Hello and welcome to the second instalment of the ‘how to read your lease‘ series. This time we will be covering ‘Third Party Rights’, ‘The Annual Rent’ and ‘Insurance’. We are intentionally missing out ‘Rent Review’ because its a complicated, and often misunderstood, part of the lease and should be covered on its own. We’ll take a l look at this next time.
Clause 5: Third Party Rights
In the last instalment there was a section that referred to ‘rights excepted and reserved’ at clause 4, that clause will assist your understanding of this clause. You may remember that clause 4 was all about the use and enjoyment of neighbouring property, and clause 5 is very similar but relates to neighbouring property not owned by the landlord.
The first consideration is – who are these third parties and how do their rights burden the property? I’m sure that a solicitor acting on behalf of the tenant will ask this question and in many situations, it will be evident from the land registry entries/deeds.
These parties are usually owners of neighbouring property who require rights of way over the property being leased, or companies that have been granted rights over the land for various purposes.
For example, a company may be given a right to install and maintain pipes and cables at the property. This kind of agreement is a ‘wayleave agreement’ and it is usually registered at the land registry against the Landlord’s title. The Landlord has entered into this agreement and will have certain obligations in respect of it and this clause in the lease is obliging the Tenant to abide by and facilitate the Landlord’s obligations.
These are just examples and there may other obligations and promises listed at the Land Registry that have to be impressed upon the new Tenant. There may also be undisclosed third party rights and it is important for solicitors to ask these questions.
Landlord’s beware, if you are obliged to do something then you have to make sure the Tenant is too. If the Tenant won’t allow access to the Property for any reason then it is the Landlord that will be held responsible.
Tenant’s beware, these third party rights may stop you using the Property for the Permitted Use and so it is important to identify them as soon as possible. You must inspect the Property and ask all necessary questions of the Landlord. If there is something that affects your use and enjoyment of the Property then you need to know about it.
If you have concerns then please draw them to our attention as soon as possible.
Clause 6 : The Annual Rent
This is the part of the lease that both parties will be very interested in (i.e MONEY!) – how much money is being paid for the exclusive use of this property; when is it being paid – what date and in advance or arrears? How is it paid/is there a rent free period?
In a standard lease the Tenant will be obliged to pay the Annual Rent (ie. the rent for the year) in four equal amounts on the Rent Payment Dates. The Rent Payment Dates are usually the standard ‘quarter days’ – 25 March, 24 June, 29 September and 25 December. Indeed ‘The Quarterly’ is released on these very days for that reason – they are very recognisable to Landlords and Tenants alike. This doesn’t mean that you have to stick to those days but they are the most common. You should note that to avoid cash flow issues, Tenants usually prefer to pay monthly amounts.
Note that I am using ‘Capital Letters’ for some of the terms used above and if you read the last instalment, you will know that this means they are defined terms. So your quick reference point for this Clause should be the definitions section of Clause 1 of the lease.
This clause usually specifies that the rent payments need to be paid by an instant payment method such as bank transfer.
Another important consideration is when does the first rental payment need to be made? The Landlord may grant a rent free period because the Tenant is paying for works to be done to the Property and the lease will need to reflect this. However, you should note that the rent free period may not be a ‘no rent to pay for this period ever’ type option but actually just inflates rent in the latter part of the term.
If the rent free period if not taken into account on rent review then the rent will be reviewed on the basis of this higher rent (ie. it will automatically make it higher than the Tenant might expect and be an unfair comparable for leasehold properties in the area). I will discuss this further in the next instalment with ‘rent review’.
There may also be VAT implications as if the rent free period is for anything other than a goodwill gesture it becomes a supply for VAT purposes and can lead to liability for the Tenant.
As an aside point, the annual rent, any VAT payable on top and the rent free period, if any, will be used to determine the Net Present Value of the Property for SDLT purposes. This is total value of the lease for the specified term and the SDLT will be calculated using this total figure. A rent free period will mean that rent for that year is reduced and will in turn lower the total Net Present Value and SDLT liability. There are also SDLT implications if rent review takes place prior to the 5th anniversary of the lease. Please feel free to contact the commercial department for additional information.
If you would like to try calculating your SDLT liability yourself, this handy online calculator may assist you.
Clause 8: Insurance
I am sure that you are all thinking that the insurance section is very self explanatory, and to an extent you are correct – you should have an idea of who is insuring the Building and who is insuring Property from the outset. But there is the first rub – sometimes the Building and the Property are different things.
Before I get into this, I should say that generally in a commercial lease of 5-20 years the Landlord provides Building insurance and then claims Insurance Rent directly from the Tenant. This will be a proportion of the total insurance premium cost and will usually correspond with how much of the Building that the Tenant is leasing (this is why it is important to establish what the Building and Property are. The Property is the extent of the Building that the Tenant is leasing).
The Insurance will be taken out for the reinstatement cost of the building, loss of Annual Rent, insurance premium tax and damage or loss caused by Insured Risks. The Insured Risks themselves include a number of potentially fantastical events including earthquakes, explosions, heave and lightening – there are many more to include but this gives you an idea of the true extent. In recent years due to the elevated number of terrorist attacks, it is now possible to insure you Building against this but it is only recommended for certain areas of the country.
As a quick note, when acting for either party you should ensure that your definition of the Insured Risks really does mirror the policy itself. Also, the Landlord rarely insures ‘plate glass’ – why? Perhaps because it is easily breakable and if it is not ‘insured’ then it allows the Tenant to arrange a replacement without recourse from the insurance. The Tenant should also consider separate public liability insurance, contents insurance, and business interruption insurance for their other purposes.
I started by saying that usually in commercial leases the Landlord is responsible for insurance but this is not always the case. If the Tenant is insuring then it is usually because they occupy the entire Building; or because more unusually the commercial lease is granted for a longer period of time for a premium. The Tenant should be very clear on this position at the start of the transaction as the Property will be at their risk and they need to put adequate insurance in place that includes any part of their Property that is reliant on/ touching the rest of the Building.
Assuming that the Landlord is insuring, the insurance clause in a lease will impose a series of obligations on the Tenant which will include:
- The Tenant informing the Landlord if anything happens that may affect the insurance;
- The Tenant agreeing not to do anything to void the policy (even insuring the Property itself as two policies will not pay out on the same damage and this could vitiate the policy); and
- Agreeing to meet all of the Landlord’s costs in the event that the Tenant has acted/ omitted to act in a way that invalidates the policy.
- The insurance provisions standardly provide that if the Property is severely damaged and this makes the Property uninhabitable (and assuming the Tenant has upheld their obligations), the Landlord will suspend all or part of the Annual Rent Payment for a period of time.
If there is so much damage that the Landlord considers that it is impracticable to reinstate the Property then the Landlord can terminate the lease by serving notice on the Tenant. If acting for the Tenant then you would want to expand this provision to allow the Tenant to serve notice on the Landlord if the Property is still unfit for occupation after a period of time, usually 3 years.
From the Landlord’s perspective however, the Landlord may allow the Tenant to serve notice after 3 years but it would need to be limited so that the notice could only be served provided that the reinstatement works weren’t substantially completed.
I have provided you with an overview of three important provisions within a lease, if you would like to discuss these further then please contact a member of the commercial property team.