Terminating & Renewing Leases of Business Premises

Published on 18 Nov 2008 under category: article

1. Introduction

These notes are a summary of basic rules that clients need to know when considering what to do about renewing or not renewing a lease of business premises - if they are tenants - or opposing and dealing with that renewal – if they are landlords. The rules summarised here are for leases that expired since 1st June 2004 and for ones which expired earlier if no termination notice was served before that date.

These notes are written by James Brenan of Cubism Law as general guidance only. They are not a substitute for proper advice on the specific facts of any situation. No responsibility is accepted for decisions taken without first obtaining specific advice from retained solicitors.

2. The Scope of Statutory Protection

The Landlord and Tenant Act 1954 in its current form (referred to here as “the Act”) grafts onto business leases an elaborate set of rules regarding the tenant’s right to renew and the landlord’s right to oppose renewal and lots of other ancillary issues.

The first thing you need to know is whether the tenancy you are concerned with is protected under the Act. In most situations that advice will be very straightforward but in some it will depend on detailed consideration of the facts. Here is a summary of the most common areas of difficulty: -

- if you are relying on an old court order or on compliance with the new procedure for excluding protection by agreement, take advice whether those rules were validly followed.

- agricultural and mining leases and all tenancies at will are outside the protection of the Act.

- any periodic tenancy is protected under the Act, no matter how short the periods are or how recently the tenancy was granted.

- a tenancy for a term of six months or less (with no tenant’s right to extend the term) is only protected if the tenant and any previous owner of its business has occupied the premises for more than a year.

- the Act’s protection only applies in so far as premises are occupied for the purpose of the tenant’s business and by employees of that business, but that occupancy can be extended into the remaining areas before the trial of a renewal claim in order to extend the tenant’s rights to the entire premises under the old lease and a landlord can voluntarily agree to the renewal lease comprising additional space which is not so occupied.

- a letting business of flats in a building does not count as business occupation whereas a market hall occupied by stallholders on personal licences does.

- premises used in breach of a covenant that generally prohibits business use or in similar breach of planning control are not protected.

3. Planning Ahead

In the year before the final year of a tenancy a landlord needs to check that he knows who is occupying the premises in all its parts and the legal basis of such occupancy. In case of any doubt the landlord can give a formal notice under section 40 requiring the tenant to give those details within a month.

At the same time the landlord needs to prepare its documents in support of any ground of opposition because litigation can start at any time once a notice of opposition has been given, as is explained further below.

If the landlord is not also the freehold owner of the premises then he needs to check and be sure that he is the “competent landlord” under the Act, because only a competent landlord can have conduct of the statutory notice procedure and my proceedings under the Act. The competent landlord is the first landlord up a chain who has an interest of at least 14 months un-expired, although a landlord whose own interest is a tenancy within the Act (and therefore subject to continuation) is treated as competent until a notice is served. The rules for establishing competent landlords need to be considered specifically in every situation where sub-leases are involved and are too detailed for any attempt at summary here.

Tenants should consider as early as possible if they can afford the rent and obligations of a renewal lease – by looking at comparable rents for other premises in their area and by seeking advice from a local valuer.

4. Identity of Occupant, Tenant, and Guarantor

Tenants should review which person actually holds the lease or a sub-lease, and take solicitors’ advice if this does not match the identity of the person or body that is in business occupation. This review should be carried out about two years before the lease runs out, to allow time for any adjustment of the position in order to protect rights of renewal.

A surety or guarantor party, for example under an “authorised guarantee agreement” pursuant to the Landlord and Tenant (Covenants) Act 1995, can not be required to continue providing their guarantee in respect of a renewal lease under the Act. Although a new lease can, if the court is persuaded, oblige the tenant to provide a satisfactory new guarantor within a specified period, this is a difficult area for landlords – who can easily find that they lose a good guarantor’s covenant on renewal.

There are particular rules concerning groups of companies, trusts and partnerships that need to be taken into account.

If premises are occupied for business by a sub-tenant then that party rather than the immediate tenant will be protected under the Act and the landlord is liable to lose the covenant of the immediate tenant. If the sub-tenant’s covenant is inferior to the immediate tenant’s then the landlord can seek and obtain additional security as a term of the renewal lease. Nonetheless, this problem is a reason why well-advised landlords are strict in scrutinising any application for licence to sub-let any premises where the lease is protected under the Act.

5. Statutory Termination Notices

If the existing lease is for a fixed term of one year or more either party can serve a notice to end the term. Where the existing lease is periodic or for a fixed term of less than one year only the landlord can serve such a notice. The landlord’s notice is served under section 25 of the Act and the tenant’s under section 26. There are prescribed forms for each. The form for a section 25 notice comes in two alternative versions, according to whether the landlord consents to or opposes a new lease.

