Lease clarity needed post-Franses

Sadly, we are all too familiar with the resulting conflict that the question of leave or remain raises. It leads to high emotions, tense battles and intricate claims and counter-claims. For once, we are not talking Brexit. Instead, this in or out argument concerns a recent test of the Landlord and Tenant Act 1954 and the desire of one landlord to implement ground (f) to defeat one of its tenants’ rights to renew and obtain possession of its unit to allow for a change of use. The Supreme Court judgment in S Franses v Cavendish Hotel (London) Ltd [2018] UKSC 62; [2018] PLSCS 212 will have a far-reaching effect on commercial leases, the ability of landlords to implement the 1954 Act, the power of tenants to stand their ground and the drafting of new leases. The facts The case involved the Cavendish Hotel on Jermyn Street, London, and its tenant, S Franses Ltd – a tapestry dealership and gallery that occupied a ground floor and basement space within the hotel complex. In short, the landlord opposed the tenant’s application to renew its lease on expiry in 2015. The reason, it claimed, was to undertake significant works so that it could reconfigure the bar area and create two new retail units. The tenant, happy with the prime space it had occupied for many years, wanted to remain in occupation and extend its lease under its rights of renewal. The result was a drawn-out legal battle that came to a head in the Supreme Court in October 2018, with judgment given in early December. The case essentially hinged on two opposing arguments. The tenant claimed that the scheme of works proposed was artificially created with the sole intent to remove it. The landlord contended that its scheme of works was significant enough that its intention for the space on vacant possession didn’t matter. The landlord won at first instance convincingly, with almost all the tenant’s arguments squared away. The tenant appealed to the High Court on nine grounds, two of which were accepted and referred to the Supreme Court for consideration. Most notable was the admission from the landlord that its works would not be the same had the tenant left voluntarily. The Supreme Court judgment When it came to the hearing at the Supreme Court, the justices had to effectively rule on whether it was open to the landlord to oppose the grant of a new tenancy if the works which it said it intended to carry out had no purpose other than to get rid of the tenant and would not be undertaken if the tenant were to leave voluntarily. The Supreme Court held that a landlord could not oppose a new tenancy if its intended works had no purpose other than to obtain possession and would not be carried out if the tenant were to leave voluntarily. It held that since the landlord’s stated position was that it only intended to undertake the scheme if it removed the tenant via the court process and not if the tenant left voluntarily, the landlord had failed to prove ground (f). This doesn’t, though, tell the whole story. Key contention points As the independent expert for the first instance case, I had the duty of assessing the proposed works from a building surveying perspective and reported it to be a scheme that fell within ground (f). Yes, there were works that on paper looked dubious, such as lowering a floor slab, moving a smoke vent and rebuilding a wall. However, they almost all stood up to scrutiny, although a number of them were referred to as artificial. The legal counter to the tenant’s overriding claim was to argue that whether artificial or not, it didn’t matter as the works were substantial enough and the intention was valid, making the tenant’s points irrelevant. Each and every aspect of the work was challenged by the tenant on the basis that it had no practical utility and no commercial purpose. Even works that were obviously substantial, such as forming large holes in the floor slab for lifts and stairs, removing floor screeds and digging out for drains, were all argued by the tenant as to be trivial works, which were neither demolition nor construction, or weren’t needed. One issue that hindered the landlord’s case was that at the time of papers being submitted, planning permission for the proposed scheme had not been granted. A decision was therefore taken to progress with a newly revised scheme (scheme 3), which stripped out any work that would require planning approval. This left the case presented to the court with some rather odd quirks – for instance, there was a large gap in the dividing wall facing the street and no street entrance into one of the retail units. The landlord also had a further scheme (scheme 4) which featured the planning works. The landlord sought to argue that it would do the works in scheme 3 regardless of whether it obtained planning permission or not. The tenant seized on this and a few other aspects of work where it argued that the works had been created just to defeat the application for a new lease. The first instance judge rejected the tenant’s evidence and his judgment is helpfully clear on that. In retrospect though, the landlord’s counterposition was risky. Despite the scope of works being substantial and justifiable, it ran a polarised response. Its stance was to say “it doesn’t matter if the works are created just to get the tenant out”. The argument was that landlords have always created such schemes since the 1954 Act became law and that a landlord can do what works are necessary to remove a tenant, even if those works involve elements that don’t add value, don’t make best use of the space, or just