Alienation – Not Just For Outer Space
Becky Staunton, a solicitor in our Real Estate team, looks at the options for lease alienation which may give tenants flexibility to get the best out of their leased commercial premises.
With more businesses embracing the ‘working from home’ (WFH) culture, some tenants may find that their need for large office spaces has diminished. Others may find a demand for larger office space to adhere to social distancing protocols and encourage employees to come back to the office environment revamped as a social working hub. Provision for ‘alienation’ is generally included in all but the shortest lettings and governs the tenant’s ability to:
- Assign the lease, i.e., to sell or transfer it to a different tenant;
- Underlet (or sublet) the premises or a part of them; or
- Share occupation of the premises.
It is unlikely that a lease will allow a tenant complete freedom to do whatever they like with the lease, so the alienation provisions and restrictions should always be checked with your property agent and lawyers before shaking hands on any agreement with a prospective assignee or new tenant. There is usually a balance of interests, so that the tenant has some flexibility in alienation but usually certain conditions must be satisfied first in order to protect the landlord’s investment interest.
An assignment transfers a tenant’s interest in the lease to another entity (the assignee). The assignee agrees to perform the tenant covenants of the lease, in particular, paying the annual rent. This is beneficial to the tenant when the space is surplus to business requirements or it becomes difficult to pay the rent. The landlord retains the same lease terms and the same rental income.
However, the landlord will want control of who the lease is assigned to so they can ensure that the new tenant is capable of fulfilling the obligations under the lease. It is therefore usual that the landlord will require that assignee is of a certain level of financial standing, to be shown satisfactory references and to have confirmation that the use of the premises will be permitted under the lease. “Tenant mix” can be specified as a ground for approval if it is important to a landlord, especially for units in a trading estate or retail shopping parade or centre. A lease will normally nowadays require that the outgoing tenant enters into an ‘authorised guarantee agreement’ to guarantee that the assignee will fulfil its obligations.*
Any of the applicable requirements under the lease will have to be satisfied before the landlord gives consent to the assignment, documented by all parties entering into a licence to assign.
It is also worth noting that leases dated before 1 January 1996 (referred to as “old” leases: these are becoming increasingly rare, but there are still some out there) will continue to bind both the original landlord and tenant to their obligations under the lease even if their respective interests are transferred to other parties. However, with leases dated on or after 1 January 1996, outgoing tenants are automatically released from their obligations under the lease on assignment, unless the landlord is able to impose an authorised guarantee agreement as a condition of providing consent.
Underletting (or Subletting)
If a tenant wants to keep part of their lease but has a lesser requirement for space, they may seek to underlet (or sublet, which means the same thing) the whole or part of the premises. They may underlet the whole if the proposed new occupier wants the entire premises but not for as long nor on the same terms as the existing lease, or if the proposed new occupier is not strong enough to secure landlord approval to an assignment. A new underlease is created between the tenant and the undertenant, usually on substantially similar terms to the current lease. The tenant will still be responsible for paying rent under their headlease but will charge a rent from a undertenant for the space they are underleasing. This can ease the rent burden on the tenant.
An underlease can be flexible for tenants in the position of paying rent for space they are not currently using – if it is envisioned that the space will be required again, the tenant can make sure that the underlease is for a fixed term shorter than their lease or agree a break option.
However, the tenant remains liable for all of the covenants in their current lease. It is important that the undertenant can meet all of their obligations in the underlease as, in the event of their default, the tenant will still be responsible for issues such as disrepair, wear and tear and redecoration, even if this was the liability of the undertenant.
Some leases will allow tenants to share occupation of premises, but usually only with companies within the same group of companies as the tenant. This can help maximise the effective use of the space if another company within the group is in need of space, and have group property liabilities in one operational or propco for accounting and tax reasons. Documenting that sharing (and the costs basis for doing so) is a good idea for intra-group housekeeping reasons.
Another example is allowing concession stands to share space in a retail unit. Landlords are often strict about the type of business that can share occupation of retail premises in particular, and the amount of floor area that can be shared, for tenant mix reasons, as mentioned earlier.
Getting Landlord’s Consent
Where the lease contains conditions to be satisfied before the landlord will give consent, the landlord must give their response to an application in writing within a reasonable time and with reasons for any refusal. Examples of where it reasonable to refuse consent include:
- Where the incoming tenant’s financial standing is not sufficient to pass a specified profits or assets test; or if it is not considered strong enough to be able to comply with the lease covenants (sometimes this is as compared to the current tenant, although it depends on what the specific clause provides) e.g. a start-up single-site clothes business taking over a lease of a high street unit from a large chain may not be considered to be able to pay a high rent.
- If there is good reason to believe that the incoming tenant intends to use the premises in breach of the user clause.
- If the current tenant is in substantial and continuous breach of their lease covenants and the landlord is not convinced that the incoming tenant will remedy these breaches.
- If the incoming tenant’s business does not fit with the landlord overall tenant-mix policy for a particular site e.g. a retail shopping centre (as long as the policy is known to the tenants and is rational).
- If there is a reason for the landlord to believe that the assignment or underletting may affect the existing rights and interests in the property, both of the landlord or other tenants.
If the landlord is unreasonable in withholding or delaying consent, the tenant may be able to claim damages for the landlord’s breach of duty under the 1988 Landlord and Tenant Act. It can also ask the court to make a declaration that the landlord is acting unreasonably and that consent should be deemed to have been given.
Landlords should also consider the professional standards they should adhere to under the New Lease Code 2020 which will be effective from 1 September.**
Tenants are recommended to bear in mind the ‘Alienation Protocol’ https://www.propertyprotocols.co.uk/the-alienation-protocol, which is a useful guide to the way to approach such an application in order to increase their chances of prompt success.
If you would like further advice in drafting or actioning alienation provisions in a lease, please contact a member of the Real Estate team.