1. The parties (and their representatives)
It may seem obvious, but heads of terms should include the name and address of the landlord, tenant and (if relevant) guarantor. Why? Because those details are required for the lease.
For companies and LLPs, the name should be their full legal name as it appears on Companies House, and if the address in the heads of terms is not their registered office, that should also be made clear.
2. Describe the property/demised premises
For the purposes of a lease, the terms ‘property’, ‘premises’ and ‘demised premises’ all mean the same thing – what is being leased.
Set out the full address. If the property is part only of an estate, building or centre, make that clear. If you have a plan showing the property, attach it to the heads of terms. There are very different drafting considerations for a lease of a self-contained building on a high street, a unit in a shopping centre, or a warehouse on the landlord’s industrial estate.
3. Conditionality
Include in the heads of terms anything that needs to be done before the lease can complete. This could be anything from obtaining head landlord’s consent to securing vacant possession if the property is currently occupied, to the landlord building the property.
4. Lease term
Not to be confused with the lease terms, which are the provisions of the lease.
The ‘lease term’, or ‘contractual term’, or just ‘term’, is how long the lease lasts. How long is it? When does it start?
5. Break clauses
Heads of terms should clearly set out the break date(s), the notice required, and any break conditions.
Both the RICS Code for leasing business premises and the Model Commercial Lease recommend that breaks should only be conditional on:
- the annual rent being up to date as at the break date; and
- the tenant giving up occupation, there being no other occupiers, and no subsisting subleases. Note – this is not the same as a requirement to give vacant possession.
Any other conditions could seriously impact the tenant’s ability to exercise the break.
The operation of break clauses and break conditions is the subject of innumerable articles. Suffice to say, they are technical areas of law, and any conditions are strictly enforced.
In the 1997 case of Mannai Investment Co Ltd v. Eagle Star Life Assurance Co Ltd [1997] AC 949, which was a dispute about a break clause, Lord Hoffmann wrote, “If the clause had said that the notice had to be on blue paper, it would have been no good serving a notice on pink paper”.
It benefits both landlords and tenants to speak to their solicitors before the heads of terms are agreed, to ensure that all parties understand the implications of any break conditions and avoid delays in negotiating and agreeing the lease.
6. Security of tenure
Security of tenure is the tenant’s statutory right under the Landlord and Tenant Act 1954 to a renewal at the end of the lease term. The parties can contract a lease out of security of tenure, meaning the tenant does not benefit from it. The heads of terms should specify either way.
For further reading, see:
7. Rent and rent concessions
If possible, please express rent as a £££ per year figure, because that’s (generally) how leases are drafted.
If you have agreed a rent free, or reduced rent, period, include it in the heads of terms. If it is not in the heads of terms, your solicitor will assume there is no rental concession.
8. Rent review
When and how?
The vast majority of rent reviews are either ‘open market’ reviews or ‘index linked’ reviews.
An open market review means exactly what it says – the rent is increased to whatever the open market rent is at the review date.
An index linked review means that the rent increases by the same proportion that the Retail Price Index or Consumer Price Index increases over the same period. Be clear whether it is a compounded increase or a simple increase – that can cause a big difference in the calculation.
If you want the lease to include a collar (a minimum rent increase) or a cap (a maximum rent increase), that must also be included in the heads of terms.
Tenants beware! Rent reviews are always drafted to be ‘upward only’, which is exactly what it sounds like. Your rent after review will be the greater of the rent before the review, and the reviewed rent.
9. Permitted Use
What will the tenant use the property for? This should be set out in detail to avoid any misunderstanding. Ideally the permitted use section of heads of terms should also include the planning Use Class.
10. Repair
A standard commercial property lease will require the tenant to keep the property in good and substantial repair and condition. The landlord and tenant may agree that the tenant’s obligation is limited by reference to a schedule of condition. This must be specified in the heads of terms.
11. Dealing with the lease
Also known as alienation, this covers assigning (i.e. transferring the lease), subletting, charging (i.e. mortgaging) and any other type of sharing possession or occupation of the property. Listed below is how different types of dealing are commonly dealt with in modern commercial leases.
- Assigning and charging part only of the lease is prohibited.
- Assigning the whole of the lease is permitted with landlord’s consent, such consent not to be unreasonably withheld or delayed.
- Subletting part only is often prohibited, but is sometimes permitted with landlord’s consent, such consent not to be unreasonably withheld or delayed.
- Charging the whole of the lease is permitted with landlord’s consent, such consent not to be unreasonably withheld or delayed.
