A tenants guide to reducing business space

Widespread working from home due to the Covid19 pandemic has prompted many organisations to consider reducing their business space. Nick Carter (Head of Commercial Property) and Russell May (Head of Property Dispute Resolution) at Boyes Turner, along with David Thomas (Occupier Advisory) at Vail Williams LLP take us through some of the key issues and outline the options available for most commercial tenants. This is the first in a series of two articles looking at the legal, employment and practical issues of returning to the office

The coronavirus pandemic has given business leaders a significant reason to reflect on how much business space they need and how they use it.

Leaders will be making judgments on how home working has affected their business, both positively and negatively. Many businesses will introduce a more flexible approach and will not expect all of their people to be in the office all of the time.  

We have been helping business leaders navigate the following issues and questions, as they look for ways to reduce their business space. 

Can I terminate my lease early?

We are receiving an increasing number of enquiries about whether leases can be terminated early, whether a disposal is possible or if the size of the space occupied can be reduced. You should approach these decisions in the context of your anticipated working practices in the short, medium and long term and with a view to maintaining your business’s corporate culture, brand and innovation.

Although we have seen landlords offering much more flexible terms in traditional leases over the last five years the average length of a traditional lease in 2019 was still 6.7 years for industrial space and just over six years for offices. This is far longer than the more flexible “serviced office” or “co-location” models where it is easier to upsize or downsize in line with your business model. However, there has been hesitancy around these shared spaces during the pandemic where there is limited control over who you are sharing the space with. With the economic downturn the ability to shed this space at short notice and return to spare bedrooms or garden workrooms to save costs has appealed to some business leaders.

Unless a tenant secured a right to terminate a lease early, by way of a break clause, a tenant will usually be limited to some standard options. The main options are to put the lease on the market with commercial agents and look to either assign (or transfer) the lease to a new tenant or to stay as tenant of the lease but to grant an underlease of either the whole, or just a part of the space, to a new undertenant. Even if the lease does not permit an underletting of part, the landlord may consider granting consent to this if another tenant can be found for the unwanted space. 

However, with many companies still employing a work from home policy and other companies looking to market their space, supply has, in some areas, increased dramatically with corresponding reduction in demand making prospects of disposal challenging.

There may also be a possibility of surrendering the lease back to the landlord (equivalent of tearing it up) but this method is usually only attractive to a landlord if they can make better use of the property, by finding a better tenant or by perhaps developing it.

In many cases where there is a relatively short term unexpired or forthcoming break date there are many landlords willing to enter into negotiations to regear leases on smaller spaces or allow relocations within buildings or estates in order to support tenants “rightsizing” their space for new working practices.

Finally, most leases allow tenants to share occupation of the premises with another business, but these rights usually limit sharing with group companies and prohibit the grant of any lease. We are often asked if a licence can be entered into with another business to use a particular room, or area, but this sort of informal sharing arrangement will be prohibited in the lease, except in limited circumstances where a tenant is part of a wider group structure. 

Can I simply walk away from my lease due to Covid-19?

Leases do not usually contain force majeure clauses which allow termination of a contract due to unforeseen circumstances such as Covid-19. Even if they did there is doubt if this would suffice to allow you to walk away from the lease due to the temporary nature of the disease.

It is not usually possible to end a commercial lease early unless there is a contractual right to do so, known as a break clause. We have seen a flurry of requests to serve break notices, but we urge caution if you are thinking of doing this without seeking advice, as we see many examples of situations where break notices are held as invalid due to unforeseen issues.

How can I use the break clause in my lease?

The Courts interpret break clauses and break notices and the conditions that need to be met to enable a tenant to validly end the lease very strictly indeed. This has led the Court to find that many attempts to end leases were invalid for what may seem like bizarre reasons. For example, in one case the Court said that if a break notice needed to be served on blue paper it would be invalid if it was actually served on pink paper, however clear it might have been that the tenant wanted to terminate. Occupiers should check the conditions carefully and seek early advice. The following conditions are common:

• Six months (or more) prior written notice must be given. 

Many tenants do not know that a lease will also set out the required method of service in a separate clause to the break clause and will fail to follow that method. Emails are generally not acceptable, and the small print often states that notices by letter are deemed served two or three days after posting which can catch many tenants out and make many notices invalid even if actually received earlier before the last date for service! Hand delivery is usually permitted and is advisable if at all possible.

• Payment of the rents due up to the break date must be made. 

We see many instances where tenants apportion their rent to the break date and as such invalidate the break notice. Leases often provide for rent payments to be made quarterly in advance, and if that is the case then the full quarter’s rent will need to be paid when it falls due, even if the break date is part way through the quarter. 

This is an even greater trap during these uncertain economic times due to Covid-19, with many landlords agreeing to accept monthly rental payments rather than quarterly. Such informal agreements (even if in an informal letter) will not override the provisions of the break clause, and an unwary tenant may think that they are up to date with their rent, when in fact they have just invalidated their break clause. It is important never to apportion rents to the break date and pay them in full and then ask for a reimbursement of any overpayment to secure a clean break.

