WE ASKED HELENA DAVIES AND USHA SHARMA OF BRABNERS LLP HOW TENANTS’ SPACE REQUIREMENTS MAY CHANGE AFTER THE LOCKDOWN, WHAT THE LEGAL CONSIDERATIONS ARE AND HOW THEY CAN FUTUREPROOF THEIR LEASES
Many businesses are looking at their properties with fresh eyes, reviewing how to use their spaces post Covid-19. What do you think the main changes will be?
With lockdown still in place we are yet to see how the pandemic has changed consumer and business behaviour, although imminent government guidelines will hopefully provide some clarity on minimum requirements. Some changes to corporate and retail identities may be permanent and some may be interim measures.
One thing is certain – in the short to medium term, as science, law and the economy adjust to a new reality, businesses will need to ensure they retain some flexibility over their property requirements.
For office users, we are expecting social distancing to be reflected by reduced occupational density, shift patterns and screens between desks. The government is also expected to announce that hot-desking will be banned, canteens and communal areas will be closed and staff will be encouraged to bring packed lunches.
For retail and hospitality, store and restaurant format will need to make customer distancing possible – so perhaps limiting the numbers allowed inside and enforcing queueing from the outside entrance as well as rearrangement of check-outs as modelled by supermarkets already.
This could result in more floor-space being required, or open spaces being reconfigured with partitions. Alternatively, it could mean a revolution in space use, with open plan and huge towering offices replaced with small cellular offices outside the cities. Jes Staley Chief Executive of Barclays was quoted as saying last week: “the notion of putting 7000 people in a building may be a thing of the past”.
If a business is finding it simply has too many properties for the new world and needs to reduce its portfolio, what legal considerations might impact strategy?
It is highly likely that the big name retailers and restaurants are going to take a critical look at their premises and consider pruning back the rent book by making sensible reductions. This will in part be led by the market: Which stores are the least profitable? Where are there multiple units sufficiently close together, so customers will not have to go to a competitor? Which locations needs to be preserved for reputational reasons?
Separately however, a legal review of the property ownership in each case should be at the forefront of this exercise, to ensure a costs saving is in fact achieved, and an attempt to lose a store does not prove to be a false economy.
Quick ways out of leased premises include:
- Any properties occupied by virtue of expired 1954 Act excluded tenancies may be mere tenancies at will, and terminable simply on notice;
- Expired 1954 Act protected tenancies can be terminated on three months’ notice (under s.27(2) of the Landlord and Tenant Act 1954 Act);
- Tenancies with a contractual expiry on the horizon should be prepared for yield up in good time before the expiry date to ensure there is no holding over/trespassing and that the rental obligation stops immediately;
- Break options can be exercised to bring tenancies to an early end.
Potential pitfalls:
- Tenants should remember dilapidations liability – vacating after the end of a lease will give rise to a damages claim if the premises are not yielded up in accordance with the tenant’s reinstating/repairing/decorating covenants. As a replacement tenant may be tricky to find, the landlord will want to recover as much money as possible through a dilapidations claim. Tenants could try to minimise this claim by doing the work themselves in advance of leaving;
- Break options are often conditional, and great care should be taken to satisfy any break conditions which are strictly construed. Specialist advice should always be taken as landlords will be keen to contest breaks in a falling market, and plentiful case law on this provides landlords with good ammunition.
If a tenant is keen to leave premises where there are years of the term still to go, then negotiating with the landlord for a surrender may be possible. Of course, leases with a long term remaining will carry a heavier surrender premium should a negotiation be required.
“New lease drafting may see the introduction of new ‘corona’ clauses, which provide that rents are paused, or in some cases refunded, in the event of any future pandemic or lockdown”
Where a business is stuck with leases, what can it do to improve its position?
Prudent tenants may try to start reducing their baseline outgoings by reviewing their leases to establish whether assignment or underletting is permitted and on what terms. This could allow the obligations to be passed to a third party, albeit finding someone to take over the lease could be difficult. If permitted, sharing occupation or subletting part could mean sharing part of the rent and outgoings whilst retaining some space for a reduced business offering.
A number of commercial tenants are already using Covid-19 as a tactical opportunity to redefine their property obligations. Rather than encourage friction between the parties at a time when everyone is financially stretched, a ‘re-gear’ of the lease could allow the parties to renegotiate their existing lease to a mutually beneficial position. By way of example, the tenant may agree to delete a break clause from the lease in return for a rent reduction. Or the tenant could negotiate a rent-free period in exchange for extending the existing lease term. This would involve a reversionary lease with an extra few years, tagged onto the end of the existing lease. These are all ways of keeping the cash in the tenant’s business when they need it most while preserving asset value for the landlord.
Another tactic is to consider whether the lease allows alternative operations at the premises. This will be documented by the user clause in the lease. For retail it could involve shifting the use from in-store shopping to home delivery or dark rooms and for the F&B industry from eat-in-dining to delivery and takeaway. With offices, tenants may need to need to review the alterations provisions to enable them to modify open plan spaces and reinstall partition walling. For all such new arrangements, care should be taken to avoid breaching the tenant’s covenants, and so consent must be sought if required. Although landlords may not be inclined to forfeit leases in the coming months, they can always seek specific performance of leases and damages, for breach claims.
Where new premises are being taken, what might a tenant want to see in a lease to allow sufficient flexibility and protection for the future?
Standard commercial leases don’t include force majeure provisions which would allow the parties to terminate the lease where occupation is blighted by an ‘act of God’. Further, there is vigorous debate ongoing about whether the doctrine of frustration will apply to any leases in the current circumstances, with the current view being that it is unlikely or at least only plausible in exceptional circumstances.
As such, new lease drafting may see the introduction of new ‘corona’ clauses which provide that rents are paused, or in some cases refunded, in the event of any future pandemic or lockdown.
Leases which calculate rent based on turnover are already being requested more frequently now and it is important that such clauses are reviewed carefully. Many provide a penalty of 25% or more of the base rent if the business is closed, which clause would bite in the current circumstances.
While some employers are now endorsing the benefits of homeworking, some employees fear that this will result in employers shifting the cost of heating, lighting, office cleaning and maintenance onto them. Not everyone has a suitable space in their home to work remotely and working in isolation can present many challenges of a social as well as psychological nature. Whilst there may be an initial cost-cutting exercise on the property landscape, office spaces will still be required as the true productivity of remote working emerges.
New tenants should always take legal advice before signing up to new leases, but especially now when flexibility will be key – negotiations could include rolling break clauses, capped service charge and creative rent calculations.