allow the landlord maximum flexibility. Future effect The final judgment is likely to have a major impact on the role and future of the 1954 Act. Tenants of high-end properties in well-traded areas will continue to be immune from such attempts but will benefit from additional protection. Their neighbours will still be vulnerable though, especially if removing them is worth the extra spend on experts and if the works stack up and their leases are well drafted. Regular commercial tenants up and down the country are likely to feel that they will benefit from the security that this judgment gives them, but that is only part of the story. Restricting change of use and redevelopment of properties may leave tenants perpetually trapped in decaying high streets, devoid of development, as landlords may be unable to unlock development opportunities until tenants default on leases. From an industry, economic and social perspective, perhaps the most worrying aspect of this judgment is the impact it will have on a landlord’s ability to reposition its properties to meet changing market drivers. In retail this could mean a lack of development on parades of shops, or removing tenants from multi-let space in the way they have been doing for the last 60-plus years. At a time when consumer habits are changing and a greater emphasis is being put on the creation of flexible spaces and customer experiences, this will likely allow troubled retail schemes to fail, without much-needed redevelopment. Lease terms There is also a high chance that in future, landlords will be much less likely to grant new leases within the 1954 Act. This could fundamentally change lease terms, or we could even see the end of security of tenure, aligning terms more with Scottish, Irish and European leases. The likeliest of changes will be for standard leases to be issued for a fixed term outside the 1954 Act, removing tenants’ rights to renew completely, so they cannot hold over and would need to negotiate a new lease or move. It is quite easy to see that such a change in leasing structures could also affect the length of leases and fit-out costs, or create a move away from traditional leasing and into highly flexible leasing arrangements. In the office market, these highly flexible leases are gaining traction anyway, but their implementation in the retail and leisure sector would mean a big shake-up. Impact on existing leases Landlords considering the redevelopment of existing properties need to have their eyes wide open before embarking on any such scheme. They need to be mindful of legal privilege regarding advice given on the required extent of a scheme and be careful to devise a scheme that stands up to scrutiny in getting the buildings back, either voluntarily or through the courts. As my colleague Nicholas Dowding QC said to me: “The acid test will be: would the landlord intend to do the same works even if the tenant were to leave voluntarily, or is its asserted intention only conditional on the works being necessary to get the tenant out? This in turn will require careful attention to the nature and quality of the evidence to be called on behalf of the landlord at the hearing. It will no longer be good enough simply to show that the works are sufficiently substantial as to fall within (f), that any necessary finance, planning permission, etc has been, or will within a reasonable time be, obtained and that the landlord has a fixed and settled intention to do the works. Of course, all these remain important – but henceforth advisers’ attention will also need to be focused on what, if any, commercial or other benefit or utility is to be derived from the works as works.” Landlords will need to have tremendous patience; historically a typical 1954 Act process is often left until the last six months of a lease. Now landlords will need 12 to 24 months of careful preparation. Will the 1954 Act survive this? Observers have made the point that a contracted-out lease will be at less rent than one with security of tenure, although I have heard the margins are negligible. Landlords need to weigh up the benefits carefully of having a contracted-out lease. While there can be little doubt that the best covenant strength tenants will continue to benefit from 1954 Act protection; for everyone else, that is likely to be consigned to history, with landlords well advised to look at their lease drafting when issuing new agreements and extensions. What works well for service charge and dilapidations claims often has a detrimental impact on 1954 Act provisions. How a lease deals with the extent of the holding or demise is crucial. Ground (f) is much easier to prove in a case where a lease only covers the inner surfaces, or an eggshell tenancy, as there is less building to work on. Leases must be much clearer if the 1954 Act is to survive. Rights of re-entry also need to be reviewed to ensure that the landlord is not able to re-enter to undertake redevelopment works with the tenant in situ. This is again a key pitfall for ground (f). What is clear from the untangling of this case and the subsequent judgment, is that this protracted argument between leavers and remainers has only served to create greater uncertainty and the need to rewrite the rulebook. Now where have we heard that before? Chris Sullivan is head of dispute resolution at Malcolm Hollis and acted as an expert for Cavendish Hotels at the first instance County Court level For more guidance on the impact of this decision, tune into EG’s podcast with winning barristers Joanne Wickes QC and Ben Faulkner of Wilberforce Chambers