COMMERCIAL REAL ESTATE | INSIGHTS | BY ANNE MARIE JENNINGS
In an ever-changing and fast-moving commercial environment, tenants are increasingly considering the need for more flexible workspace to cater for changing working practices. Existing premises may not always be suitable or capable of being adapted to cater for these demands. In this article, we consider the options available to a commercial tenant looking to upsize, downsize, move on from impractical space, or just relocate to alternative premises.
Assignment
An assignment involves the transfer of an entire leased premises, along with the exiting tenant’s rights and responsibilities in respect of same, to a new party (the “assignee”) for the entire remaining term of the lease. The assignee assumes all the obligations of the exiting tenant under the original lease.
Common restrictions on assignment contained in commercial leases include:
- Landlord Consent – the assignment of almost all commercial leases is typically subject to landlord consent, which cannot be unreasonably withheld. What is “reasonable” will depend on the circumstances of each individual case. However, in general, so long as the exiting tenant can show that the proposed assignee has sufficient resources and ability to comply with the lease obligations (by offering a guarantee or rent deposit where necessary), the exiting tenant should be entitled to receive consent to the assignment of the lease. Considerations which may justify refusal of consent include existing breaches of lease, the possibility that the assignee might compete with the landlord’s other tenants and the possible devaluation of the landlord’s interest. The lease may also specify criteria to be satisfied.
- Prohibition on Assignment of Part – most commercial leases will usually include an absolute prohibition on an assignment of part of the premises only.
Sub-Leasing
A sub-lease is an agreement whereby a tenant (the “sub-lessor”) who holds a lease (the “head-lease”) to a commercial premises rents out all or part of the said premises to a secondary tenant (the “sub-lessee”). This sub-lessee treats the sub-lessor as their landlord. The head-lease remains in place and the sub-lessor remains liable to the head-lessor under the terms of the head-lease as tenant.
Common conditions or restrictions on sub-letting in commercial leases include the following:
- Landlord Consent: as with assignments, almost all commercial leases include clauses which restrict sub-letting without landlord consent, which consent cannot be unreasonably withheld.
- Evaluation of Proposed Sub-Lessee: prior to issuing consent, the landlord generally has the right to request certain information about any proposed sub-tenant and their financial standing. This allows the landlord to carry out a comprehensive evaluation of the proposed new sub-lessee and determine whether a guarantee or rent deposit may be required. Any costs incurred by the landlord in respect of the evaluation process will usually be for the account of the sub-lessor, who must discharge same in full.
- Sublease of Part or Entire: the sub-lease usually must be of the entire premises only – particularly where a property is not designed or intended for multi-lets. The head-lease terms may also contractually allow a partial sub-lease, but subject to certain conditions.
- Form of Sub-Lease: in the event that the head-lease is terminated (for whatever reason), the head-lessor will be obliged to step into the shoes of the sub-lessor and have a direct relationship with the sub-lessee on the terms outlined in the sub-lease. To protect the head-lessor’s interests in such an eventuality, landlord consent to sub-leasing is usually subject to the terms of the sub-lease being substantially in the same form as the head-lease. The alignment of the terms of the sub-lease and the head-lease is also beneficial from the sub-lessor’s perspective, as it helps to reduce the risk of breaches of the head-lease by the sub-lessee.
- Rent: a standard commercial lease will typically require the rent in a sub-lease to be the open market rent or the rent then passing under the head-lease, whichever is the greater. This could pose a challenge to subletting if market rents are lower than the rent specified in the head-lease.
- Direct Covenant: sub-lessees are usually required to enter into a direct covenant with the head-lessor to comply with the covenants and conditions in the head-lease, thereby enabling direct enforcement, if required.
- Deed of Renunciation: to ensure the sub-lessee does not acquire statutory rights to renew their sub-lease, the execution of a Deed of Renunciation by the proposed sub-lessee would be a standard pre-condition of a sub-lease.
