Subleases can be tricky beasts. Even their name is controversial. Although many in the industry call them subleases, I was taught that they should properly be called “underleases”, with a lease granted out of an underlease then being called a sub-underlease. But for the purposes of this article, I will call them subleases, and just hope my old land law professor doesn’t read it!
What is a sublease?
Subleases are, in essence, a lease granted out of a lease. So, if A owns the freehold of a building and grants a lease of the building to B, any further lease granted by B to C will be a sublease.
There are many reasons why B might grant a sublease, including:
- The building is only surplus to B’s requirements in the short term, so B doesn’t want to dispose of its interest completely.
- B has some spare space within the building, but B’s lease (like most leases) prohibits assignments of part.
- B is an investor who has purchased a long lease of the building at a low rent, with a view to granting rack rent leases of the individual floors of the building.
- Market conditions prevent B from assigning its lease, but someone is prepared to take a sublease for a shorter term and/or at a lower rent.
The same but different
A similar hierarchy of leases can also be created in a different way. A might grant an occupational lease to C and A may then grant another lease to B (a so-called “lease of the reversion”) that sits between A’s freehold interest and C’s occupational lease. As with the scenario above, B becomes C’s immediate landlord.
This arrangement will be indistinguishable from a true sublease for most purposes. However, because C’s occupational lease was not created out of B’s lease, any subsequent termination of B’s lease will not affect C in the same way as discussed below for true subleases.
Consent complications
Creating a hierarchy of multiple interests can, however, create issues.
Imagine the tenant at the bottom of the pile wants to assign its lease, or make alterations to the property. Depending on the terms of the leases, they may require consent not just from their immediate landlord but from every person with a superior interest. That can be a tortuous and time-consuming process.
And expensive too, with all those lawyers and surveyors to pay.
Headlease termination
Matters become even more complicated if the headlease ceases to exist. The outcome for the subtenant depends on how the headlease is terminated.
If the headlease is surrendered to the freeholder, the sublease continues as a headlease. The subtenant becomes the direct tenant of the freeholder, on the terms of the sublease.
A similar outcome arises if the head tenant acquires the freehold interest and merges the headlease into it.
But there are other scenarios where the termination of the headlease can also bring the sublease to an end. This is sometimes poetically referred to as the branch falling with the tree. This will occur where the headlease is determined in accordance with a provision of the headlease, such as a break clause or a forfeiture clause.
While a prospective subtenant will obviously be wary of taking a sublease that extends beyond a break date in the headlease, the risk of the headlease being forfeited by the freeholder cannot usually be avoided. Even where the subtenant is protected by the statutory security of tenure afforded to business tenants under the Landlord and Tenant Act 1954, section 24(2) of that Act confirms that this will not prevent the sublease terminating on the forfeiture of a superior tenancy.
And while we probably all share the same Pavlovian response that the subtenant can, of course, apply for relief from forfeiture, relief is not always the complete answer for the subtenant. Ignoring for one moment the cost, lost sleep and general hassle that the loss of the sublease and an application for relief will inevitably bring, relief is an equitable remedy awarded at the discretion of the court, it is not guaranteed.
Furthermore, the reality that relief will usually be given on headlease terms may put the subtenant in an invidious position, especially where the sublease was at a lower rent than the headlease, or where the sublease was of part only (although section 146(4) of the Law of Property Act 1925 expressly allows the court to grant relief in respect of part of the premises demised by the headlease). The subtenant also risks being required to make good the breach that led to the forfeiture, which may include the head tenant’s rent arrears.
There is a different outcome again if the headlease is disclaimed, perhaps by a liquidator of the head tenant. If that happens, the subtenant is left with a “bundle of rights” that entitle the subtenant to remain in occupation provided it continues to pay the rent and comply with the terms of the headlease. The subtenant can seek a vesting order if they wish to regularise the position, but this will attract many of the same problems discussed above in the context of seeking relief from forfeiture.
Over-dependency
A well-drafted sublease will reflect its status as a sublease and the existence of a superior lease. But potentially dangerous gaps can arise following surrender of the headlease if the terms of the sublease are tied too tightly to the headlease.
The following scenarios are potentially problematic if the sublease continues without the headlease in place:
Rent
- The sublease reserves a rent equal to “the rent payable from time to time under the headlease”.
- The sublease reserves its own rent, “or if higher the rent payable from time to time under the headlease”.
- The sublease reserves its own rent but provides for rent reviews to take place “on the same dates and on the same terms as the headlease”.
Insurance
- The sublease does not contain exhaustive insurance provisions, just a landlord’s covenant to enforce the insurance covenants in the headlease.
- The sublease includes a tenant covenant to pay (or contribute towards) the insurance rent payable under the headlease.
Repair and other covenants
- The headlease contained landlord’s obligations to repair and provide services, paid for via a service charge, with the sublease obliging the landlord to enforce the superior landlord’s covenants in the headlease and requiring the subtenant to pay or contribute towards the service charge payable under the headlease.
- A sublease by reference obliges the subtenant to comply with the tenant covenants contained in the headlease (save for payment of rent).
- A sublease of part includes a landlord’s covenant to comply with the tenant covenants contained in the headlease to the extent that they are not passed onto the subtenant.
The solution?
The key is to appreciate that the sublease may not always remain a sublease and to ensure it can function as a standalone lease in the event that the headlease disappears, leaving the subtenant as direct tenant of the freeholder.
Obviously this is less significant for the tenant under the headlease, since they will be out of the picture, but it is crucial for the subtenant and the freeholder. The subtenant will have no say in any surrender of the headlease and doesn’t want to risk losing the benefit of important landlord covenants in the headlease. When negotiating the sublease, they may want to make it absolutely clear that such covenants become landlord covenants of the sublease if the headlease is surrendered.
Equally, the freeholder does not want the subtenant to have any arguments that they are not fully responsible for rent and other payments once the headlease has gone. Approving the form of sublease should therefore be given due respect, ensuring that rent, insurance rent and service charge will continue to be calculated on the same basis as if the headlease had continued.
Ultimately, though, subleases are a necessary and commonly used device. The vast majority cause few issues, and some simple precautions can reduce the risk of problems arising.
Bill Chandler is a professional support lawyer at Hill Dickinson LLP
