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New lettings - Key issues for landlords in Heads of Terms

After spending some time agreeing terms for new lettings, landlords want those terms documented and the tenant in and paying rent as soon as possible. They don't welcome new points being debated or any delay caused by further discussions on commercial points that they thought were agreed.

Below I discuss four areas where more focus at the heads of terms ("HoT") stage could shorten the period of time taken to get to a binding contract.

Index- linked review clauses

Index linked review clauses are now quite common place. Heads of terms often state "5 yearly uplifts, index linked, cap and collar of 3%/ 5%"- but what exactly does this mean? Often, when it comes to documenting such deals, it becomes clear that the parties had different things in mind. Such misunderstandings can result in fresh negotiation, and even fresh board approval, being required.

So, the HoT should be clear on:

  • which index should be used - Retail Prices Index, Consumer Prices Index, Producer Price Index, and  should mortgage interest be included
  • whether the increase is to be compounded year on year and
  • whether the cap and collar is to be applied each year (if the increase is to be compounded) or only in the year of the review.

Uninsured risks

The Code for Leasing Business Premises in England and Wales brought in the concept of damage by an uninsured risk remaining with the landlord. Prior to this, the generally accepted position was that it was a tenant risk. While not mandatory, the moving of this risk from tenant to landlord has become fairly common practice and is now considered institutionally acceptable in Scotland. Uninsured risk in this case is a risk from a predetermined list, which then becomes uninsured due to cover not being available or not available on normal terms in the UK. The Leasing Code provides that, if there is damage or destruction caused by an uninsured risk, the tenant gets a rental abatement and the landlord makes good the damage. It's not exactly the same position as insured risk damage, as in the case of uninsured risk damage the landlord gets a period of time (usually 6 or 12 months) to check that rebuilding would be financially viable and to get the funds in place. If the landlord decides not to rebuild, the lease terminates.

The main concerns for a landlord are terrorism or something particular to their building, for example flooding. Terrorism insurance is widely available at the moment, but will be more of a concern in certain areas and with certain tenants.

Any well advised tenant is likely to revise an uninsured risk damage provision into the lease, so it is well worth agreeing the position upfront.

Service charge code

Service charge is the issue most likely to strain landlord and tenant relationships. This was the reason why the RICS brought out a service charge code of practice.

The third edition was published last year. The first edition set out the expectations for the standards and management required in commercial property. The second edition had enhanced engagement with the legal profession as a key aim, and the third edition has clarified areas of the second edition in relation to sinking funds, accounting and fees.

The code is not legally binding, but has the status of a guidance note. The RICS hoped that it would be used by landlords in new leases or variations of existing leases. The City of London Law Society produced wording which could be included in new leases to reflect the Code. They also produced uninsured risks wording. A landlord wishing to follow (or not) the code should deal with this at the HoT stage. While many of the institutional or other major landlords in the market today insist that their managing agents adhere to the code, they are nervous about taking the next step and adding it to the lease, in case this reduces marketability of the property in the future.

As a result, many tenants still take comfort from extended service charge exclusions or service charge caps.

Monthly rent concession letters

A creature of the credit crunch years, many tenants asked to pay rental monthly - to aid to cash flow. Increasingly some tenants now request this as standard throughout the term. Often the HoT simply state that the tenant can pay monthly, but it also worth considering:

  • should an administration fee be added? The managing agents will need to issue invoices and collect rent 12 times a year, rather than 4
  • should the concession be personal to the first tenant, but not benefit any assignees? and
  • should there be a sanction in the event of default? Perhaps the payments should revert to quarterly?

Agreement on these commercial points can decrease the legal bill, speed up negotiations and ensure that all commercial points are taken into account as a whole package.