A new lease of life for business

Joanne Humphreys runs the rule over a code of practice that aims to reduce red tape in commercial lettings

Enterprise has been under threat over the past year, with the number of start-ups in the UK contracting by18%, and business failures increasing by 4%.

It is little wonder - especially as commercial property prices continue to rise by 8% annually - that prospective tenants are looking for fairness and flexibility in taking on a commercial lease.

Until recently, power has been firmly in the hands of landlords who are able to dictate their terms to commercial tenants, even when business is asking for clemency.

But a code of practice for commercial leases, launched on 22 April 2002, potentially offers enterprise a new lease of life.

Commercial property investors have much more freedom than residential property agents when formulating contracts.

The average lease is between ten and 15 years, with the tenant often required to pay for insurance, ongoing repairs, and periodic upward-only rent reviews.

Tenants can end up liable for payment of rent and carrying out repairs, even if their business fails.

Where they have guaranteed the obligations under the lease, they may need to sell personal assets to meet costs.

Commercial risk

The outcome is to expose prospective tenants to considerable commercial and financial risk and potentially to deter enterprise.

No wonder business is wary and, after the uncertainty of recent months, is looking for increasing flexibility and protection in its negotiations with commercial landlords.

This is not lost on the government, which in 1995, after the recession of the early 1990s, recognised the stranglehold of draconian leases on commercial enterprise and introduced a voluntary code of practice - but unfortunately to little avail.

Eight years on, the new code of commercial practice for leases in England and Wales was introduced after concern that some small businesses are still being forced into leases with unattractive obligations and responsibilities that could make or break them.

The code makes it clear that encouraging commercial investment will not be at the expense of enterprise and, this time, legislation may follow if the reforms do not have the necessary impact.

The code aims to give back negotiating power to tenants, especially in regions where demand for property outstrips supply.

It covers 23 key areas of common discourse, which are divided into ten recommendations regarding initial negotiations and 13 recommendations for conduct during the lease.

For business, there are important implications:

l Negotiation - the code requires landlords and tenants to negotiate openly and constructively and to consider each other's views.

Seemingly common sense, what it will require is a more constructive attitude and willingness, especially on the part of landlords, for moderate demands.

Negotiations by tenants need to be well informed and any business entering into a lease should think seriously about appointing a surveyor from the outset, who will know the market and the likely areas of risk and who can help put together clear heads of terms.

Leaving it until a solicitor becomes involved may be too late and result in extra costs to formulate and renegotiate the provisions of the lease.

l Service charges - the code recommends that landlords provide estimates of service charges and other outgoings for the tenant, before they enter into any agreement.

While this might be possible for an older property, where a history of service charges exists, in the case of newer premises, negotiation may be needed to restrict service charge liability for the tenant by capping it.

l Break clauses and opt-out options - with economic uncertainty, it is no surprise that tenants are looking for increasing flexibility in break clauses, or alienation options, or the ability to sub-let the whole or part of the premises.

The code states that landlords (and property-funders) 'should consider offering tenants a choice of the length of term, including break clauses, where appropriate'.

The aim is to counter the tendency for investors, eager to protect their long-term income stream, imposing terms, which deter tenants from setting up who might be able to do so with more forgiving break clause options.

l Rent review - traditionally being in only one direction (upwards), rent review is a continual source of friction for tenants.

The code recommends that the usual 'open market' rent be used as a guide, with upward and downward rent review options to reduce risk.

l Repairs and services - in most cases, liability for repairs falls to the tenant, with obligations to repair being incorporated into the lease.

Therefore, business can find itself unexpectedly exposed to considerable financial risk with difficulties at the end of the lease, when a tenant has failed to keep up with repairs during the term and is served a much-feared schedule of dilapidations for costs of putting the property into the condition required in the lease.

Not uncommonly, the tenant is required to carry the costs of all repairs on behalf of the landlord.

The outcome can lead to protracted negotiations for months, sometimes years, after the lease has expired.

l The code states that 'repair obligations should be appropriate to the length of term, condition and age of the property at the start'.

This needs the professional advice of a surveyor.

Full repair obligations can be reconsidered and tenants may benefit from a schedule of condition, which reflects the condition of the property at the outset and limits liability for repair obligations.

Alternatives to uncertain service charges can be negotiated by capping, or rent inclusive of service charges, providing tenants with fixed budgeting parameters.

l Insurance - previously, tenants have often had no say in the insurance of the building, potentially exposing them, for up to 15 or more years, to less than favourable premiums.

The code has insurance recommendations, which include the landlord obtaining competitive rates and the possibility of the tenant influencing the choice of insurer.

l Alterations and use - the ability of the building to cope with business needs as it grows, or changes, can be limited by restrictions to alteration or use imposed by landlords - even internal, non-structural alterations.

Tenants are then compelled to pay for landlord's consent to minor alterations.

The code recommends that limitations on alterations should not be 'any more restrictive than necessary to protect the value of the premises'.

Guidance on conduct

The remaining 13 recommendations provide guidance on conduct and when to take advice in areas of dispute, service charge issues, renewal of lease and rent reviews.

The code potentially helps business in two ways.

Firstly, by reducing exposure to commercial and financial risk, especially in the case of dilapidation, which can run into tens of thousands of pounds.

Secondly, it allows business the scope to negotiate terms, enabling the premises to be adapted to serve the changing needs of the business rather than compelling the business to incur the cost of re-negotiation or re-location.

Ultimately, the code is still voluntary, although the patience of government and commerce is wearing thin, and there is no legal obligation for a landlord to adhere to it, especially where market forces are strong and there is competition for commercial space.

A prospective tenant's leverage in negotiating will be increased, where it appoints a surveyor at the outset who can assess the premises and the risk and put together heads of terms, which can then be incorporated into a lease by a solicitor.

Most importantly for the region, it provides a general framework and guidance, which seeks to redress the balance of power in the market-place, without being overly interventionist and stifling investment.

Potentially, if business makes good use of it, the code of practice offers a real opportunity for landlords and tenants to cast-off some of the restrictions within commercial lettings to kick-start entrepreneurial growth.

Joanne Humphreys is an assistant solicitor in the commercial property department at Nelson & Co Solicitors in Leeds