Tenants should be aware that while sub-leasing might appear an attractive solution to their under-utilised space problem, it does come with an inherent risk of default. This risk arises because regardless of the wording of the sub-lease, the sub-lessor, as the original lessee, will remain fully on the hook for the rent and all other tenant obligations in the head-lease. As such, if the sub-lessee stops paying rent, causes any property damage or breaches any of the obligations of the tenant under the head-lease, the sub-lessor will remain liable to the head-lessor.
Break Option
A well-negotiated lease might include an early termination clause (a “break clause”), which allows for early termination of the lease by the tenant on an agreed date / dates (the “break date / dates”). This is usually subject to the satisfaction of certain conditions (“break conditions”).
In order to protect the landlord’s position, break conditions are strictly construed by the courts and, accordingly, must be strictly complied with by a tenant in order to validly exercise their break option. For this reason, it is always strongly recommended that a tenant seek legal advice as to how to validly exercise their break option well in advance of the break date.
Common break conditions include:
- Service of Notice: all break options are subject to service of notice of the tenant’s intention to terminate the lease. The notice period will usually vary from 3 to 12 months prior to the agreed break date, depending on the length of the lease. Failure to serve notice within the specified period or in the specified manner will invalidate the break option. It is therefore strongly advisable for all commercial tenants to diarise the break date and the notice period required, and to review their option at least 12 months before the notice period commences.
- Break Penalty: break options are sometimes subject to payment of a penalty of circa 6/12 months’ rent to be paid to the landlord prior to the break date.
- Payment of Rent: upfront payment of all rent, service charge, insurance and other sums due under the lease up to the break date is another common condition of a break option. This payment is usually sought at the time of the service of the break notice, made in full, and strictly in accordance with the term of the lease. For example, if the lease requires rent to be paid quarterly, the full quarter’s rent must be paid even if part of the rent payment relates to a period beyond the break date. Some leases will provide for a partial return of rent that has been overpaid.
- Vacant Possession: all break options require that the tenant must deliver “vacant possession of the premises free from encumbrances” to the landlord on the break date. The test for compliance with this condition is two-pronged:
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- The tenant must deliver full vacant possession of the premises on the break date. The test of vacant possession is more than just about giving up occupation. It means ensuring on the break date that all tenant stock, machinery, fixtures and fittings are removed where required by the lease or supplemental documents, that keys are returned and that no persons are present in or in occupation of the premises with the express or implied authority of tenant.
- The premises must be delivered free from encumbrances – this means that the tenant must provide evidence on or prior to the break date that any sub-leases have been terminated and that no statutory renewal rights have been accrued by any sub-tenants. In addition, the tenant must provide evidence that any security registered over the lease has been released by the relevant bank.
- Compliance with Lease Covenants: the exercise of a break option is also commonly made subject to the tenant’s compliance with the covenants on the tenant’s part in the lease.
Lease Surrender
If a break option is not on the cards and a suitable sub-lessee or assignee cannot be found, paying out the remaining lease term may be the only viable option left to a tenant seeking to break a commercial lease. In such cases, a tenant may approach the landlord and request a lease surrender in consideration of a reverse charge premium. It is at the discretion of the landlord as to whether or not it will agree to such a surrender.
Conclusion
In this article we have explored four of the main ways in which a tenant might break its commercial lease. Depending on the terms of a particular lease, however, there may be further options available to a tenant that fall outside of those outlined here.
Breaking a commercial lease is never straightforward! Success in a tenant’s lease exit strategy will depend on current market conditions, lease terms, and their chosen approach. Moreover, even with a good relationship between a landlord and tenant, the process of breaking a commercial lease can be as complex as a divorce. If you find yourself in a position where you need to terminate your commercial lease early, please contact our Real Estate team who would be more than happy to guide you through the process.
How we can help
If you have any queries or concerns, or would like to discuss the above in further detail, please feel free to contact Anne Marie Jennings in our Real Estate Department ([email protected] / +353 (0)1 440 8336).
This article is for general information purposes. Legal advice must be obtained for individual circumstances. Whilst every effort has been made to ensure the accuracy of this article, no liability is accepted by the author for any inaccuracies.