Heads of terms (or HOTs) are used as a point of reference throughout a transaction.
To avoid delays and misunderstandings, it is critical to make sure you are not agreeing to anything within the HOTs which you do not understand or are unable to deliver on.
The following are particularly important considerations when dealing with lease transactions:
Ensure you are happy with the financial strength of the party you are contracting with, especially where payments may be made on a deferred basis or a party is carrying out works. Particular care should be taken where new companies are set up specifically for a transaction.
Consider the basis for any rent review, as well as the frequency. With inflation and interest rates rising, the HOTs should always specify whether rent reviews will be fixed, on an open market basis or index linked. Should a rent review cap be agreed?
If planning permission is required to carry out fit out works, be clear on the types of application to be sought and what will constitute a satisfactory planning consent. Consider whether any contributions will be made by either party and when drawdown of those funds should be made. Consider too whether the fitting-out works will be disregarded on an open market rent review, as this can have a significant impact on the revised rent.
If the lease will contain a break clause, what pre-conditions will apply? This can be particularly pertinent for a tenant; the RICS Lease Code provides a good starting point. Will the break be personal to the contracting party only or will it continue to exist on assignment? Remember that any break clause will also have valuation implications at open market rent review.
As with the rent review, caps on service charge may be negotiated, and as a tenant, you may be wary about index linked caps. Both parties should give careful consideration to how the responsibility for service charge is apportioned - whether a fair proportion or a percentage basis. Case law usually favours a landlord's discretion to determine the 'fair proportion' of service charge payable by its tenants, so long as the landlord acts with rationality.
It is best to set out any works obligations or other transaction specific requirements in the HOTs. If you have internal requirements to meet in order to proceed then these should also be taken into account in agreeing proposed timescales within the heads of terms.
Where possible, resist signing HOTs. If signatures are required, make sure the HOTs are stated to be “Subject to Contract” in order to avoid any question as to whether a binding agreement has been entered into.
For more information on this article, please contact Lola Skuse.
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