How to avoid some of the common issues that can arise in property leases

Michael Luckman: Hello I'm Michael Luckman and Chair of our ThinkHouse events and I'm talking today to Clive Chalkley and Felicity Lindsay on some of the common but substantial property issues that might come across a General Counsel's desk.

Clive, most businesses these days operate under leases. How do I get out of a lease?

Clive Chalkley: There are probably three common ways to get out of a lease. The first is a surrender. A surrender is basically where both parties agree to give up the lease before the end of its of term. The second is to exercise a break clause, so if your lease contains a break clause that's a clause that permits you to end your lease before the end of the term. Then the third one is to assign your lease, so give it to somebody else.

Michael: So Felicity, we have just heard Clive mention break clauses. What is a break clause?

Felicity Lindsay: So a break clause is a clause in a lease that allows one or both parties to bring that lease term to an end early. The break clause nearly always requires service of a notice, so something is needed to trigger that break clause taking effect. The break clauses almost always have conditions around them, so that tends to be payment of rent for the full quarter in which the break takes place and sometimes also conditions around yielding up with vacant possession which is a legalistic term, but which is one that you need to make sure that you catch and you comply with early.

Michael: And Clive if the landlord accepts the break, what then?

Clive: Yeah I mean even if a break notice is invalid, it is open for a landlord to waive that breach and if he does so then the lease will break in accordance with the terms of the notice.

Michael: Are email notices accepted?

Felicity: Generally in a property context email notices aren't accepted and that's because we as property lawyers know and love section 196 of the Law of Property Act 1925 and that says that notices can be served by registered post. A recent case E.ON v Gilesports confirmed that serving notices if the only notice provision in the lease is section 196, serving notices by email won't be valid. Of course sometimes you see a clause in a lease that expressly allows email service and if that's the case that's fine, but if it's only 196 then I'm afraid email service is out.

Michael: And I understand in sort of group structures that very often their lease is guaranteed by some other company in the group. Can a tenant assign a lease to its guarantor?

Clive: The short answer to that is no. It may sound crazy because most of the time it's the commercially sensible thing to do. But let me sort of just explain briefly why you can't do it.

Before 1996 it used to be the case that when a tenant took out a lease they were liable for all of the covenants for the entire length of the lease. So if they took a 25 year lease for that entire 25 year period, they were liable for the rent and other covenants on the lease, even if they had assigned it to another person. This created all sorts of problems, say somebody took a lease for 25 years, assigned it after five years and then 15 years later he then gets a massive bill for rent and other breaches of covenant that he had nothing do with, nor knew anything about. So parliament stepped in and said we've got to stop this, we have to stop this, we are going to introduce the Landlord and Tenant Covenants Act 1995. In brief, it said that once a tenant assigns its lease it is released from the covenants, i.e. so you assign it from one person to the next you are then released - section five. It then said the same is true for guarantors if you guarantee a lease, when that lease is assigned the guarantor is released and any attempt to try and get around this was caught by a section 25 that just said it's void, so it never happened.

In one of the cases that I was involved in K/S Victoria, the Court of Appeal had to consider this and they commented and said look we think these provisions mean that you cannot assign a lease from a tenant to a guarantor. Then in the recent case of EMI that was confirmed, you simply cannot do it. So whilst it may sound crazy it's one of those little intricacies or oddities of property law. You can't assign the lease from tenant to guarantor.

Michael: Talking of crazy and digging back in my memory of land law past. I remember a lot of discussions about dilapidations and I understand there are two types of dilapidations, normal ones and terminal ones, could you expand on that?

Felicity: Dilapidations during the term of the lease relates to breach of the repair covenant. Whereas terminal dilapidations are all covenants, breach of all covenants relating to the state and repair of the premises. So terminal dilapidations are much wider, they pick up things like breach of the decoration clause, breach of any clauses that require you to comply with statute in relation to the state and condition of the premises and also in relation to yielding up at the end. So putting back any alterations that you've made during the term, so terminal dilapidations is a much wider concept.

Michael: I'd imagine there's plenty of scope for bun fights at the end of leases to who pays what. Are there ways to protect yourself from a big dilapidations bill?

Clive: There are. It's probably just worth discussing two at the moment because there are a number of them. Probably the first one is to consider section 18 of the Landlord and Tenant Act 1927. Now this effectively means that the amount of damages that a landlord can recover for a breach of a repairing obligation is limited to the diminution in its reversion, so what do I mean by that. Let's say your lease was worth £1 million if it was fully repaired, a £1 million value, but in its state of disrepair it was worth £950,000, that would mean that the £50,000 difference is the cap on what the landlord can recover for breach of repairing obligations. So an important tool for tenants when they are looking at these things and have a massive bill to remember section 18.

The second answer one I would say, is a lot more practical. The second is just make sure when you're a tenant and you're leaving make sure you have a proper evidence of what the state of the premises is like. You won't get a chance once you've left the premises to go back in and video it, so make sure you have a full video diary account of what the premises look like at the date you leave.

Michael: So Felicity what are your key takeaways for a General Counsel sitting at his or her desk fretting about property issues?

Felicity: OK well I guess it's realise that property is a key part of the business and mistakes made on the property side can be costly. Property law, as I think you've heard from us today is often a bit illogical and slightly counterintuitive and so I guess it's just making sure that you've got those processes in place to make sure that those counterintuitive issues are picked up. So making sure that people who are serving and receiving notices know about these pitfalls and make sure that you have the systems in place to pick those things up early.

Michael: Felicity, Clive very interesting and thank you very much.