by Christopher Morris
Businesses expand and contract according to market conditions. A business which has unexpectedly ceased to expand or which is passing through a period of contraction (“Status Co”) may desperately need the extra income to be gained from subletting part of its building. An expanding business (“Go Co”) may, in the current economic climate, prefer as a matter of prudence to take a sublease of part of a nearby building rather than committing itself to moving the whole of its business to new premises. Surveyors and solicitors have a vested interest in ensuring that the need of Status Co to let excess space is successfully married to the requirements of Go Co. To ensure this success each client must be advised of, and reach agreement as to, the perils peculiar to subletting which will otherwise undermine the transaction.
This article will address the hidden perils facing a firm which is subletting part of its own office space to a prospective subtenant — but remember that the same problems will need to be addressed by the prospective sublessee.
Imagine that you are advising Status Co, a business paying a high rent for an office building, part of which is empty. Subletting part of the building appears an attractive solution. You advertise the premises and, after a struggle, eventually find an appropriate subtenant, Go Co. Negotiations then take place and an “agreed set of heads of terms” is drawn up which covers the space to be sublet, the rent, the frequency of rent review, the term, the permitted use, the rights to assign, sublet and alter, and the level of contribution towards service charge and insurance. Both parties feel “agreement has been reached” and you are about to hand the respective solicitors the agreed terms. At this stage you should pause to remember that subletting transactions can fall apart in acrimony because certain practical issues have not been discussed when the deal was struck.
The Perils
Access and security
Will the subtenant, Go Co, be given a separate entrance? A separate entrance will avoid the problems which often arise concerning security, treatment of reception facilities, and signs in the entrance hall (see below). Usually there is a common entrance. Go Co may require 24-hour access, seven days a week. Have you considered how additional costs arising from that access are to be dealt with if Status Co does not require access to be available during those hours? Does Go Co carry on a particularly sensitive activity which will increase the amount of security needed — and therefore the cost of providing it?
Signs
This may be Status Co’s headquarters. Will the presence of Go Co damage the image that Status Co wishes to create for visitors to the building? Some subtenants will press for a sign outside the building which Status Co may consider totally unacceptable. It is difficult to resist Go Co’s request for a sign in the reception area, but will Status Co be prepared to see Go Co’s corporate logo appearing at the entrance to Status Co’s headquarters? Negotiations in this area, fuelled by corporate pride, are often prolonged. It is not unusual to see agreements to sublet which specify the size, location and appearance of the permitted sign. As this area, although relatively minor compared to issues such as rent, is so emotive, it should be discussed at the heads of terms stage.
Reception area
Assuming there is no separate entrance for Go Co, are Go Co’s visitors to come through Status Co’s reception area? Is Status Co happy for Go Co to use its reception facilities? If so, what amount should Go Co pay for those facilities?
A separate reception at the ground-floor entrance for Go Co will destroy the image that this is “Status Co’s building”. This problem is sometimes resolved by sending visitors for Go Co to a separate reception on that particular subtenant’s floor. Such a system could present difficulties from a security point of view, because visitors are being given access to the lifts in the building before they have been identified.
Security and confidentiality within the building
Ideally the building will have a security system which allows access to common parts on all floors, but which precludes Go Co from entering Status Co’s business floors. If such a system is not already in place then installing a system will be an additional cost of subletting. Go Co for its part will need to satisfy itself that Status Co’s staff cannot gain access to its premises.
As a general point, before subletting a building you should explain to Status Co the disadvantage from a security viewpoint in the fact that it can no longer assume that all persons within the building are either its staff or its visitors.
Subtenant’s employees/visitors
Did your instructions to find a subtenant exclude direct competitors of Status Co? This may have the effect of excluding a large number of possible tenants who would have used the space in a way compatible with Status Co’s use. If Go Co is involved in a business which is outside Status Co’s market sector will this have a detrimental effect on the image of the building? If Go Co’s staff or its visitors follow different business practices, or dress or behave differently from those in Status Co’s line of business, then this could change the whole atmosphere and character of the building.
Lifts
It will be unusual for the building to be so well served that Go Co can be given a separate lift for its use. Shared lifts give the building a “public” feel: there may always be people present who are from outside Status Co.
A practical aspect which should be considered before even deciding which areas to sublet is whether there is a goods lift available. It is preferable if visitors to Status Co’s building — or indeed its own staff — are not put into a position where they need to share a lift which is used for heavy deliveries or for the removal of rubbish!
Toilets
Ideally Go Co will use, clean and maintain its own separate toilet accommodation. If Status Co is subletting part of a floor, or if it is subletting a floor which has no toilets, this may not be possible. Is there an agreed system of cleaning and maintenance of the toilet accommodation and an agreed scheme for sharing the costs?
