Traditional lease arrangements do not offer the flexibility that tenants and investors now require. Scott Pearman suggests two solutions
The trend in the lettings market is to go for shorter more flexible leases. Tenants are becoming increasingly dissatisfied with the traditional rack rent lease which is seen as too rigid and outmoded. New thinking is required both from investors and tenants and this will not be easy given that the traditional rack rent lease has had a blinkering effect. This article explores two new approaches: lease fusion deeds and the use of planned maintenance specifications in repairing covenants and service charges.
Lease fusion deeds
It has always been the case that tenants of whole buildings can expect to exercise a greater degree of control than tenants of part. They are generally in control of security, repairs, the provision of services to the building, reception and the operation of the building on a day to day basis. However, the downside is that having a single lease of a whole building is relatively inflexible.
The usual position is that the tenant may not assign part; underletting part is restricted; and, if the lease contains a break clause, normally it may only be operated in respect of the whole of the premises. A lease fusion arrangement overcomes this inflexibility while still allowing the tenant the same control as if it had a single lease of the whole building.
Imagine a building with five floors. Rather than taking a single lease of the whole building the tenant takes a separate lease of each of the floors. The floor leases are on a normal internal demise basis and contain service charge provisions. The tenant also takes a sixth lease in the form of a lease fusion deed that comprises a lease of the remaining parts of the building (eg the roof, walls, common parts etc). It also contains a management regime to enable the tenant to run and control the building and suspend the service charge provisions during this period.
The tenant therefore has the whole of the building demised to it. It is in control of the provision of services to the building, but also has the flexibility of being able to assign or underlet on a floor by floor basis. Further, if the leases contain break clauses the tenant may operate these on a floor by floor basis. The landlord may consider restricting the basis upon which any such break clauses can be operated. For example the landlord may require that the clauses may only be operated so as to break the leases from the ground floor upwards. The point being that the landlord will want to preserve its ability to re-let the remaining parts of the building.
The lease fusion deed concept is based upon the idea of ‘consolidating leases’ which has been around for some time. However, it is something that today’s tenant, looking for a flexible lease arrangement, would be well advised to explore. It may be particularly attractive to a large corporate that likes to run things its own way but wants to hedge against a rigid long term commitment.
A lease fusion deed calls for sophisticated drafting. Consider the following:
lShould the tenant have the ability to end the fusion arrangement by terminating the lease of the remaining parts? If the tenant is to have real flexibility the answer is ‘yes’. In other words the tenant may wish to have the right to put back the obligation to provide services on the landlord. However, if the tenant does want to pass on the burden of running the building, and fully considers the matter, probably his best course of action may be to get a facilities management provider to supply the services: you can choose and change your facilities management provider but you cannot usually choose or change your landlord.
Should the fusion arrangement come to an end as soon as one of the floor leases is terminated or assigned? If so, the lease of the remaining parts of the building should also terminate on the first assignment or operation of a break clause in any of the floor leases. Landlords may well consider that their ability to re-let any space in the building would be enhanced by a conventional service charge arrangement where the landlord would have direct control over the quality of the services provided. However, the tenant’s response perhaps should be that so long as it is providing the services in a proper manner there is no reason why the arrangements should end. For the tenant to continue to provide the services in a multi-occupier building gives rise to points such as:
” a mechanism for the landlord to pay service charge to the tenant in respect of the floor lease which has terminated/been assigned;
” the need for rights of entry to enable the tenant to provide services in respect of those parts of the building no longer let to it;
” new services are likely to be required. For instance those appropriate for a multi-tenanted building: common reception, signage, shared facilities etc.
Lease fusion arrangements can provide additional flexibility to tenants but if they are thought out properly they will necessarily be a rather complex arrangement.
Planned maintenance specifications
A corporate real estate client of mine put it this way ‘when you hire a car, provided you look after it properly, you don’t expect to have to pay the hire company for replacing the engine and tyres if they have worn out by the time you return the car’. Following the analogy, a tenant who has fully maintained and serviced a building throughout the term of his lease should not have to face a schedule of dilapidations at the end.
Where landlords buy into this concept their primary concern should be that the underlying quality of the real estate must still be maintained.
The way to combine the positions of the landlord and tenant is by using a detailed planned maintenance specification (including both service requirements and dates when items may need replacement). Based upon the operating and maintenance manuals for the plant and equipment in the building but considerably developed beyond those, the planned maintenance specification should set out in detail how each part of the building should be serviced, maintained and repaired.
The principle is that so long as the tenant has maintained the building in accordance with the planned maintenance specification the landlord should have no claim against the tenant in respect of dilapidations.
The planned maintenance specification should also be of benefit to landlords as it should lead to the building being looked after to a high standard throughout the duration of the lease.
The landlord should inspect the building at regular intervals to ensure the tenant is fulfilling its obligations; from the tenant’s point of view, it will be comforted that the landlord accepts the tenant is keeping its end of the bargain. The landlord should protect itself with a provision by which it can give notice of non-compliance to the tenant. Failure to remedy the non-compliance would permit the landlord to take over the maintenance and services itself. The landlord would provide these in accordance with the planned maintenance specification and collect the cost of this through a service charge.
A maintenance regime, linked to a planned maintenance specification, gives the tenant an additional flexibility. If the tenant chooses it could engage a facilities management provider to provide the services and maintenance rather than doing this itself. The precise details of what the facilities management provider would have to supply will already be set down. If the landlord complains to the tenant about the way the building is looked after the tenant should then have a corresponding complaint to the facilities management provider.
Planned maintenance specifications can play an important role in service charge arrangements. An additional factor here is that tenants might also require minimum response times from the landlord. For example if the lights fail in a reception area the tenant may need to have this repaired within hours. If the planned maintenance specification sets down a minimum response time for this which is not met then the lease may provide that the tenant can repair the lights and invoice the landlord for it; and it may go on to provide some other sanction against the landlord.
The use of planned maintenance specifications in service charges may go a considerable way to avoiding service charge disputes. For example they should facilitate:
” transparency as to what maintenance and decoration will be due to occur in the future. Everyone should be able to see what will need to be done and at what intervals;
” avoiding large unexpected service charge bills;
” budgeting and spreading the service charge costs over a number of years. Some landlords may prefer to go for rents inclusive of service charge so as to enhance the marketability of their space and this should avoid service charge disputes completely.
The use of planned maintenance specification in service charges should assist landlords wishing to pass responsibility for the provision of services to a facilities management provider in relation to a particular building or the whole of the landlord’s estate.
Conclusion
There have already been instances of the use of lease fusion deeds in practice and many examples of where planned maintenance specifications have been used, particularly in a facilities management context. These concepts are however still relatively new to the market and are ones that may have much to offer both landlords and tenants.
Scott Pearman is a partner in the property group at Richards Butler
|
Key points |
|
” lease fusion arrangement can overcome the inflexibility associated with traditional leases, but they call for careful drafting ” A planning maintenance specification can go some way to avoid dilapidations claims and service charge disputes |