• Giving up “vacant possession” on the break date.

Although becoming less common this condition is still seen regularly, particularly in leases that were granted before 2015. This wording can cause unexpected breaches. Case law has decided that vacant possession can amount to more than simply vacating the premises and returning the keys to the landlord. The Courts have decided that these words can include a requirement to carry out certain works such as the removal of alterations carried out. If any alterations have been made, even if just erecting some partitioning, expert advice should be sought as to what works need to be done to ensure vacant possession.

Can I get better terms if I agree not to exercise the right to break?

Having a right to terminate early can also provide the necessary lever to open negotiations with a landlord to obtain better terms, such as a rent holiday or reduced lease payments for the remainder of the term. 

However, we see many opportunities missed because there is not enough time to legally document that agreement before the last date to serve the notice passes. For a lease variation to be legally valid it has to be contained within a formal Deed of Variation. Informal agreements are not legally binding and can be challenged by a landlord. The process usually takes a good few weeks to get professional advice and to document an agreement, so diarising well in advance is key. 

If there is no time to do a deal a tenant may consider exercising the break clause and then try to negotiate better terms. The issue with this is that once a break notice has been served it cannot be legally withdrawn by a tenant or waived by a landlord. Any informal waiver could be later challenged by the landlord as it would not be legally binding. Also, the landlord may have other plans for the building, such as residential redevelopment, or may simply not be willing to agree less favourable terms. The tenant may be left looking for alternative premises much more quickly than it had bargained for, causing serious disruption to its business.

What are the legal hurdles to disposing of a lease by an assignment or underletting the whole or part of the space?

The main legal hurdle is complying with the conditions in the lease to enable you to dispose of space and in particular in obtaining formal consent from the landlord. There are some traps and key issues to look out for when submitting and dealing with applications for consent under a lease.

The key principles are not only set out in the terms of leases themselves but are governed by a strict statutory regime. The main purpose is to protect tenants and facilitate the marketability of properties.

Getting this wrong can result in delays in getting rid of unwanted space and if that delay causes a potential tenant to walk away it can lead to claims for damages against a landlord for unreasonably withholding consent.

The majority of commercial leases provide that a landlord cannot unreasonably withhold or delay consent to applications to assign or sublet a lease or to carry out alterations. The statutory regime dictates how the landlord should respond to applications.

Key issues for tenants

• The Courts have decided that a “reasonable time” for a landlord to give consent can be a matter of weeks, not months. This depends upon the circumstances and the quality of information provided to a landlord to enable them to consider the application. If all necessary information is given in good time then the time can be brought forward, especially where a tenant makes it clear that the application is urgent.

• Start the clock on what is a “reasonable time” by properly applying for consent. This means following the method for service of notices set out in the lease. Delays can happen where the tenant simply speaks to or emails the landlord or its agent and doesn’t make it clear that a request is a formal application under the terms of the lease. A lease will usually state that a notice needs to be in a letter, often served at the landlord’s registered office. 

• The application should contain all necessary information that the landlord will need to consider. This should include the full legal identity of the proposed new tenant and sufficient financial information to enable the landlord to determine the financial standing (i.e., whether they will be able to pay the rent and perform the lease covenants). Typically, landlords ask for copies of the last three sets of audited accounts and sometimes references. A rule of thumb is that landlords want to see three consecutive sets of accounts showing net profit equal to at least three times the rent. If this is not possible, say where the proposed new tenant is a new company without a trading history, a landlord may require a guarantor or rent deposit. Therefore, some early consideration to this is helpful. 

• Tenants should note that they will need to cover the landlord’s professional legal and surveyor’s costs, as well as their own, in respect of the application. Tenants should therefore expect their solicitor to ask for funds on account as they will be asked to give a legal undertaking at the outset that the solicitor will pay the landlord for their legal and surveyor’s costs on completion. 

When might a surrender of the lease to the landlord be an option?

It is technically possible to surrender a lease, effectively ending all obligations and liabilities for both the landlord and tenant at any time. This could be a surrender of the whole property or just a part of it. This can be effected either formally by a “Deed of Surrender” or, if certain conditions are met, by simple agreement with the landlord, which will include handing back the keys.

A lease will not include a right to surrender. Therefore, it will only be attractive to a landlord if it can use the property in a better way. A surrender of a lease often happens if a new tenant can be found. Instead of having to assign the existing lease to that tenant, the landlord may agree to accept a surrender and simultaneously grant a new lease to the new occupier. We have recently documented such a deal for a business in Oxford and it creates a win-win situation. 

In a challenging economic climate, such as we are facing now, a landlord is probably going to be concerned about finding another suitable tenant and so may refuse consent or increase its demands. Sometimes a surrender is only acceptable when an additional “surrender premium” is offered, perhaps equating to the outstanding rents, business rates liability, service charges to the end of the term and for costs towards putting the property back into good repair and condition (“dilapidations”).