Understanding your Heads of Terms – Key points for Commercial Tenants

Jun 18, 2020

Once a tenant has decided that they wish to take a commercial lease of a property, the landlord and tenant must agree the Heads of Terms. This is a document setting out the principal terms of the new lease, and it is likely to include the following.

Property

The extent of the property being leased needs to be clear. This is particularly important in relation to the tenant’s repairing obligations (see below). If the property forms part of a building, the parties may wish to attach a plan to the Heads of Terms.

If the tenant requires specific rights over the remainder of the landlord’s estate, such as a right to use certain car parking spaces, this should also be included in the Heads of Terms.

Term

The term is the length of the lease. It will be for a fixed number of years, but there are ways to build in some flexibility. This could include the right to end the lease early (break rights – for more information, please see our article What is a break clause? ) or an option to acquire a longer lease or freehold interest in the property (options).

A tenant should also consider security of tenure under the Landlord and Tenant Act 1954. This is a tenant’s right to remain in the property at the end of the fixed term. The parties can agree to exclude this right in the Heads of Terms, and a tenant should consider the implications before giving up this right. For more information, please see our article on Security of Tenure.

Rent and rent review

Most commercial leases will require the tenant to pay an annual rent.

In order to entice a “good” tenant or a tenant who will have to spend time fitting out the property, the landlord may also offer a rent free period of a few months.

Some leases will contain rent review provisions. This is a mechanism by which the rent is altered during the lease term. The rent could be increased by set amounts on set dates (agreed before completion of the lease), or the rent could be changed to reflect the level of market rents of comparable properties at the review date (often on an upwards only basis, so that the reviewed rent will be the higher of the existing rent payable, and the open market rent at the review date).

Usually the tenant will be required to pay service charge, insurance costs and other outgoings relating to the property (such as utility charges) in addition to the annual rent.

The landlord may require the tenant to pay a rent deposit on completion of the lease (often equivalent to 2 – 6 months’ annual rent). In addition, the landlord may request a tenant’s guarantor. Both these points should be negotiated at the Heads of Terms stage of the transaction.

Service charge

If the property is subject to a service charge, the service charge will be collected by the landlord or managing agent to pay for any services they will carry out. Some services must be performed whereas others are discretionary. The charge is likely to be collected in advance in accordance with an estimate provided to the tenant. The tenant will pay a fair or quantified proportion of the sums due and will have to pay any excess to the landlord.  The tenant should consider the arrangements in place, particularly with regards to the services it will use, and the proportion of the costs charged. A tenant may wish to consider a service charge cap to add certainty to the cost and to prevent the tenant being responsible for a proportion of very expensive capital expenditure such as the replacement of the roof of the building.

Repair and decoration

Repairing obligations place a considerable financial burden on tenants. Where appropriate, tenants should ensure their obligation is to keep the property in no better condition than it was in when the tenant first completed the lease. This is achieved by annexing a Schedule of Condition to the lease, which will contain photographs evidencing the condition of the property at the start of the lease. The agreement to annex a Schedule of Condition to the lease should be documented in the Heads of Terms.

Tenants should also be clear about the extent of the property they are required to repair. For example, the tenant could be required to repair the interior, whilst the landlord is responsible for the exterior, conduits and communal areas. However, the respective responsibilities can be negotiated. For example, the tenant may wish to take on all interior repairs but exclude the window frames.

For more information about the repairing obligation pitfalls for tenants, please see our article: What is a Full Repairing and Insuring Lease?

If the landlord is required to undertake any works to the property, this should also be included in the Heads of Terms.

Alienation (assignment, subletting and sharing occupation)
If the business needs of a tenant change, it may wish to vacate the property or share possession with another party. A tenant should consider whether it will need the ability to assign the lease, grant a sublease of whole or part of the property, or share possession of the property with a group company. The landlord may agree to such provisions but may require that specific consent be given on each occasion.

Permitted use

The Heads of Terms will confirm the permitted use of the property. For example, use as offices or for retail purposes. Usually the landlord will not confirm that the property has the necessary planning permission for this use, and the tenant should consider this as part of their investigations in relation to the property. We can investigate the planning history of a property by carrying out a local search for a tenant. For more information, please see Why do we do Commercial searches? 

Alterations

A tenant may wish to make internal (and external) alterations to the property to fit in with its business needs. The landlord may allow certain alterations to the property without specific consent being obtained, but often the landlord’s formal consent is required. In order to obtain the landlord’s consent, the tenant will need to provide details of its proposed alterations to the property to the landlord. The tenant must also consider whether planning permission or building regulations approval is required for the alterations.

If you require further guidance regarding your proposed Heads of Terms or advice on commercial leases in general, please contact Rosie Edwards, Solicitor, or Daniel York Partner, in our Real Estate department or email your query to realestate@herrington-carmichael.com; call us on 01276 686222 or visit our website https://www.herrington-carmichael.com/contact/

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Yazar: Rosie Edwards

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