Tim Rayner offers a straightforward guide to the options facing corporates thinking about downsizing.
A recent poll by the Institute of Directors revealed 50% of businesses said that their intended use of the workplace in the long-term will be slightly or significantly less. This probably reflects, in part at least, some move to flexible working, which is almost certainly here to stay in some form.
Whatever the long-term trend, in the short-term most businesses will be looking at their property requirements and trying to make savings where possible, and that may extend to exiting from some offices altogether.
Concession/waiver
The obvious start in seeking to reduce property costs is to see if the landlord will agree to a temporary concession or waiver of some or all the rent. The government’s code of practice for commercial property relationships during the Covid-19 pandemic, released in June, identifies the main options available to landlords and tenants if both parties are keen to try and find a solution.
Termination by surrender
Tenants keen to exit from their leases entirely may seek to agree an early surrender. This will require the landlord’s consent. However, unless the landlord has another tenant lined up, that consent will likely come at a premium. In calculating that premium, landlords frequently factor in the rent and other lost income to the end of the term, as well as the tenant’s likely dilapidations liability. A surrender could be prohibitively expensive in the current climate as landlords will try to claw back as much of the future lost income and expenditure as possible.
Simply abandoning a property will not terminate the lease or the liabilities arising under it, unless coupled with a positive act on the landlord’s part of taking back possession (for instance by accepting the keys unreservedly and/or going back into possession). It is unlikely in the current market that any properly advised landlord will inadvertently accept a surrender of lease in this way.
Exercising a break right
If the landlord is not willing to consider a surrender but a tenant wants to exit early, it may want to consider if the lease has any express break rights. Broadly, this is the only way a tenant can unilaterally terminate a fixed-term lease early.
To exercise the break successfully, certain conditions will need to be complied with. As a minimum, the tenant will be required to give prior notice in writing.
Leases often contain additional preconditions which need to be satisfied for the lease to be broken. For instance, the tenant may be required to pay the rents due or ensure the property is free of occupiers or give vacant possession. These more basic preconditions may not always be what they seem. Some breaks are even more onerous and might require full or perhaps “material” compliance with all lease covenants. With these more onerous breaks, there can be much uncertainty as to what needs to be done to ensure they are successfully exercised. Well-advised tenants will usually need to adopt a twin-track approach, seeking to comply with the conditions as best they can, while encouraging the landlord to accept a surrender and a payment in lieu of compliance.
In almost all cases, it will be necessary to instruct a solicitor to serve notices and provide advice, particularly in the current climate where landlords may be keen to hang on to their rental incomes for as long as possible and find ways to argue a break has not been properly exercised.
It is not unheard of for tenants to tactically give notice to break a lease of a property they intend to continue to occupy, in order to prompt the landlord to offer a rental reduction, especially in a weaker market. This can be effective, but remains a risky option, not least because once served, a break notice cannot be withdrawn, even by agreement.
The very topical alternative to a break is the argument that a lease has been “frustrated” by the pandemic. Much has been said about the legal niceties of this argument. In reality, termination by frustration is likely to be applicable in only very limited circumstances.
Expiry of fixed term
If a lease is excluded from the Landlord and Tenant Act 1954 then it will end automatically without the need for a notice.
Even if the lease is protected by the 1954 Act, provided the tenant is out of occupation by the expiry date, the lease will come to an end, again without the need to give notice.
Assign/sublet
If the lease does not contain a break right and a reasonable surrender offer is not forthcoming, a tenant may want to consider assigning or subletting in order to try to recover some rent for the property. The barrier for either of these options is finding a tenant willing to take the lease on. The second barrier is that both assigning and subletting will usually be subject to consent from the landlord, acting reasonably. That consent may come with conditions. In respect of an assignment, a landlord may be able to insist on a guarantee by the tenant of the assignee’s obligations; and for different reasons a tenant will remain liable in the event of default of a subtenant. The covenant strength of the assignee/subtenant is therefore important.
A main difference between these two options is that a sub-tenant will have no direct contractual relationship with the landlord. This can have numerous implications but is often particularly relevant in respect of dilapidations at the end of the term. Even if a tenant can pass on some of the dilapidations claim “down the chain” to the sub-tenant, the tenant will still be on the hook for the whole claim and responsible to recover what it can from the sub-tenant.
Sharing occupation
There have been examples in the retail sector of co-retailing (sharing retail premises with another retailer), and perhaps this will become more prevalent in the corporate occupier sector as well. If consent is forthcoming from the landlord, then it may well be that the main difficulties will be operational in terms of sharing a workspace with another corporate occupier.
Service charges
In these Covid-19 affected times, tenants will wish to minimise their service charge expenditure and they should speak to their landlords first to minimise this. Should that fail, the following may be worth some investigation:
- Are the services being provided actually listed in the lease? If not, is there a general sweeping up provision which might give the landlords more freedom to recharge for services even if not specifically listed?
- Is the level of charges reasonable for the services provided?
- Are the service charges otherwise reasonable? A tenant may avoid or reduce liability if the charges relate to works which are of a long-term nature, but the tenant has a short lease.
- Has the landlord complied strictly with the mechanism of the service charge provisions? Did the landlord provide an estimate at the start of the year, has the actual expenditure been properly certified and were the accounts sent out within the requisite period after the end of the service charge year?
Dilapidations
Dilapidations (the law and practice concerning obligations relating to the physical condition of the premises) can be a significant cost for tenants and need to be considered as part of any overall exit strategy.
Unless a tenant has undertaken a regular programme of maintenance – and even then – it will almost certainly face a claim by the landlord for damages for “terminal” (or end-of-lease) dilapidations.
Generally, the more the property has been looked after during the term, the lower the landlord’s dilapidations claim. Undertaking works before the end of the lease should have the effect of reducing the landlord’s associated claims for professional costs, lost rent and interest.
However, incurring costs in undertaking remedial works before lease expiry may not be sensible in some circumstances; for instance, where the landlord after lease expiry carries out works to the property which supersede the works the tenant has done or where the works do not add any value to the property.
It is a widely held view that disputes increase in a weak economy. Dilapidations claims are no different. For a start, tenants may cut back their spend on maintaining their premises. This will almost certainly heighten the risk (and size) of dilapidations claims. Also, landlords are more likely to do only those works required to relet, as opposed to embarking on costly refurbishments.
Tenants therefore need to ensure they have protected their position by making informed choices about the claim and how best to settle it, ideally prior to costly legal proceedings being issued.
Business rates
Reducing business rates payments is another area an office-based business might consider. Many businesses had to work from home during lockdown and many still are. They should consider appealing against their rates bills on grounds of material change of circumstance, particularly since office businesses received no relief following Covid-19, unlike those in the retail, leisure and hospitality sectors.
Open dialogue and engagement
Clearly obtaining early and specialist advice is prudent for all occupiers in seeking to minimise liabilities.
However, what currently seems to engender the most amount of support from reasonably minded landlords is honest and transparent engagement. The code of practice has been criticised for lacking any real teeth given the concurrent anti-landlord measures introduced by the government via the Coronavirus Act 2020. However, the code’s core aim is to encourage open dialogue between landlords and tenants, and, in this very difficult time, that surely must be the aim for all sides.
Tim Rayner jointly heads the national real estate disputes team at Irwin Mitchell