The notice serves to confirm a date for termination of the existing lease, which must be on or after the contractual term date and not more than 12 months and not less than 6 months away, taken from the date of service.

A landlord’s notice under section 25 that does not oppose a new lease must set out the landlord’s proposals as to the property to be comprised in the new lease, the new rent payable, and other terms. A tenant’s notice under section 26 must do the same.

Any grounds of opposition (see below) need to be specified.

Where the landlord is operating a contractual right to break two notices should be given: a break notice under the lease and a section 25 notice (stating a ground of opposition).

Once one party has served such a notice then the other party can no longer do so. Once the tenant has served a section 26 notice the landlord has two months in which to serve a notice in reply, stating if it intends to oppose the new lease and its ground(s) of opposition.

Such a notice can stand as an offer capable of formal acceptance in order to create a contract for a lease. If the party giving the notice wishes to reserve a right of withdrawal, in case of a possible change of mind in the future, then the notice should be worded so that detailed terms remain to be determined by the court. (There is authority that a tactical section 26 notice can be given by a tenant who does not genuinely intend to take up a new lease - for example to try and establish whether the landlord intends to redevelop the property, which would be relevant to the tenant’s potential liability of dilapidations - but this step should only be taken under thorough advice.)

There are “deemed service” rules under this Act which rely on the date of sending, and so notices can be validly given even though they are not in fact ever received.

6. The Many Ways of Terminating a Protected Lease

The following three ways exist at common law:

(1) A tenant’s notice to quit or break notice. One of these can be given even after one of the statutory notices referred to below. However, where there is a sub-tenant in occupation who has the protection of the Act this will probably carry on regardless of the head-tenant giving notice to quit.

(2) Surrender - note that any agreement to surrender has to conform to the notice requirements of subsection 38(1).

(3) Forfeiture - which will kill off any sub-lease as well, but subject to the complex rules for obtaining relief. (See Cubism Law´s separate notes on “Forfeiture of Leases”.)

The following further ways exist under the Act:

(4) A landlord’s section 25 notice with application to the court for a new tenancy.

(5) A tenant’s section 26 notice with no such application.

(6) A landlord’s successful application to the court for the denial of a new tenancy under one of the statutory grounds.

(7) Disposal or dismissal or discontinuance of the tenant’s application to the court for a renewal tenancy and the expiry of a further 3 months.

(8) Expiry of a notice given by the tenant under subsection 27(1) stating that it does not want a new tenancy.

(9) The tenant duly vacating on the lease term date; this is risky for a tenant to rely upon in case it is late in clearing out.

(10) A tenant’s notice to landlord under subsection 27(2) stating that it does not wish the tenancy to continue and specifying any termination date. One of these cannot be served after a tenant’s section 26 notice or after an application has been made to the court.

(11) The parties can reach an agreement for a new tenancy under section 28.

(12) An order is made under subsection 31(2) terminating the tenancy within a year where the landlord narrowly failed to establish an intention under grounds (d), (e) or (f) and the tenant in effect consents (rather than waste money on a further round of litigation).

(13) The tenant applies to court within 14 days of the court fixing the terms of the new lease, under subsection 36(2) and the tenant then must pay costs of the case.

7. Grounds of Opposition: General Note

A landlord can only rely on grounds of opposition in subsequent proceedings that have been notified as above. However, if the tenant commits a breach of covenants in the intervening period the normal rules and remedies for forfeiture of the lease apply.

Any ground of opposition stated by a landlord in its section 25 notice or its counternotice to the section 26 notice must be genuine because including a hopeless ground renders the notice void.

8. The Seven Grounds of Opposition

These are:

(a) Disrepair - that must be so serious as to jeopardise the value of the landlord’s investment.

(b) Persistent delay in paying rent – though courts will often forgive this.

(c) Other substantial breaches of duties by the tenant or any other substantial reason connected with the tenant’s use or management of the premises that it occupies.

(d) Reasonable alternative accommodation – which has to be reasonable with regard to the terms of the present lease, the nature and class of the tenant’s business, and location and facilities of the present premises.

(e) Avoiding an uneconomic sub-division of a larger premises if the landlord owns the whole and the present lease was a sub-letting of part only.

(f) Landlord’s intention to demolish or reconstruct the premises occupied by the tenant’s business or to do substantial works on them which could not be done without obtaining possession. (The tenant may be able to raise a statutory defence to this ground – see below.)

