The recent years of economic turmoil have forced many tenants to revisit their leases in order to reduce their financial exposure; for some tenants many of the commercial terms agreed in the past have become onerous. With very few landlords having a waiting list of prospective tenants, they do not want to see their existing tenants fail and their property become vacant. An empty property is an expensive property as the landlord will not only lose the rental income, it may also become liable for empty business rates.
Both landlords and tenants are therefore becoming more willing to renegotiate commercial terms in order to improve or consolidate their respective positions. The variation of the commercial terms of a lease is considered a “re-gear”.
Re-gears commonly involve a tenant agreeing the deletion of its break option in return for a reduction in rent for a specified period. The tenant reduces its immediate financial commitments and the landlord achieves an enhanced capital value, and the greater certainty of an unbroken income stream for an extended period.
Re-gear terms may also involve a landlord paying the tenant a capital sum to refurbish their premises in return for the tenant agreeing an extended lease term. This allows a tenant to avoid the considerable cost of relocation and the landlord to prevent a potential void.
Once the commercial terms of a re-gear have been struck, the terms will need documenting. Most re-gears involve deeds of variation and/or reversionary leases and this article will concentrate on issues arising out of these two documents.
Deeds of variation
Surrender and re-grant
Certain variations to the existing terms of a lease will take effect as a surrender and regrant. Jenkin R Lewis & Son Ltd v Kerman [1970] All ER 414 identified two variations that constitute a surrender and regrant: increasing the demise and/or increasing the term. Such variations should only be dealt with by way of reversionary or supplementary leases. Any reduction in the demise or term should be dealt with by way of a surrender of part or agreement to surrender.
Whether an increase (other than by way of rent review) or decrease in the level of rent will also be a surrender and regrant has been held to depend on the intention of the parties. In Friends Provident Life Office v British Railways Board [1995] 2 EGLR 55, the variation was an increase in the yearly rent and the court held that where a landlord and a tenant enter into an agreement that varies the terms of an existing tenancy but show a clear intention not to create a new tenancy, the court will give effect to such intention. The only exception to this assumption is where the only way to give effect to the variation at law is to imply a surrender and regrant.
Guarantors
Under general law, a guarantor (under a contract of guarantee but not necessarily a contract of indemnity) will be discharged if a variation is material and actually or potentially prejudices the guarantor, unless the guarantor has consented to or is a party to the change. The discharge relates only to future breaches but the reduction in a tenant’s covenant strength as a result of releasing the guarantor may have a negative impact on a landlord’s asset value.
Many leases contain provisions purporting to exclude the general legal rule, but these will not exclude the “partial” release of a former tenant’s liabilities under an authorised guarantee agreement or a guarantor of a former tenant, under section 18 of the Landlord and Tenant (Covenants) Act 1995 (the 1995 Act).
It is also important to note that if the variation is outside the purview of the original guarantee – so as to create substantially different provisions and, certainly, more than comparatively minor variations – the guarantor may be released by the variation, even if the guarantee contains the “standard” non-release wording (see Triodos Bank v Dobbs [2005] EWCA Civ 630). This “purview” limitation applies to any guarantor, whether of a current or a former tenant; however, the guarantor consenting to the variation should overcome it.
Section 18 of the 1995 Act applies to both old and new tenancies, save for variations effected before 1 January 1996. It operates to relieve a former tenant and its guarantor from liability to pay any sum referable to a variation that was effected after the former tenant had assigned the lease and was, essentially, one which the landlord had an absolute right to refuse.
The former tenant’s liability following such a variation will be governed by the decision in Friends Provident that a former tenant will only be liable under covenants that have been varied after it has assigned the lease and where the variation in question was contemplated by the original lease, eg an increased rent payable after a rent review. Section 18 does not apply to guarantors of current tenants (other than a former tenant under an authorised guarantee agreement), for whom the general law applies.
In any event, a guarantor should be required to join in the deed of variation, consenting to the changes effected by it.
SDLT, consents and registration
If the landlord’s interest is itself leasehold, or if the property is charged, it should be established whether any consents from such superior landlord or mortgagee to the variation are necessary.
The tenant may receive consideration in the form of money or money’s worth in return for agreeing to the variation and this may trigger a liability to pay SDLT. The Finance (No 2) Act 2005 covers the situation where any consideration in money or money’s worth (other than an increase in rent) is given by the tenant for any variation of a lease, other than a variation of the amount of the rent or the term of the lease. An example is the payment by a tenant to remove onerous covenants. Such a variation is treated as an acquisition of a chargeable interest by the tenant, and potentially requires a return to be made and SDLT paid.