- For tenants it is useful if charging the whole by way of a floating charge is permitted without landlord’s consent. If a tenant’s finance arrangements include debentures, they will include a floating charge over all property interests, including leases. A floating charge is still a charge, so taking a lease when the tenant has an existing debenture, or entering into a new debenture when already a tenant, amounts to charging the lease.
- Sharing possession or occupation of the whole or part of the property with a group company is permitted without landlord’s consent.
- Any other dealing or sharing of possession or occupation is prohibited. If a tenant requires concession stands in the property, needs to grant licences to occupy, or just intends to allow third parties to work out of a room in the property on an informal basis, this must be referred to in the heads of terms.
12. Alterations
Alterations are usually categorised as internal/external, and structural/non-structural. Typically, external alterations (whether structural or non-structural), and internal structural alterations are prohibited, and internal non-structural alterations are permitted with landlord’s consent, which is not to be unreasonably withheld or delayed.
If the property is a retail unit, installing and altering the shop front/fascia should be permitted with landlord’s consent, again not to be unreasonably withheld or delayed.
Sometimes limited internal alterations, such as installing demountable partitioning, are permitted without consent.
13. Insurance
In multi-let properties/estates, the landlord will almost always insure and recharge the cost to the tenant as insurance rent. Heads of terms often set out the current year’s insurance contribution, but this is not necessary for the parties’ solicitors to draft or negotiate the lease.
14. Service charge
Whilst service charge provisions take up multiple pages in a lease, heads of terms only need to include certain key points:
- Is there a service charge?
- How is it calculated? A fixed amount (infrequent) or (more usually) calculated by reference to service use/size of property?
- Is there a service charge cap? If so, does the cap increase over time?
15. Rights granted to the tenant
If the property is part of a larger building or estate, the tenant will need rights over land retained by the landlord. These rights may be as simple as rights of way over common accessways, corridors, etc, or they may be far more extensive.
With very limited exceptions, rights granted are a practical matter, and solicitors cannot know what is required without being told. Heads of terms should therefore set out any specific shared facilities that the tenant will be entitled to use, such as parking, shared toilets/kitchens, a bin store, etc.
Depending on the nature of the property, air-conditioning equipment, or other plant fixed to the external wall or roof, may be outside of the property. The tenant will therefore need rights to install, access (for repairs) and connect to that plant/equipment.
Parking is one right that needs some additional thought. Sometimes parking spaces are included within the definition of property. That means the tenant’s lease covenants, e.g. repair, apply to their parking spaces. More commonly (in commercial leases), a tenant will be granted the right to park. The heads of terms should specify not just how many spaces, but whether use of those spaces is exclusive to the tenant and whether the landlord has the power to reallocate spaces during the lease term. Be aware that, if a tenant has exclusive use of specified spaces for the whole term, and the landlord cannot relocate them, that could amount to the spaces being demised (i.e. leased).
16. Additional documents
There are a number of ancillary documents that are commonly required alongside leases.
16.1 Rent deposit deed
If the tenant is paying a rent deposit, it must be documented in a rent deposit deed. Your solicitors will need to know:
- The amount. This seems obvious, but most heads of terms we see specify a deposit equivalent to a number of months’ rent, or set out a figure that is based on anything between one and six months’ rent. When drafting the rent deposit deed, if the landlord has opted the property to VAT, they will want the rent deposit to cover VAT, so the figure in the rent deposit deed can be 20% higher than the figure in the heads of terms. This can come as a nasty surprise to tenants. To avoid this miscommunication, specify in the heads of terms whether the rent deposit figure includes or excludes VAT.
- Is the deposit held for the whole term, or is it released early? If early, when? Are there any conditions to early release?
- The bank where the landlord will hold the deposit. Most rent deposit deeds require the landlord to hold the deposit in a separate bank account, and to specify the bank.
16.2 Licence to alter
If the tenant is carrying out fit out works at the outset, they will almost always need documenting in a licence to alter.
16.3 Licence to underlet
If the landlord is themselves a tenant under a headlease, that will affect the lease drafting. A licence to underlet may be necessary. If you know that your property is leasehold, set that out in the heads of terms.
16.4 Warranties
If the property has been constructed or substantial works have been carried out within the last 12 years, the landlord may have the benefit of collateral warranties. Standard commercial property pre-contract enquiries (known as CPSEs) specifically ask about this.
If there are defects in the works, a tenant with a standard full repairing obligation will have to repair damage caused by those defects. Tenants may therefore want the benefit of collateral warranties to protect against this eventuality.