(g) Landlord’s intention to occupy the premises itself, or with a partner, through an agent or a manager or a subsidiary company, either commercially or residentially – provided that the landlord has owned the reversion for the past 5 years (with an exception in favour of intended occupation by another company within the same group as the landlord company).

9. How to Prove Opposition under Ground (f) – advice to landlords

This is the ground that landlords rely on most often. Since proceedings can follow immediately after a notice or counternotice of opposition is given no landlord should rely on ground (f) unless it has to hand the necessary evidence. The evidence must show that within about 4 months after the date of the court hearing – 4 months being the typical interval it takes then to obtain possession if it were granted – the landlord will be in a position to demolish or redevelop the relevant premises. Thus the landlord will be expected to show the following four matters by documents and evidence of its witnesses:

(i) a fully formed intention to carry through a particular scheme of works, and a board resolution of a company would be appropriate to state this;

(ii) that planning permission exists for the proposed works (assuming it is necessary under planning laws) or is likely to exist immediately after that period of 4 months;

(iii) the funds or funding to be available without more to be drawn down at that time; and

(iv) it follows there must be a budget for the scheme of works and that will only be possible if there are architects’ drawings and specifications in place which have at least been put out to tender to building contractors and tenders obtained, unless possibly the landlord has direct labour for these works.

It may be necessary for a landlord to rely on expert evidence in order to prove this ground of opposition. This could be from a town planning consultant, or an architect or a surveyor – depending on the issues arising from its case.

The fact that a landlord intends to clear the tenant out of the site and then sell it with vacant possession is not enough to prove this ground, though it may assist for justifying a short lease or a break clause in the new lease.

10. How to Avoid Opposition under Ground (f) – advice to tenants

Instead of or as well as putting its landlord to proof as above, a tenant faced with landlord’s opposition under ground (f) can sometimes save its claim for a renewal lease by relying on one of the dispensations set out in section 31A. The first of these is for the tenant to agree to the new lease including terms for the landlord to have access and facilities which would reasonably enable the landlord’s intended scheme of work without interfering to a substantial extent or time with the tenant’s business.

The second of these is for the tenant to be willing to accept a new lease of an economically separable part of its business premises so that the first above condition is satisfied in respect of that part or to enable the landlord’s works to be done on the vacated part. The separation of the holding into parts in this way has to be economic from the point of view of the landlord, in that the combined rental values of the two parts (once completed) needs to be not substantially less than the rent reasonably obtainable for the whole premises as so improved.

Also, a tenant can sometimes exercise its contractual and/or statutory rights to carry out improvements and alterations to its premises as a way to pre-empt or defeat its landlord’s reliance on ground (f). This tactic requires careful planning and is best started in advance of the final year of the lease term, assuming that the tenant can then find out its landlord’s redevelopment plans – for example, by inspecting the planning register at the local council’s offices. Thus, the tenant commandeers the landlord’s own redevelopment scheme. This is risky because landlords can change their plans. It would not work where the landlord intends to merge the premises with adjacent ones.

11. Statutory Compensation

This is payable when a new lease is denied through the landlord’s reliance on any of the following grounds of opposition:-

Ground (e) - avoiding uneconomic division of formerly sub-let premises,

Ground (f) - intention to demolish or redevelop, and

Ground (g) – intention to occupy.

No Court proceedings are necessary from the tenant’s point of view, in order to obtain statutory compensation, if the tenant gives up the premises on expiration of its lease in response to landlord’s reliance on any of these three grounds of opposition alone. This right to compensation is liable to be lost if the tenant gives up occupation of the premises any earlier.

If the court at trial finds in favour of a landlord on one of those three grounds and on one or more of the other (non-compensation) grounds – (a) to (d) – the tenant can ask the court to certify that compensation should still be paid. This rarely arises, as tenants generally do not like to go to trial.

The amount of compensation is a multiple of the rateable value of the premises occupied by the tenant’s business as of the date of the section 25 notice or the landlord’s counternotice. If by the date of the tenant leaving the premises the tenant (or its predecessors in the same business) has been in occupation for more than 14 years the multiplier is 2. If that length of occupation is any less then the multiplier is 1.

If the tenant’s business occupation has expanded over time so that part of its premises have been occupied for more than 14 years, and part not, then there have to be separate calculations for each part.

This compensation is not taxable in the tenant’s hands as a capital gain. Nor does it attract VAT.

Tenants should beware entering into a surrender for similar compensation because then Capital Gains Tax and VAT will apply, and the landlord would also have to pay Stamp Duty on that amount. Thus a surrender is a different legal event – especially in its tax treatment – compared to a non-pursuance of statutory rights at term or notice expiry date in the face of a ground of opposition under the Act.

