Lease re-gearing: communication, continuation and not determination of a lease

Date published

18/11/2020

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As a tenant, if you were to review your lease obligations during a time when the country and the world was functioning as normal you may have limited concerns over complying with those obligations. However, as the economy has transformed since March 2020, there is a continued demand for change by occupiers who find themselves locked into lease arrangements that may no longer be suitable for their business.

Whilst the terms of a lease can only be changed by agreement, collaboration between landlords and tenants, as evidenced by the introduction of the recent COVID-19 Code of Practice for Commercial Property Relationships, is being encouraged to ensure the collective survival of those financially impacted by the current crisis. In these circumstances, re-gearing of leases is a good option for both parties.

What is re-gearing?

Re-gearing is a process that allows landlords and tenants to renegotiate and amend existing lease terms. The newly agreed terms can be documented by way of a reversionary lease and/or a deed of variation or side letter.

Examples of re-gearing provisions include granting tenants:

  • The ability to pay rents monthly rather than quarterly to assist cash flow
  • Rent reductions or rent-free periods to cover lockdown periods
  • Rental payments based on turnover rather than fixed rent payments
  • Nil increase rent reviews for those review dates which have passed
  • A reduction/freeze on service charge payments, especially on the basis of non-occupation of premises in a centre
  • An amendment to the user of the premises which offers a wider user class (subject to planning)
  • Agreeing to sub-letting clauses (of whole or part) if these are not included in the lease already and/or
  • A rental repayment plan in respect of existing rent arrears.

Whilst the above re-gear terms would favour the tenant, there needs to be a balance. Landlords could therefore agree to the granting of these concessions on the basis that:

  • The tenant’s right to break a lease in the future is removed and/or
  • A new reversionary lease is entered into by the parties which will apply from the day after the current lease expires thereby extending the tenant’s occupation of the premises for a fixed term.

Re-gearing will not only provide the occupier with some breathing space, it will also allow both parties in the long term to enhance and develop their goodwill, income and business relationships. A refusal to negotiate and a subsequent failure by a tenant to pay the rents could prove costly to a landlord as any income (however small) they had from the premises will be lost. Consequently, they may have to pay business rates and cover service charge voids as well as increased security costs for empty premises. The mantra should therefore be continuation of the lease and not the determination of it depending on the circumstances.

The consequences to be aware of when entering into any re-gears

Although re-gearing may be the perfect solution in this current storm, there are potential pitfalls that need to be considered and advice obtained before any final decisions are made to amend the existing lease terms as set out in the table below:

Party

Considerations

Landlord

 

Accidental release of a guarantor’s obligations under the original lease

Ensure that any guarantor is named as a party in a deed of variation and reversionary lease

Granting security of tenure to a tenant whose original lease was contracted out of the Landlord and Tenant Act 1954

Ensure that any reversionary leases are granted outside of the security of tenure provisions of the 1954 Act

Any lease agreement variations may require the prior consent of a superior landlord or lender (where applicable)

Check the lease requirements carefully to ensure the landlord is not breaching the terms of its lease or any facility agreements

New method of rent payment (from fixed to turnover rents)

Consider whether any changes are to be temporary or permanent.

 

Before agreeing to any changes to the rent, advice should be taken from a surveyor. As turnover rents require a lot of information from a tenant, appropriate IT systems should be in place to ensure the correct rent is being paid from the evidence the tenant provides

Tenant

 

Documenting the revised terms

A landlord may only be willing to grant concessions temporarily by way of a side letter rather than by a deed of variation so such letter needs to be checked carefully to ensure it covers all concessions granted and applies to successors in title for the landlord

Certain types of variations can result in a deemed surrender and re-grant of a lease, which will have stamp duty land tax (SDLT) and Land Registry implications

Take legal advice before agreeing to any variations as it could prove costly and will avoid unnecessary payment of SDLT and Land Registry fees by the tenant

Comment

Communication is key to a landlord and tenant relationship as well as transparency. A re-gear will only work and be approved by all stakeholders if the parties understand the difficulties facing their businesses. In this way, a compromise can be reached without being detrimental to one particular party.

Ongoing dialogue needs to occur as we are in a fluid situation with a second lockdown and no end in sight. It is now apparent that the current climate is going to be the new norm for a while. So, whilst re-gears of leases may have to be revisited, perseverance, flexibility and a willingness to re-negotiate is key to help businesses and the economy survive.

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