KNOWLEDGE

Back to Basics - What is a Lease?

Morton Fraser Legal Director Chris Clarkson
Author
Chris Clarkson
Legal Director
PUBLISHED:
30 November 2023
Audience:
Real Estate
category:
Blog

I recently found myself providing our new trainee cohort with training on the main commercial clauses of a full repairing and insuring (FRI) lease. 

I was tasked with giving a whistle-stop introduction to clauses dealing with matters such as the repairing obligation, rent review, alienation, and so on.  I realised, however, that before looking at the commercial terms it is fundamental to understand what a lease actually is and what exactly is required to create a lease.  That may seem like a simple point, but one which is often over-looked.  If key requirements are not met, then your lease might not do exactly what it says on the tin.

A lease or a contract (or both)?

Fundamentally, a lease is a contract between the owner of a property (the landlord) and another party (the tenant).  The contract grants the tenant the right to use and occupy the relevant property in exchange for recurring payment (rent), and subject to other agreed terms and conditions.  However, the contract must meet certain key requirements in order to formally constitute a lease.  If these requirements are not met then the document in question cannot be a lease, but rather a simple contract or licence granting occupational rights.

The key requirements are as follows:

  1. Separate parties
  2. Leased subjects
  3. Rent
  4. Duration
  5. Exclusive possession

These are detailed further below, but first…

Why does it matter?

A tenant's interest in a properly constituted lease is a "real right".  It is distinguishable from a contract which creates personal rights, which binds the named parties only.  This is because a real right is enforceable against both the granter of the right (that is, the landlord) but also that party's successors.

The consequence of this is that if an owner of a property sells subject to a lease, then the purchaser will automatically inherit the landlord's part in the lease. The landlord will be able to enforce the obligations against the tenant and the tenant will be entitled to remain in occupation, all in terms of the lease in question.

This is important in that it protects the tenant's occupation of the premises in the event of a change of owner, but it is also one of the key tenets that underpins commercial property as an income generating investment asset.  If a purchaser of a property with an incumbent tenant was not automatically able to receive the corresponding rental income then there would be no real investment market for commercial properties.

Whether or not "a lease" is indeed a lease also has ramifications on how the law impacts on the occupational arrangements in question.  There are various common law and statutory rules that govern leases in Scotland.  These include principles such as "tacit relocation"; notice requirements in respect of terminating the lease at its natural expiry; impositions on the landlords' actions where it seeks to terminate the lease for tenant breach (irritancy or forfeiture); and so on.  It is important, therefore, that the parties are aware of what exactly they are signing up to.

It is worth noting that lawyers often receive instructions from clients to put in place a "Licence to Occupy".  If that document meets the key criteria outlined in this article then it may comprise a lease, regardless of what it says on the front page.  The term "Licence to Occupy" is often used as a term of art to mean a short term, tenant-friendly lease.  It is, however, important to understand where a licence is a lease in all but name, and to consider the potential consequences of that.

The Constituent Parts

(1) Separate Parties 

A lease must identify both the landlord and the tenant.

The landlord under a lease must be the party that owns the property.  As noted above, the landlord's obligations under a lease will automatically bind any successor in title to the property in question.

The tenant should be accurately identified so that there is no doubt as to who holds the tenant's interest in the lease, and thus is responsible for fulfilling the tenant's obligations.  Without specific drafting saying otherwise, a tenant will be entitled to transfer (or assign) its interest in the lease to any party it so chooses.  A well-drafted lease should, therefore, prohibit the tenant from assigning its interest in the lease without landlord's consent.  The landlord's ability to withhold consent will normally be qualified, often subject to tests of reasonableness linked to the financial strength and respectableness of a proposed assignee. 

(2) Leased subjects 

It is essential that the lease confirms what exactly is being let.  At the very least a description of the premises by reference to a plan is recommended.  The more accurate the description, the less chance there is for dispute in the future.

Clearly the level of detail required will depend on the nature of the property.  If a tenant is taking, for example, a standalone industrial shed then it may be that the description of the leased demise can be straightforward and simply include everything within four red lines on a plan.  If the property in question is an office unit within an office block or a retail unit within a shopping centre, then it is important to take care in the drafting to identify what is (and what is not) included within the tenant's occupational extent.

Accuracy in respect of the subjects being leased is not only important to confirm what the tenant can occupy, but also to clarify the tenant's repairing liability.  Generally speaking, a tenant will be responsible for maintaining the "property".  For that reason, it is important to confirm whether the "property" includes (for example) the structural elements of a building, certain fixtures and fittings, suspended ceiling systems, carpet tiles, plant and equipment, and so on.  If these are included, then it follows that the tenant is responsible for maintaining those items in accordance with the repairing obligations imposed on the tenant under the lease.

(3) Rent

Without a specified rent due by the tenant to the landlord there can be no lease.  For the avoidance of doubt, rent must be periodical (i.e. monthly, quarterly or annual) for it to be considered a rent - a lump sum at the start of a lease is not sufficient.

That said, the rent need not be a commercial or even a substantive rent.  For example, it is common practice for a substation on a new development to be documented by way of a lease imposing a rent of £1 per annum (the benefit to the landlord being derived from the fact that the substation is necessary to power the development).  Such a figure is enough to tick this particular box.

(4) Duration

The duration of the lease must be clearly ascertainable.  Any occupational arrangement which simply continues until terminated by either party will not constitute a lease. 

If no duration is expressly confirmed in the body of the lease then the law implies that it is granted for one year.

It is worth noting that whilst a lease may state that it continues to a particular date, it is not the case that the lease will automatically terminate on such date.  In the absence of a valid and timeous notice to quit having been served by either party, the lease will run on for a period of one year on identical terms under the doctrine of tacit relocation.  We have covered this subject and possible reforms in this area previously.

(5) Exclusive Possession

The tenant must have exclusive occupation of the property.  Any agreement which grants some form of space sharing or non-exclusive use will not, therefore, constitute a lease. 

A lease may, however, grant certain ancillary non-exclusive rights (i.e. rights of access through a shared reception area to an office suite, or perhaps a right to use common car parking spaces on a "first-come-first-served" basis).  Care should be taken to ensure that such rights are indeed ancillary, and that exclusive use is not inadvertently granted.

Conclusion

When a new lease is being agreed the parties will focus on the commercial terms, and so they should.  It is, however, of utmost importance that the lease documentation conforms to the fundamental requirements outlined in this article, in order to avoid unintended or unexpected consequences. 

At Morton Fraser MacRoberts we have a large and experienced real estate team who would be pleased to offer our expertise and guidance on any leasing matters. Please get in touch if you have any queries.

Disclaimer

The content of this webpage is for information only and is not intended to be construed as legal advice and should not be treated as a substitute for specific advice. Morton Fraser LLP accepts no responsibility for the content of any third party website to which this webpage refers.  Morton Fraser LLP is authorised and regulated by the Financial Conduct Authority.