The amount of statutory compensation is a mere sop compared to the loss of goodwill and costs of relocation that any successful and location dependant business will suffer on loss of its premises.

12. Tax Position of Statutory Compensation

This compensation is not subject to tax as a capital gain because it arises by operation of law rather than on the disposal of an asset. Nor is the payment liable to income tax, since it is of a capital nature.

Tax liability is triggered though if a tenant receives a sum of money for surrendering his lease other than by following the Act’s procedures.

The Inland Revenue accept that receipt of such compensation by a tenant after the landlord has formally raised a qualifying ground of objection does not trigger a tax liability.

13. Damages for Misrepresentation

To prevent the Act being used cynically by landlords to gain vacant possession of their premises just for the ease of selling them or re-letting them from empty, the Act provides that a tenant who vacates its premises or is ordered to do so as a result of some misrepresentation or concealment of material facts can later apply to the court for compensation to cover its resulting loss or damage. It appears that only the tenant victim’s loss is recoverable here, rather than wrongdoer’s profit – and so the Act does not award “disgorgement damages” - but that loss may still be great.

14. Starting Court Proceedings

Unless there is some real commercial advantage that stands to be lost by the additional time which it takes, your solicitor should attempt to resolve any dispute by correspondence with the opposing party or their solicitor, before resolving to the issue of proceedings.

Once a landlord has served either a section 25 notice stating a ground of opposition or a counternotice of opposition to the tenant’s section 26 notice he can issue a claim before the court for an order that no renewal tenancy is to be granted. This claim must set out details of the ground of opposition and, in case the opposition fails, it must also propose terms of a renewal lease.

A tenant can issue a claim before the court for a renewal tenancy once two months have passed after the landlord’s section 25 notice or its own section 26 notice.

If neither party issues such a claim by the date specified in the relevant notice under section 25 or section 26 for termination of the existing lease then the tenant’s right to renewal lapses and the tenant must vacate the premises. However, the parties can extend this deadline by written agreement - which a solicitor should prepare.

The tenant’s claim is required to state a number of detailed matters to do with its business, ownership through any company or trust, whether it relies on section 31A as above, whether any part of its premises is not occupied by the tenant or an employee for its business, proposed new terms of lease and certain details of persons known to be interested in the reversion.

A landlord’s claim is required to state the grounds of opposition, details of the grounds and terms of any new tenancy proposed to be granted in case the claim fails.

Once issued the claim needs to be served within 2 months, rather than 4 months which applies to most other litigation. Any contested renewal or termination claim has to be issued and proceed under Part 7 of the Civil Procedure Rules, and the Part 8 procedure is reserved for only the uncontested ones.

15. Progress of Court Proceedings

The defendant party is required as usual to acknowledge service within 14 days and file its defence within a further 14 days. A formal reply is sometimes given by the claimant party to answer any new points raised in the defence. Either side can raise a formal request for further information – e.g. to seek full particulars of the landlord’s intended scheme for redevelopment or to probe circumstances that will be important in deciding on new lease terms.

A landlord should issue its proposed draft lease as soon as possible in order to open up correspondence on any drafting issues.

The parties will be required to file questionnaires in the normal way and the case will come before the court for a case management conference within about 3 months of service of the claim.

At the conference the court gives directions on a number of matters, including:

- whether to try any point first as a preliminary issue, such as a ground of opposition or a question as to the correct premises for the renewal lease,

- issue of the draft lease and negotiations over its contents,

- permission to call expert witnesses on each side, or a single joint expert possibly in a small case, and a time-table for the experts to confer over measurements, comparables and exchange of reports,

- exchange of witness statements on any contested issues of fact – for example, concerning the need for certain new clauses in the renewal lease, and

- to allocate the case to track and a period for the trial.

There can be several interim hearings in more complicated cases or when parties fall behind with compliance with previous directions.

A landlord can amend its case, for example to propose a break clause for redevelopment in the terms of the new lease, at any stage before the case reaches trial.

16. The Contents of the Renewal Lease

The term cannot exceed 15 years and otherwise is a matter for the parties to agree or for the court to decide in view of their cases and evidence.

The rent will be the new open market rent for the particular lease terms to be granted - disregarding the business occupation and goodwill, and any enhancement or reduction of value due any improvement made voluntarily by the tenant or its predecessor during the current lease term or the preceding 21 years.

The other covenants in the lease will be agreed or laid down by the court applying principles from the House of Lords’ decision in the case of O’ May -v- City of London Corporation. These principles require the new lease to follow the wording of the old one unless a party seeking a change can justify that change as being fair and reasonable. A permitted change can be compensated by an adjustment in the rent and it should not materially impair the tenant’s security in its business. Thus the court would never exclude protection under the 1954 Act for a renewal lease.

