Gearing up for the ‘new normal’
How landlords and tenants can work together to mutual advantage as they follow the roadmap to recovery.
The current lockdown and the previous ones, together with other enforced social distancing resulting from the coronavirus pandemic, has obviously caused a severe economic impact for virtually all businesses over the past 12 months. However, those in the travel, leisure, hospitality and non-online retail sectors have probably been hit the hardest. Now that the Government has set out its roadmap for exiting the latest lockdown, in tandem with its vaccine roll-out plan, and the Chancellor has delivered the latest Budget, businesses are now actively planning how and when they can re-open.
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 – and in a legally safe way. Such lease re-gearing can help tenants to get back on their feet again prior to trade restarting in earnest, whilst landlords seek to mitigate the economic impact for them of Government protection measures for their tenants, which have, in some cases, resulted in landlord’s being without regular rental income for months.
Although primarily aimed at landlords and tenants in non-online retail, restaurant, pubs and bars, hotel, travel, leisure and sports and other public venue sectors, where the impact of the crisis has hit hardest, this article is of relevance to all commercial landlords and tenants in England and Wales.
Why should this happen now?
The recently unveiled package of financial measures announced in the Budget to provide protection to commercial tenants for the next few months, as the country heads out of lockdown and businesses re-open, are expected to be the last of their kind and are unlikely to be extended again. Landlords and tenants therefore need to start talking now to explore strategies that will enable tenants to weather the economic turbulence which will occur as the Government’s business assistance and protection schemes are wound-up at a time when tenants’ businesses will still be struggling to return to the ‘new normal’ trading environment.
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-to-mid-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, once the Government’s protection and support schemes for business are withdrawn, to enable them to survive the journey out of the current economic 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.
- A change to a turnover based rent arrangement – albeit one perhaps limited in time – which would link the level of rent payable to the tenant’s trading performance.
- 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
As a result of the seismic economic shock caused by the pandemic, and the uncertain trading environment as businesses follow the Government’s roadmap to exit lockdown, landlords will doubtless discover that previously model tenants will still find themselves with a battle on their hands as they continue to experience a continued reduction in their cashflow as their business, and their customers, adjust to ‘the new normal’ and Government support schemes are withdrawn. They may therefore be unable to pay their rent, or other charges associated with their lease, as a result – and need short-term help to survive to thrive again in the future.
By providing a lifeline to such tenants at this critical time, landlords can help them to weather this temporary economic turbulence and have a breathing space within which to get their businesses back on their feet and trading profitably again. Although many landlords will be keen to see rental income flowing again as soon as possible, the smart ones will realise that if they can provide a lifeline to their tenants during this challenging transition period, then they can reap the rewards that may flow from grateful and loyal tenants thereafter. In addition, in the short-term, they can prevent forcing tenants out of business, and thus, avoid unoccupied voids which would see the landlord’s rental income decrease, make them liable for paying empty business rates and negatively impact 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 of business premises, a lender to either, or a guarantor of a tenant’s liabilities under a commercial lease, 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 unintended 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 email@example.com.
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).