by Chris Vollers
Whether acting for a firm of managing agents, or employed in-house to manage a property portfolio, many surveyors from time to time will be asked to advise on whether consent should be given to a subletting or assignment that has been proposed by a tenant of a client’s or a fund. In this article Chris Vollers gives some essentially practical pointers on maximising this opportunity to enhance the client’s interest.
The first thing to do is to check the lease, and in particular the covenants restricting alterations or parting with possessions. These will usually give varying degrees of control to the landlord in respect of assignment and subletting of the whole or part of the premises by the tenant. These contractual provisions are affected by the provisions of the Landlord and Tenant Acts of 1927 and 1988 which in general require that landlord’s consent is not to be unreasonably withheld or delayed to an assignment or subletting.
“Windows of opportunity” appear at various times during a lease, and this is one. The surveyor should take the opportunity to check on compliance with the lease covenants by the existing tenant, whether there are any aspects of the existing tenure which should be changed and whether, perhaps in a redevelopment, it would suit your client to take a surrender — nevertheless bearing in mind the “reasonableness” requirement. Assuming that you have checked that the premises are in good repair, there are no arrears of rent or service charge, you do not think there are any aspects of the lease which could usefully be changed at this time and there is no advantage to your client in taking a surrender of the lease, then there are three major aspects relating to the proposal which you should consider: defective covenant; inappropriate user; and lack of control.
Defective covenant
If your client’s tenant proposes to assign his interest, then it is important to check the covenant of the incoming tenant. If the tenant is a plc with a household name there should be no necessity to seek references, unless the lease obligations are very substantial, but if you are in any doubt then references should be sought.
A banker’s reference, which should be applied for via your own or your client’s bank, for reasons of confidentiality, is the most important. From my experience, “considered good for your figures and purpose” is a standard and acceptable reference; “unlikely to enter into any commitment which he could not meet” is a subtle warning by the bank; and anything on the lines of “unable to speak for …” is a direct warning from the bank that there are insufficient funds to meet the rental obligation. If in any doubt speak to your own bank for an interpretation.
As well as a banker’s reference it is usual to apply for at least two trade references from those who provide goods or services on credit to the applicant. These are usually fairly bland, but they may provide a useful pointer. An inability to produce such references is of course a useful pointer in itself. It is preferable to take up the references yourself, so that their authenticity is not in doubt. A reference from an existing landlord will also be very useful.
If there is a rent review or lease renewal impending in the lease to be assigned then references should be applied for at the level of rent likely to apply following the review or renewal, in order that your client can be sure that the new tenant will be able to pay the increased rental. It is also advisable in high rate areas to include the tenant’s prospective rate liability.
If the references are not wholly satisfactory, or there is a large rent reserved under the lease, then it would be advisable to check the applicant’s accounts, presuming the applicant is a limited company. The general rule of thumb used by surveyors is that the applicant should be able to show net profit before tax covering the rent three times over in the profit and loss account for the preceding three years. Another measure of financial status which can be examined is gearing, which is long-term debt as a proportion of capital employed. The more highly geared a company the greater is its capacity to offer high returns to its equity shareholders — but also the more vulnerable it is to any downturn in income.
Even if the income is not satisfactory, a substantial asset base in the balance sheet can be taken into consideration. Reading a company’s accounts is a skill, however, and if you are in any doubt do not hesitate to seek an accountant’s opinion.
If a company is newly established then it will not be able to provide accounts or references. That being the case you may wish to seek a guarantor: this can be either an individual, perhaps a director of the company, or a parent company or their bank. In the case of the former their covenant should be checked in the way outlined above.
When seeking a personal guarantee, you may wish to discuss with your client whether they would, in the final analysis, exercise their rights against an individual. Some institutions, for instance, may be unwilling to bankrupt an individual when recovering arrears from him as a guarantor, and the guarantee under the lease may therefore be of little use. Providing a personal guarantee is, however, a very significant statement of intent by the applicant.
If you still have doubts about the covenant, you may wish to hold a deposit from the tenant. This will be held in an escrow account and the interest will accrue to the tenant. The effect of the escrow account is that the money may only be used in certain circumstances, for instance non-payment of rent by the tenant. Such deposits are usually of one or two quarters’ rent. Deposits are useful in that they show an ability on the part of the tenant to produce a sum of money at the time they take over the lease, and they also provide a cushion to the landlord in the event of default by the tenant.
It should be noted in this connection that proceedings for possession on the grounds of non-payment or persistent late payment of rent are unlikely to be successful until the deposit has been used up.
The clock does not start running in respect of legal proceedings until that time; therefore the overall benefit of a deposit is somewhat limited.
Inappropriate user
Having satisfied yourself on the proposed tenant’s covenant, you will need to check on any change of user from that provided for under the lease.
If you are managing a parade of shops or a shopping centre, you will, for instance, need to consider how the proposed new user will fit into the existing mix of users, or comply with any proposals your client has for changing that mix.
Beware also of positive covenants in other leases of premises owned by your client against competing trades, and any restrictions that there may be either in your client’s headlease or running with the land. With the new B1 Use Class you may also need to consider, for instance, how a light industrial user may fit in with existing office occupiers.
Controlling users in multi-occupied premises requires a balance. Erring on the side of strict control can lead to problems at rent review when a deduction may be applied by the arbitrator to the market rent to take account of that restriction. Erring the other way means you may lose control of the users, and effective management will be much more difficult. Ultimately the investment value of the property may be affected.
An often-used formula is for user clauses to be worded on the lines of “…not to be used other than for the trade or business of x or for any other purpose within Class x of the Town and Country Planning (User Classes) Order 1987 subject to landlord’s consent not to be unreasonably withheld provided that it is agreed that the withholding of consent on the grounds of good estate management shall not be deemed to be unreasonable”. This wording appears to provide a sufficient degree of control without the landlord losing out at rent review.
Lack of control
If a tenant requests consent to a subletting, should you encourage him to assign his interest instead?
If the tenant sublets your client is preserving the direct landlord and tenant relationship, and since there is no direct relationship with the incoming subtenant, you will not need to vet the subtenant’s covenant quite so closely as would be necessary in the case of an assignment.
You should, however, be aware that at the expiry of the lease your client’s tenant will not be able to renew as of right if they have sublet the whole, and the subtenant may demand a new lease under the Landlord and Tenant Act 1954.
The closer you are to the renewal date then the closer you should examine the subtenant’s covenant.
Similarly, should your client’s immediate tenant default and forfeit his lease the subtenant would become your client’s direct tenant under the Law of Property Act 1925.
The downside to subletting as opposed to assignment is that your client loses a degree of control over the occupation of the premises. Any communications should go via the chain of tenancies, and it may be difficult to manage the property effectively in some cases.
Under current law, although there are now proposals for change, should the assignee default then the landlord can revert to any of the previous tenants for compliance with any lease obligations. It may be appropriate for the landlord to carry out company searches to find the most substantial previous tenant.
In conclusion I would recommend that any surveyor should treat an application for assignment or subletting as a rare opportunity, which may not arise again for some years, to enhance their client’s interest.