The new rent is the last matter for the court to decide. The court will not allow a landlord to alter substantially the scheme of the lease in regard to repairs or services to be provided against a tenant’s wishes and to suit the landlord’s preferences.

The party seeking change will have to give evidence to support it if the matter goes to trial.

The renewal lease will be allowed to be updated to take account of new legislation. With regard to the Landlord and Tenant (Covenants) Act 1995 the courts favour imposing new terms that are more sympathetic to the tenant – and so, for example, the landlord’s right to require an authorised guarantee agreement or to demand guarantors for a proposed assignee of the lease is to be subject to a requirement of reasonableness. There can therefore be significant differences – for the tenant’s benefit – between a lease that is renewed under this Act and one that the landlord can grant on the open market in respect of an empty premises. The court does not regard “market practice” - assuming that were proveable in evidence – as the basis for deciding the contents of detailed clauses in the renewal lease and certainly is not bound by standard requirements of institutional investors and lenders.

This is one of the major advantages of statutory protection for tenants. It is therefore also a good reason for landlords, when letting from empty, to insist that the lease is excluded by formal agreement from protection under the 1954 Act.

A break clause will be allowed where the circumstances warrant it – regarding the potential for early redevelopment by the present landlord or a future one. A party that seeks a break clause has to request it within its statement of case, i.e. particulars of claim or answer, at the beginning of the proceedings or by way of amendment later on.

If the existing lease has no rent review clause then the tenant should insist that any new rent review clause is for downwards as well as upwards review. If there is an “upwards only” clause in the old lease this will be permitted to be repeated in the new one – although the initial rent fixed by the court may of course be a reduction against the passing rent.

Outstanding disrepair and any condition for reinstatement in any previous licence for alterations need to be considered, particularly by landlords, before the draft new lease is put forward.

17. Withdrawal and Discontinuance

A tenant need not exercise its rights under the Act. It can just vacate on or before the contractual term date or it can give 3 months’ notice to this effect under section 27. Tenants considering vacating should, as ever, beware of terminal dilapidations claims. However, terminal dilapidations claims are unlikely when the landlord relies on ground (f), due to the statutory cap on such claims limiting them to the diminution in value of landlord’s reversion.

In response to a section 25 notice or after giving a section 26 notice (but on changing its mind) a tenant can also give notice of 3 months to end the tenancy on the old term date or later.

After the tenant has commenced proceedings it can discontinue by formal notice and then its right to occupy will lapse on the later of the term date or after 3 months. If the landlord issues proceedings and the tenant does not want a new lease, the tenant should so notify the landlord and the court and that will dispose of the matter.

Discontinuance will trigger a liability for costs unless the court can be persuaded to order otherwise.

If a case goes to trial and the court then fixes the terms of a new lease the tenant has only 14 days in which to apply to the court to be released from those terms: the court will release the tenant and probably award costs to the landlord for the abortive litigation.

18. Interim Rent

Once a lease’s contractual term date has passed or a periodic term has been ended by a section 25 notice, either party can apply to the court for an interim rent to be fixed. This will cover the interval between the earliest date that could have been specified in a section 25 or section 26 notice and the date when a new lease terms starts or when the premises revert back to the landlord. Such an application can only be made within 6 months after the termination date of the existing tenancy.

There is now less scope for the interim rent to differ from the new rent that the court eventually fixes or the parties agree for the renewal lease. There is still scope for a difference where either the area of the new demise is smaller than the old one due to parts of the old demise not being in business occupation or the landlord objects to anew tenancy being created (which puts the tenant’s title in some jeopardy).

When fixing such interim rent in its discretion the court will assume a yearly tenancy and have regard to the rent payable under the tenancy and any sub-tenancy. In these situations the interim rent is typically fixed at around 10% to 15% less than the new rent. Other factors can cause variance from this norm, such as a very low passing rent or landlords’ breaches of covenants.

A tenant should apply for an interim rent if it thinks that the market rent is below the passing rent.

19. Stamp Duty Land Tax

This tax is payable on the rent which falls due from the date when the original lease ends until the formal grant of new lease or other termination of the statutory continuation. (This taxable rent amount may by greater or even less than the old passing rent, depending on the operation of the above “interim rent” procedure or an agreement by way of compromise.) Stamp Duty Land Tax is also of course payable on the new lease that you may eventually obtain. Your solicitor must be astute to make the necessary declarations on time to Her Majesty’s Revenue & Customs, or else you stand to become liable for penalty tax and interest.