Lease Renewal: Who Decides the Terms when Landlord and Tenant Cannot Agree?
26 April 2013
#Commercial Real Estate
The landlord and the tenant will generally negotiate the terms of a lease on renewal, but if the parties cannot reach agreement, the court will decide on the terms.
The usual procedure is for either the landlord or the tenant to set out their proposals for the new lease in the landlord’s section 25 notice or the tenant’s section 26 request. (A landlord will generally only serve a section 25 notice to renew a lease when he believes that he is likely to get a rent increase on the renewal lease). Once the initial terms are proposed, the parties will negotiate. Very often terms will be agreed without reference to the court, but if terms cannot be agreed then the only way of determining the terms will be to make an application to the court.
As with any negotiation, the bargaining strength of each party will determine what is ultimately agreed. Bargaining strength will also of course be affected by the current market conditions.
If agreement cannot be reached, what is likely to be decided with regard to the main terms of the lease?
Under statute, the tenant is entitled to a new lease of those parts of the premises that it actually occupies for the purposes of its own business. The two exceptions to this are:-
- The landlord can insist that the tenant takes a new lease of the whole of the premises originally demised. So if the tenant originally took a lease of a whole building but has sublet floors, the landlord is still entitled to require the tenant to take a new lease of the whole building. (The landlord may not wish to have to manage a multi-let building). The court has no discretion with regard to this issue and, if the tenant does not wish to take a lease of the whole of the building, its only option is to refuse to take the renewal lease;
- Where the landlord is proposing to object to a renewal of the ground that it wishes to demolish or reconstruct the building, the tenant may offer or the landlord may request (but cannot insist) that the tenant takes a new lease of something less than the whole if that part is an economically separable part.
The landlord and the tenant can agree any length of term for a renewal lease but if agreement cannot be reached and the matter goes to the court, the court is only able to grant a new lease for a maximum term of 15 years, even if the original lease was for longer.
If the tenant has only requested a short term, it will be usual for the court to grant the tenant’s request as the point of the Landlord and Tenant Act 1954 is to provide security of tenure to the tenant, not to protect the landlord’s investment.
Under the Landlord and Tenant Act 1954, the court must determine the yearly rent payable by reference to the rent at which the property might reasonably be expected to be let in the open market by a willing landlord.
The court is obliged to disregard the following matters when determining the market rent:-
- The fact that the tenant or the tenant’s predecessor in title has occupied the premises. This allows poor condition of the premises, resulting from the tenant’s non-observance of repairing covenants, to be ignored;
- Any goodwill attached to the premises by reason of the carrying on there of the tenant’s business, whether by him or by any predecessor in that business;
- The effect of any relevant improvement. This is an improvement carried out by the tenant for the time being other than in pursuance of an obligation to his immediate landlord. It must have been done either during the current tenancy or not more than 21 years before the application for the new tenancy;
- Any value attributable to a licence to sell “intoxicating liquor” where the benefits of the licence belong to the tenant.
The open market rent may be affected by the profitability of the tenant’s business, evidence of which can therefore be given. On the other hand, if the premises could be used for a more profitable purpose, the more valuable use must be considered.
- Other terms
If the other terms of the tenancy cannot be agreed by the parties, they will also be determined by the court. The court must have regard to the terms of the current tenancy and all relevant circumstances.
The new lease will generally follow the current one, but variations will be ordered. The party seeking a variation will normally have to show:-
- That there is a reason for the change;
- That the other party will be adequately compensated by an adjustment to the rent;
- That the tenant’s security in carrying on his business will not be materially impaired;
- That it is fair and reasonable between the parties
Examples of change include the case of Gold v Brighton Corporation in 1956 where the permitted use of the premises was varied to accord with the tenant’s actual business. However, a landlord’s attempt to substitute an absolute covenant against assignment and underletting for a qualified one was rejected in Card Shops Limited v Davis in 1971 because it imperilled the tenant’s goodwill.
The fact that the current tenancy was created by a lease in which the tenant’s covenants were guaranteed by a surety does not automatically entitle the landlord to demand that the same shall apply to a new tenancy. On the other hand, where appropriate, the court’s discretion is wide enough to order the provision of a suitable surety or to order a new tenancy conditional upon the tenant providing one.
- Break clauses
The tenant cannot insist on a break clause in a renewal lease, even if it had the benefit of a break clause in the original lease. Again, if the landlord is opposed to the inclusion of a break clause, the matter will have to be referred to the court and the court will look at all the circumstances, in particular the term to be granted and details of the break rights in the original lease and will exercise its discretion.
Generally, a court may be less likely to repeat the break rights in the renewal lease if the original break clause specified specific dates which have passed by the time the renewal lease is to be granted. The court may be more inclined to include break rights in the renewal lease if the break clause in the original lease was specified to be on a rolling basis, for example every three years or five years from commencement of the term.
It is always worthwhile discussing the terms on a renewal with your surveyor or solicitor to ensure that the best terms possible are obtained.
Clarkslegal, specialist Real Estate lawyers in London, Reading and throughout the Thames Valley.
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