With uncertainties remaining this winter over Covid-19 and flexible working being the new norm, business owners may be looking at their commercial lease agreement with renewed interest.
Some will be the lucky ones who have seen rapid growth during the pandemic and may now require larger premises, or conversely perhaps, a business whose employees are working from home with little ongoing requirement for an office.
Whether upscaling or downsizing now or in the future, most business owners will have to get their head around a commercial lease agreement at some point. However, assuming a commercial lease has much in common with a residential lease is one of the biggest errors made.
Unlike a residential lease, in a commercial lease, nearly all of the responsibility lies with the tenant which means the tenant or business owner should not enter into any agreement without fully understanding what it is they are signing up for.
However, in the rush to secure a new location or premises for their business, too many tenants sign on the dotted line without really understanding what it is that they are tieing themselves into.
It is always best to seek legal advice when entering into a new commercial contract – especially as the landlord is likely to have legal experts working on their behalf.
Although each lease is very different, there are common issues that arise time and time again:
Length of the lease
A lease maybe five, ten or twenty years plus but once established, neither side can end it before the agreed timeframe without the other’s consent. A business owner cannot change their mind and hand in the keys if business is bad, or if they grow too quickly and need more space, so it is essential to get everything negotiated prior to signing.
Early termination/break option
Only if negotiated beforehand, the tenant may have the right to end the lease early. Check the wording of any early termination clause very carefully, as if the tenant is in breach of the lease in any way, then the notice is ineffective and the tenant is legally bound to stay in the lease to the original end. So the tenant could be a few days late with the rent, or not have carried out some seemingly minor repair – and be stuck with paying for the remainder of the lease.
The lease is full insuring and repairing
The tenant must keep the premises in good condition and carry out/pay for all repairs. Any repairs are their responsibility. The landlord insures the premises, but the business pays for the upkeep – sometimes this will include the exterior of the property too. This isn’t always entirely understood but is clearly something that a tenant needs to budget for.
Particularly on short term residential leases, it’s common for some landlords to cover utility bills, council tax etc. but think again for commercial leases: while small premises may be eligible for rates exemptions, in the main, the tenant is responsible for rates which can add on a substantial amount to a business’s monthly outgoings.
Survey – before taking possession
A building survey will confirm that the rental and other financial considerations being asked or demanded by the landlord are fair, and also highlight any defects. When the lease comes to an end it will be the tenant’s responsibility to remedy all defects and leave the premises in good condition. However, the tenant takes the premises over in whatever condition they are in unless the landlord agrees to any repairs. If a unit was in poor repair when taken over by a new tenant, that will not help at the other end of the lease. The pre-possession survey is a tenant’s best assistance or defence in seeking to negotiate a limitation on the dilapidations.
Photographicschedule of condition
As well as the survey, it is often worth adding a photographic schedule of condition to the lease. The item is a set of photographs of every part of the premises which acts as a visual record of the state of the premises before the lease starts. The tenant can also add written descriptions of defective or poor areas. The tenant’s obligation is thus limited to returning the premises to the landlord at the end of the lease in no worse condition than shown in the schedule of condition.
Schedule of dilapidations
At the end of any lease, a landlord issues a schedule of dilapidations which is a list of repairs. completing these repairs is the tenant’s responsibility. The tenant can attempt in advance – i.e. before signing the lease – to limit the works to be done in the future, but only if they have a schedule of condition. If they didn’t get a survey, they take the risk that the landlord may deny that there were any defects or disrepair when they took over, and the tenant and the tenant alone will be stuck paying for the work.
The tenant’s responsibilities include health and safety, asbestos control, fire safety, public liability insurance, gas and electrical certification. As part of due diligence, the tenant’s solicitor can require the landlord to provide the appropriate equipment or safety precautions prior to taking over, but after that, the tenant is solely liable to ensure the premises are lawful.
Who is the tenant?
The advantages of using a limited company as the legal tenant are numerous: there are possible tax advantages but a bigger sway is that all legal liabilities fall on the company alone. If the business fails or cannot continue the lease, the landlord can only take enforcement action against the company and not an individual owner. However, most landlords will almost certainly ask for a personal guarantee for rent and/or a rent deposit to be paid to him and held either for the whole term of the lease, for a set period of years until the tenant shows that they are company trustworthy.
If no termination notice is served coming up to the end of the lease, it will continue under what is known as ‘tacit relocation’ for a period of one year. If the lease contains a provision stating a specific period of notice for termination, then err on the safe side and serve whichever is the longer period of notice between the lease provision and the statutory minimum to ensure the business can get out when it needs to.
Stamp Duty or Land and Buildings Transaction Tax (Scotland)
It is important to know before committing to a lease whether and how much stamp duty or LBTT is due. It’s a graduated tax, so the higher the rent and/or the longer the lease, the more likelihood there is for tax liability
One thing to be aware of is that if there is a duty to make a return, a further return must be made every three years or a penalty will automatically be imposed on the tenant. If there is at some point a rent increase or extension of the lease’s length, there may be additional LBTT to pay. One oddity is that where VAT is charged on the rent, LBTT is calculated based on the rent PLUS the VAT – so the tenant is being taxed on tax!
In the excitement of finding a new location for a business, it’s vitally important that the tenant takes a cautious approach to any new commercial lease for all the reasons documented above.
Many tenants shy away from seeking legal advice at the start of a contract but the costs of that counsel are minimal in comparison to some of the expenses tenants are obliged to pay if they don’t negotiate preferential terms.