Varying leases: avoiding the pitfalls


In a series of video insights on issues affecting real estate, Philip Collis and Alexandra Holsgrove Jones look at varying leases. 

  • If the alterations clause in a lease is too restrictive, could the tenant get it varied?
  • What could the impact be on other lease provisions?
  • What do you need to think about if you agree an extension to the term?
  • Should you use a side letter?
  • Will it bind successors?
  • What can happen if a guarantor doesn’t consent to a lease variation? 

Varying leases: avoiding the pitfalls

Transcription

Alexandra Holsgrove Jones:

Welcome to another of our TLT taster sessions, looking at current issues affecting the real estate sector. I'm Alexandra Holsgrove-Jones, senior professional support lawyer in TLT's Real Estate Group. And I'm, again, joined by Philip Collis, a partner who specialises in property-backed security and landlord and tenant work.

Alexandra Holsgrove Jones:

In a previous session, we talked about drafting for pandemics in the context of new leases, but what if you're looking at an existing lease? Today, we'll be looking at the pitfalls to avoid when varying a lease. So, Phil, owing to the current pandemic, lots of tenants are requesting variations to their leases. That could be to vary rental terms, or to include a break option. The landlord may agree to these variations in return for something else, perhaps an extension to the term in return for a rent-free period. Could we just run through some of the traps to avoid in documenting these variations? Firstly, let's look at the scenario where the parties agree to a rent-free period, but to take account of that rent-free, the term of the lease is going to be extended for a term equal to the length of the rent-free period.

Philip Collis:

Well, Alex, extending the term of the lease amounts to a deemed surrender and regrant of it. That means that, even if you document it by a deed of variation, it will take effect at law as a surrender of the existing lease, and the grant of a new one. This can cause particular problems if the lease is to be contracted out of the security of tenure provisions, of the Landlord and Tenant Act 1954. This is because the statutory procedure that had been carried out in relation to the existing lease would not apply to the lease granted by the deemed surrender and regrant. The tenant would also have to pay stamp duty land tax on the grant of the new lease, but may, if the conditions were met, be able to claim overlap lease. Therefore, for these reasons and more, deemed surrenders and regrants are to be avoided, or at least very carefully managed.

Alexandra Holsgrove Jones:

If we don't want the arrangement to take effect as a deemed surrender and regrant, and the parties don't actually want to surrender the existing lease and enter into a new one, so as to avoid any 1954 Act issues, how could they document the arrangement?

Philip Collis:

Yeah, well, there are other ways of doing it. One option is to grant a reversionary lease, which is where you grant at lease to take effect at a future date, i.e., at the point of termination or expiry of the existing lease. A couple of points to note about these. Firstly, it will be void if the term won't begin for more than 21 years after the date of grant. Unlikely, to be an issue in most circumstances, as the terms mostly sort of under 10 years. More importantly, if it's going to take effect more than three months after it is granted, which is quite likely, you need to register it at the Land Registry, regardless of the length of the term, which is different from most other circumstances and scenarios. You could find yourself having to register a lease with a term only a few months. Which isn't problematic, but as I say, is unusual, and can often be missed. There are other issues to consider with reversionary leases, for example, you need to remember to link termination and alienation provisions with the existing lease, so that the two go along together.

Alexandra Holsgrove Jones:

What about SDLT, stamp duty land tax, on the reversionary lease? When does that have to be paid?

Philip Collis:

The effective date for SDLT purposes is the date of the grant, rather than the date of the term commencement. The window filing and payment will start running on the date on which the lease is granted, which obviously a long time before the term actually starts.

Alexandra Holsgrove Jones:

Another scenario that it might be useful to explore is when the parties agree to a change in payment terms, perhaps from quarterly to monthly. Or they may agree to a rent reduction for a period of time, or allow a longer time to pay the rent. How should that be documented? Could they just change the terms by using a side letter?

Philip Collis:

Well, the parties to the lease need to consider whether the concession is just a temporary one, or if they are intending to vary the lease on a longer permanent basis. If it is a waiver or deferral rather than a variation, then it may well be more appropriate to use a side letter. Consideration needs to be given whether the variations, whether the waiver, whether the deferral, et cetera, is to be binding on assignees, both of the lease, and of the landlord's interest. The impact of a side letter on other lease provisions should also be taken account. For example, what is the effect on the landlord's right to forfeit under the lease?

Alexandra Holsgrove Jones:

Thanks Phil. There may also be tax implications to consider, and I'll be looking at the tax issues involved in varying leases and introducing break clauses in another session. Now in our session on drafting for a pandemic, we looked at break clauses. Tenants with existing leases may want to vary their lease, include a option break. Perhaps if their business model has changed as a result of the pandemic and they think they may no longer require premises in the future. We've discussed extending the term, even documented, using a deed of variation, would amount to a surrender and regrant. Is the same true of varying the lease to include a break option?

Philip Collis:

No, no, it's not the same. That could be quite properly documented by using a deed variation. They should however, consider whether the break is personal to the existing tenant or whether it should remain in place if the tenant to assign the lease to someone else. As with all variations, it is important not to consider them in isolation, and instead to look at the lease as a whole. So variations could, for example, have an impact on the open market rent review, so that if more advantageous to the tenant, rent from the review could be greater than it could have been without the break, so that may well need to be dealt with as well if that is not what is intended.

Alexandra Holsgrove Jones:

And what if there is a guarantor to the lease, does that guarantor need to consent to the variation?

Philip Collis:

The basic rule is that a guarantor will be released from liability under its guarantee. If firstly, the terms of the lease are varied. And secondly, that that variation is binding on the party whose liability the guarantor has guaranteed. In the case of a lease, that will obviously be the tenant. Also, thirdly, the guarantor hasn't consented to the variation. So whilst most leases will contain provision saying that liability of the guarantor will not be affected by any future variations, it is always best practice to ensure that you get the guarantor's consent. And the simplest way of doing that is to make them a party to the deed of variation.

Alexandra Holsgrove Jones:

Thanks, Phil. And we'll be looking at guarantors and potential release from their liabilities in the context of alterations, in our session on alterations clauses. Thank you for joining us. If you have any questions on the points that we've discussed, please get in touch and you can also sign up for future TLT taster sessions.

 

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