landlords and tenants.
- If a tenant’s lease is mortgaged, any variation to the terms of the lease may require their lender’s consent.
These are not the only examples of potential risks and it is therefore absolutely imperative that the tenant seeks expert legal advice before agreeing to any re-gearing even if on the face of it, the commercial proposals looks attractive and the documentation straightforward.
What are the legal risks faced by landlords?
Landlords also need to take care to ensure that their solicitors carefully document lease re-gearing transactions so as to avoid hidden dangers which include the following risks:
- If the original lease was contracted-out of the security of tenure provisions of the Landlord & Tenant Act 1954, and any deed of variation giving effect to the re-gearing agreement causes an unintentional surrender and re-grant then the re-granted lease may result in the tenant having security of tenure.
- If there was an existing guarantor, a deed of variation or an unintended surrender and re-grant, may serve to unintentionally release the guarantor.
- If a landlord wishes to safely extend the term of the lease without causing a surrender and re-grant, a new additional lease will need to be created which will take effect after the original lease expires. Such a lease is known as a reversionary lease. Great care needs to be taken in the drafting of reversionary leases and there are specific Land Registry procedures which must be following in relation to them.
- Landlords will need to ensure, if their property is subject to a mortgage that any re-gearing transaction is consented to by their lender.
- If the landlord’s lease is an underlease, they will need to check if the terms of any superior lease require the consent of a superior landlord to avoid breach of their own lease.
- Landlords will also need to give careful consideration to tax issues which can arise for them from re-gearing transactions such as the VAT, SDLT or LTT consequences of any surrender – intentional or otherwise.
Therefore again, it is imperative that a landlord discusses any suggestion for re-gearing with a solicitor who is experienced in advising on these types of deals, even before making any proposals to a tenant. This prevents proposals being put forward which then have to be retracted by the landlord, potentially upsetting the working relationship with the tenant.
How Butcher & Barlow can help you
Whether you are a landlord or a tenant, or a lender to either, Butcher & Barlow are able to provide expert advice on lease re-gearing transactions and the negotiations leading up to them. Our team of commercial property experts will also ensure that such arrangements are documented so as to be legally effective, whilst avoiding the common pitfalls which either party may face as outlined above.
It is very important that landlords and tenants who are seeking to revise their current lease arrangements take specialist advice before proceeding, not least as there are many hidden dangers and informal, undocumented variations can have serious future adverse consequences for both landlords and tenants.
This article is intended as an overview of the benefits to landlords and tenants of lease re-gearing. Each lease and situation is different and therefore for specific advice on your lease and the options available, please contact Daniel Woodcock at our Gadbrook Park office on 01606 334309 or by email at firstname.lastname@example.org.
Daniel is an approachable and knowledge commercial property solicitor who has been consistently included in the Legal 500 as a Recommended Lawyer for commercial property work being previously described as “extremely thorough in his work; very pro-active and quick to respond” (2017 Edition); “first rate” (2019 Edition); and “experienced” (2020 Edition).