Consent of superior landlords to subletting/use/fit-out works
Consent is likely to be required to subletting and to carrying out fit-out works from either one or more superior landlords; consent may be required for the proposed use. Have you checked the terms of Status Co’s lease? The superior landlords are unlikely to have much incentive to deal with applications for consent quickly. Try to speak informally to superior landlords or their agents before “striking the deal” and submit formal applications for consents as quickly as possible.
To assist in this Go Co should be asked at an early stage to provide copies of its accounts and details of its business with a note of the exact proposed use for forwarding to the superior landlords.
It is worth emphasising that, before even marketing the space, Status Co should check with its legal advisers that the type of subletting proposed is one which is either permitted by the headlease or one to which the superior landlord cannot unreasonably withhold its consent.
Similarly you should elicit from Go Co at an early stage the type of fit-out works which it wishes to carry out. You should check that these are works that can be carried out either without the need for consent or with the consent of the superior landlord, which cannot be unreasonably withheld. An indication of a superior landlord’s attitude towards those works should be obtained as quickly as possible. This should be followed by a full submission of details of the works as soon as they are available.
There is no point negotiating and agreeing the minutiae of other parts of the transaction only to find that your superior landlord will not consent to the subtenant’s fit-out proposals.
It is not uncommon for a subletting transaction to fall through where the superior landlord delays its consent, either to the subletting itself or to the associated fit-out. An early application for consent will, in the case of applications to assign or to sublet, assist any future argument that the superior landlord has not given its consent within a reasonable time for the purposes of the Landlord and Tenant Act 1988.
Fit-out works — using up service capacity within the building
Go Co may wish to make connections to the services within the building in a particular way in order to make the best use of the sublet space. For example, Go Co may wish to install a computer room which will make high demands on electrical supply — or it may wish to install a kitchen or conference room which will need additional air-conditioning. Make sure that, before acceding to these requests, Status Co is sure that the installation will not interfere with or inhibit Status Co’s present or possible future uses of space within the building. Status Co must not allow Go Co to use up disproportionate amounts of the power in the building if Status Co, in future years, may require the additional power or additional air-conditioning capacity for its business.
Warn Status Co of the possibility that it may be involved in future sublettings. If Status Co gives away all the spare capacity of the building to Go Co, will Status Co effectively be precluded from subletting other parts of the building?
Fit-out works — disruption in the building
Interference by Go Co with air-conditioning or electrical supplies may invalidate warranties (of which Status Co has the benefit) for the installation of the air-conditioning and electrical systems. Interference may render void the provisions of a maintenance contract or a contract of insurance of which Status Co takes the benefit.
A common problem which arises during fit-out is that minor works such as installing non-structural partitioning can affect the balance of the air-conditioning for the rest of the building. If Status Co has spent a year ensuring that the air-conditioning balance is correct, make sure it takes advice on the impact of the new partitions before accepting a particular layout.
The risks of interference with Status Co’s service media (such as electricity cables and air-conditioning equipment) or the maintenance of insurance contracts for those media may lead Status Co to require that all works affecting service media are carried out by Status Co’s own contractor. The cost implications of such a “monopoly” situation mean that Go Co will wish to avoid it.
The works themselves may disrupt Status Co’s use of the building. It may wish to impose on Go Co a working regime to minimise noise and other interference with Status Co’s business, or to specify a particular access route for fit-out contractors.
Fit-out works — timing
Fit-out works can be a stumbling block. Go Co should not commit itself to taking a sublease without being sure that the space can be used as Go Co wishes. A decision to “take the space” and instruct solicitors often predates consultation with the end-users as to how the space should be fitted out. It takes time and costs money to finalise fit-out proposals. Often subtenants begin to formulate their requirements only after they have “agreed” (through signing heads of terms) to take office space. Even if Status Co agrees to Go Co’s works it may be impossible to consent to them quickly because of the necessity for a superior landlord’s consent.
The aim must be to elicit as much information as possible about the way in which Go Co proposes to fit-out the space before agreeing final heads of terms with Go Co. Go Co for its part may be reluctant to commit itself to the cost of preparing fit-out drawings until it is reasonably sure that it will be able to proceed with the space.
The happy ending
Sublettings may, despite all these dire warnings, prove a useful way for Status Co not only to cover its own rent but also even to make a profit. This will particularly be the case where, in a rising market, Status Co sublets the space midway between the rent-review dates under its lease.
Identifying practical difficulties early on will enable Status Co to take a balanced view in deciding to sublet, and your advice should help it to predict and understand Go Co’s requirements. Addressing the matters referred to above at an early stage (and before heads of terms have been “agreed”) will prevent Status Co from giving the impression that it is trying to renege on the original deal and will help to set a precedent for a good relationship with Go Co. The surveyor and the solicitor involved will win no friends if practical issues are swept under the carpet until a late stage when they become major problems. A positive, realistic and practical approach should ensure that Status Co instructs you on future sublettings.
