Whilst not (usually) binding, Heads of terms, or HOTs, are used as a point of reference throughout a property transaction, and are particularly useful when a lease is being granted. The HOTs will set out the key terms of the lease including, amongst others: parties, rent (and other payments), length of the lease, any options to terminate early, permitted use, and the obligations on the landlord and the tenant during the lease.
To avoid delays and misunderstandings, it is important 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 some important considerations for a tenant taking on a lease.
Rent:
- Principal rent is usually expressed as an annual sum, but will be payable either quarterly or monthly; commercial rents are nearly always payable in advance.
- Is the rent “inclusive” i.e. will it include payments of service charge and insurance premiums and, in serviced offices and similar scenarios, business rates and utilities? Most often, the principal rent is payable separately from these sums, and there can be an SDLT benefit for the tenant in doing so, but an inclusive rent gives the tenant certainty as to the total amount it will pay.
- Will the rent be reviewed during the term of the lease? This is usually every 5 years in longer leases. Will the rent review be at fixed increments, to “open market” value, or index-linked? Will the review be “upward only”, even if market values fall? This is still the most common type of rent review, but is clearly tipped in favour of the landlord. Can a rent review cap be agreed?
Length of Lease Term:
- A tenant is obliged to pay the rents and comply with the obligations in the lease for the whole of the lease term, unless there is a tenant’s break option or it can assign the lease to another tenant or agree an (often costly) surrender with the landlord. Note that, even if the lease can be assigned, the landlord can usually require the outgoing tenant to guarantee that the incoming tenant will comply with its obligations in the lease; this is known as an “Authorised Guarantee Agreement” or “AGA”.
- How long is the tenant prepared to be tied in? Shorter leases will usually attract higher rents, because they offer more flexibility, whereas longer leases give more security for both the landlord and tenant.
- Tenants of business leases benefit from a statutory right to renew at the end of the term, under the Landlord and Tenant Act 1954, unless agreed otherwise (often referred to as ”contracting out of the 54 Act”). It is very common for shorter leases to be “contracted out” and there is a set procedure which must be followed to do this. The HOTs should make it clear if a lease is “contracted out” or not.
- A lease may contain a break clause giving the tenant the opportunity to end the lease early. Break clauses may be subject to pre-conditions, but these must be considered very carefully, as seemingly innocuous conditions can render the break option useless. A tenant will usually pay a higher rent for a lease with a break option, so will want to be sure it can be used effectively.
The Demise:
- What area is the tenant taking a lease of? Is it a whole building (in which case the tenant would probably be responsible for all internal, external, and structural repairs and decoration) or an internal demise of only part of a building?
- Will the tenant have access to everything it needs (e.g. kitchen areas, toilets)? What about car parking?
Use:
- What are the premises going to be used for? Not only must the lease permit the intended use, but the tenant will need to check that the use is authorised under planning law. The landlord may permit a particular use, but a tenant could still find itself unable to use the premises, yet tied into the lease, if it doesn’t have the right planning permission.
Fit Out Works:
- Will the tenant need to carry out fit-out (or other) works before occupying the premises? Who will pay for them? Are any planning permissions needed? Should the tenant be obliged to remove the works at the end of the lease? How will the works be treated at rent review?
Service Charge:
- If the demise is internal and there are shared parts of the building, such as stairs and lifts, the tenant will often be expected to contribute to a service charge. This can vary year on year, depending on the expenditure required.
- How will the service charge be apportioned with other tenants in the building? Will there be a cap on the service charge? Are there items a tenant shouldn’t be expected to contribute to, such as the maintenance of the lift where the tenant only has a ground floor lease?
Rent Deposits and Guarantors:
- A landlord may require back up if the tenant doesn’t pay the rent or comply with its other obligations in the lease, such as a rent deposit or a guarantee. A tenant should take care with both options and consider, for example, the circumstances in which a landlord may use a rent deposit, and when and how it will be returned.
- Any guarantor must be made aware of their obligations, which are often very onerous and may include an obligation to take on the lease in their own name where the tenant defaults.
Signing HOTs:
- Don’t, unless they are clearly described as non-legally binding! In any event, HOTs should be expressed to be “subject to contract”.
- Remember, HOTs are not meant to be binding, so anything you want to make stick must also be contained in the lease (and ancillary documents).
For more information, please contact Lola Skuse or Tamara Paul.