If the lease is registered at the Land Registry, an application should be made to register the deed of variation, even if it is not in effect a surrender and regrant or does not create or vary an easement, option or pre-emption. This is a matter of good practice. If the landlord’s title is registered and the lease is noted against the title, for the same reason an application should also be made to note the deed on the landlord’s title.
Reversionary leases
A reversionary lease is a lease that creates a term that will commence at a date in the future. A key point to remember is that the term of a reversionary lease granted in consideration of reserving a rent cannot commence more than 21 years from the date of the reversionary lease as it will be void (with certain limited exceptions). This does not, however, invalidate a contract to grant, at a date more than 21 years after the date of the contract, a lease which, when granted, will begin not more than 21 years after the date of grant of that lease. An agreement for reversionary lease can therefore be used to overcome this point.
The effective date of a reversionary lease for SDLT purposes is the date of grant, not the date the term commences, and therefore SDLT, where relevant, will be due within 30 days of the date of grant of the reversionary lease. An agreement for reversionary lease will have the benefit of deferring the date on which SDLT is payable; SDLT will only be payable on exchange of an agreement for reversionary lease where the agreement is substantially performed.
Occupation under the existing lease is not treated as substantial performance of the agreement for reversionary lease, so SDLT will not be due until 30 days after the date of completion of the reversionary lease.
If the reversionary lease is to be granted outside the security of tenure provisions of the 1954 Act, the contracting out notice must be served and the declaration made prior to exchange of the agreement for reversionary lease.
The form of the reversionary lease should reflect any relevant statutory and other changes that may have occurred since the existing lease or other lease referred to was granted. Examples of modifications are set out in the box below.
If the term of the reversionary lease starts after the end of three months beginning with the date of the lease, the reversionary lease is compulsorily registrable, even if the term of the lease is seven years or less. If this is the case, Land Registry-compliant demise plans will be required.
Finally, a premium or reverse premium may be payable in consideration of grant of a reversionary lease and the reversionary lease should therefore make provision as to dates and mechanism of payment. A reverse premium (paid by the tenant to the landlord) is usually outside of the scope of VAT unless the tenant is seen as providing a service to the landlord outside normal lease terms. Specialist tax advice should be sought if a payment is being made or received.
Critical issues
The issues highlighted in this article will become ever more critical as the difficult economic situation causes landlords and tenants to re-evaluate their commercial relationships. As can be seen, there are a large number of traps for the unwary and careful thought must be given to the implications of what superficially may be perceived to be simple deeds of variation.
Consequences of a surrender and regrant
? The deed of variation may be subject to stamp duty land tax (SDLT) and, if a registrable term, will require registration at the Land Registry.
? Where the party to the variation is not the original tenant, any original tenant’s liability will be extinguished following the surrender and regrant. The landlord cannot preserve its rights against an original tenant in this situation and the same position applies to other former tenants and guarantors.
? The new lease which is impliedly granted following surrender and regrant will be a “new tenancy” under the 1995 Act. If the old lease was not a new tenancy, the landlord will lose the benefits of the privity of contract regime, and unless the deed of variation contains appropriate drafting, the alienation and other provisions of the old lease will not be suitable for a new tenancy under the 1995 Act.
? The new lease which is impliedly granted will fall within sections 24 to 28 of the 1954 Act unless the contracting out procedures are followed.
Modifications to the reversionary lease may be necessary to reflect:
? Land Registry prescribed clauses.
? Land Registry plan requirements.
? Energy Performance Certificates.
? CRC Energy Efficiency Scheme and the recovery of costs via service charge.
? Health and fire safety regulation changes.
? The 1995 Act – including consequential amendments to the alienation provisions to account for the reversionary lease being a “new tenancy” and privity of contract will not apply.
? The new procedures for contracting out the reversionary lease and any future underleases from the 1954 Act.
? Changes to insolvency events in the forfeiture clause.
? The provisions of any deeds of variation in respect of the existing lease.
? The reversionary lease only being assignable to the same party as the tenant under the existing lease.
? The reversionary lease automatically determining if the existing lease is determined.
Benjamin Shore is a senior associate and Fiona Smith is an associate at Olswang LLP
