We are regularly approached to discuss a commercial tenants exit options. In this day and age, commercial tenants getting into financial difficulty is not uncommon and we are frequently asked ‘how can I get out of my lease’? Tenants may also want to exit their lease for other (better) reasons i.e. expansion – the premises which they are operating from have become too small, business is booming and they are looking for larger premises.
Fortunately, there are a few options available to tenants who want to ‘get out of a lease’ – some options more attractive and viable than others. These options are explored below:
Exercise a break option
One of the first ports of call for a commercial tenant should be to check its lease to check whether the lease includes a break option. A break option allows the tenant to exit a lease early, usually on a specific date or on a date which is for example, anytime after the fifth anniversary of the lease. If a lease is ‘broken’, the lease comes to an end, so it is an attractive way for the tenant to be released from liability under the lease, going forwards.
Tenants should however beware, even if the lease does contain a break option – there may be conditions attached to the break which the tenant must comply with. Common conditions include:
- The break date is on a specific date – usually break options are available at set intervals during the term of a lease. For example, in a ten-year lease, it would not be uncommon for a break option to be available at the fifth anniversary. If the break date has passed, the tenant will have lost its right to break;
- Serving at least three or (more commonly) six months’ written notice on the landlord. Tenants need to be careful here and should always seek legal advice when serving a break notice. There will be strict provisions in the lease as to how notices should be served and failure to serve a break notice correctly, could render the break invalid;
- Payment of all rents up to date on the break date. Tenants again need to be careful and look at what are reserved as ‘rents’ under the lease. Rents will inevitably include the annual rent reserved under the lease but they may also include other charges like service charge and insurance charges;
- Giving up vacant possession on the break date. Tenants should check whether they are obliged to hand the property back with vacant possession i.e. clear of all occupants, equipment and belongings or whether they are simply required to hand the property back without any occupants in it;
- A break notice penalty. These are fairly less common but if a penalty (i.e. a fixed sum of money payable to the landlord) is included in the lease, the tenant should ensure that this is paid on the correct date and in the correct manner.
Break options will bring the lease to an end (provided the conditions in the break option have been complied with) but they will still reserve a landlord’s right to pursue the tenant for a breach of covenant. For example, if the tenant has unpaid rent or has left the property in a poor state of repair – the landlord can still require these breaches to be remedied.
Assigning a lease
Depending on the terms of the lease, a commercial tenant may be able to assign (i.e. transfer) a lease to a third party (the assignee). This means that from completion of the assignment, the assignee becomes the tenant and is bound by the tenant covenants under the lease.
An assignment of the lease is a way of the tenant not being liable to comply with the lease covenants but it is usually not the end of the story for the tenant. Landlords will usually want to approve the new assignee and only give consent to the assignment if certain conditions are met. Common conditions on an assignment include:
- Obtaining the landlord’s consent to the assignment. This consent is usually documented in a licence to assign and the costs of the landlord’s solicitors in preparing the licence to assign are usually payable by the tenant. Landlords do have statutory obligations to respond to a request for consent in a timely manner and to only refuse consent where it is reasonable for them to do so;
- Obliging the tenant to guarantee the future performance of the assignee in an ‘authorised guarantee agreement’. This means that the tenant is liable for the assignee’s performance if the assignee defaults i.e. it will need to step into the shoes of the assignee if the assignee defaults. It is therefore essential that when a tenant assigns a lease, it checks out the financial position and covenant strength of the assignee;
- Obliging the assignee to provide a guarantor, to guarantee the assignee’s performance. This may be a personal guarantee from a director of the assignee or a parent company guarantee;
- Any arrears of rent or other sums due under the lease are paid by the tenant prior to the assignment.
If the lease allows, creating an underlease does allow the tenant to vacate the property and for a third party to take occupation. The creation of an underlease does not however, absolve a tenant from liability under a lease and it is often seen as a last resort. If for example, a lease demands a rent of £10,000.00 and the tenant creates an underlease and the underlease only demands a rent of £8,000.00 – the tenant will still have a direct contractual relationship with the landlord and have to pay the £2,000.00 shortfall every year.
As with assignments, if an underlease is permitted under the lease, there will be conditions attached to it so that the landlord can exert some control over who is in occupation and preserve the value of its reversionary interest. Common conditions include:
- Obtaining the landlord’s consent to the underlease. This consent is usually documented in a licence to underlet and the costs of the landlord’s solicitors in preparing the licence to underlet are usually payable by the tenant. Landlords do have statutory obligations to respond to a request for consent in a timely manner and to only effuse consent where it is reasonable for them to do so;
- The underlease being excluded from the security of tenure provisions contained in the Landlord and Tenant Act 1954. By excluding security of tenure, this will mean that when the contractual term of the underlease expires, the undertenant will have no statutory right to remain in occupation;
- The underlease rent to be not less than the rent charged under the lease and for the rent to be reviewed in the same manner and at the same times as the review of rent under the lease. This ensures that the landlord’s reversionary interest is protected and would provide the landlord with some protection if the tenant went bust, leaving the undertenant in occupation.
Negotiate an early surrender
A surrender of the lease is usually negotiated by the landlord and the tenant. The surrender will not usually benefit the landlord unless it has some advantage to end the lease early i.e. it has a ‘better’ tenant already lined up or the landlord wants to take the property back and occupy it himself. Due to the lack of benefits to a landlord, it is not uncommon for a landlord to ask the tenant for some sort of surrender payment i.e. a compensation payment. The surrender payment should be a realistic sum which compensates the landlord for its actual loss i.e. loss of rent for a period, the cost of finding a new tenant, the cost of putting the property back into a lettable condition etc.
If an early surrender has been agreed between the landlord and tenant, it would be prudent on both sides to get a formal deed of surrender drawn up. A deed of surrender will be conclusive evidence of the end of the lease and will usually contain releases for both the tenant and the landlord. In a formal surrender, the parties will want to ensure that their liability comes to an end when the surrender has completed and they are released from being obliged to comply with the covenants in the lease i.e. putting the property into repair, paying the rent.
If a formal surrender has not been agreed but the tenant vacates the property and the landlord takes the property back or takes some other act which unequivocally indicates that the landlord is treating the lease as at an end i.e. changing locks, re-entering the property, re-marketing the property to let etc, a surrender can be implied by conduct. This is a risky area for the tenant and it is always advisable for a formal deed (with the appropriate releases) to be completed.
For advice regarding your commercial lease and potential exit options, contact our commercial property team on 0116 289 7000 or email email@example.com.