Exit Series part 1: Moving premises? Consider these key issues
21 June 2023
Exiting an office space can have implications for your business. By being well prepared and understanding your legal position, you can get it right first time and avoid any costly delays. In this series we cover key considerations when exiting your office space to reduce stress and stay on track.
As a corporate tenant planning an office move midway through your lease term, there are a number of important legal and commercial implications to consider. Whether you are exercising a break right, negotiating a surrender or looking to assign or underlet, this article signposts some of the key issues that you will need to navigate.
One of the main methods for a tenant to secure a “clean exit” from their space, is to exercise the tenant break right (if the lease contains such a right of course). Breaks are typically only available on specified dates during the term, and usually stipulate a minimum notice period – often between three and six months, though they can also be rolling (i.e. the break right can be exercised throughout the term, or, more commonly, at any time from a certain date onwards).
The notice provisions in the lease will stipulate the form that the notice must take, as well as the required method of service (whether email or post, for instance). Case law makes clear that these are strict requirements; if the lease stipulates that the notice must be printed on pink paper, it will be invalid if it is printed on white paper. While it is possible for a landlord to cure an invalid notice, this would be at its absolute discretion, and it would be extremely unwise to rely on the landlord doing so – you should aim to get it right in the first place.
The break clause will most likely contain conditions that need to be complied with on or before the break date. It is usual for a break to be subject to all principal rent having been paid up to the break date and to there being no outstanding material breaches by the tenant. However, sometimes a break will be subject to delivering up the premises with ‘vacant possession’ at the break date, which renders the break virtually impossible to exercise in practice. Vacant possession is an extremely high threshold to meet, requiring all items brought onto the property to be removed and all alterations to be reinstated. This may not be possible, depending on the alterations that have been made. For example, if telecommunications apparatus have been installed, the tenant probably would not have control over their removal, and almost certainly could not arrange for their removal within such a short notice period.
It is, therefore, vitally important to engage solicitors at the earliest possible stage:
- to understand whether the break conditions are capable of being complied with; and if so
- to ensure that the break notice is in the correct form and validly served on the landlord in time for the deadline.
If the break is not valid, you will remain bound by the lease until the end of the term, absent any further break dates or agreement with the landlord. Depending on when the final rent payment date falls in relation to the break date, you should also seek legal advice as to whether or not the lease provides that you are able to reclaim an apportioned sum of rent from your final payment. A well-drafted lease will provide for this but, if your lease does not, the likelihood is that you will pay the full quarter’s rent up front and will not receive any back in respect of the days you are no longer occupying the premises.
If your lease does not contain a tenant break, or it is too late to serve notice, an alternative is to negotiate a surrender with the landlord. Whether or not this is possible is entirely at the landlord’s discretion and may require you to pay what is known as a reverse premium to the landlord as an inducement to accepting the surrender. Conversely, if it is the landlord requesting a surrender, you may be able to negotiate a surrender premium from the landlord. The amount of reverse premium that you pay (if any) will be determined by commercial negotiation with the landlord. If the property is under-rented and/or is a valuable asset, it may be that the landlord is more willing to accept a surrender and you are able to negotiate a lower reverse premium.
A typical full repairing and insuring lease requires the tenant to repair and reinstate the premises to the condition described in the lease (sometimes by reference to a schedule of condition) during and at the end of the term. It is common for a dilapidations settlement – an estimate of the cost of repairing and reinstating the premises based on its condition at the date of the surrender – to be paid in lieu of actually having to comply with the reinstatement obligation. Reverse premium and dilapidations payments should be made separately as they are treated differently for tax purposes; you should seek advice on the tax implications of each payment.
Most leases (other than very short leases) also permit assignment and underletting with the consent of the landlord and subject to certain conditions. Assigning a lease essentially transfers your lease to another company who takes on the role of tenant in your place. By contrast, if you underlet the property, you remain the tenant under your lease and become the immediate landlord to an undertenant. The key limitation of both approaches is that the lease will remain a liability on your accounts. If the landlord consents to you assigning the lease, it will usually require you to enter into an authorised guarantee agreement whereby you guarantee the performance of the incoming tenant’s obligations until it subsequently assigns (or the lease ends). If you underlet the property, you will still be “on the hook” for your rent payments under the superior lease with your landlord if your undertenant is in arrears of rent under the underlease. Neither option will give you a clean break from your obligations under the lease.
Further, if you grant an underlease of the premises, matters can get complicated if you later wish to exercise the tenant break under your superior lease or negotiate a surrender with the superior landlord, because you will have sitting undertenants. The underlease is very unlikely to contain a landlord break, as this would be off market, therefore you may need to negotiate an early surrender of the underlease with your undertenant.
Whichever route you are looking to go down, it is vital to plan ahead and consult with your solicitors at the earliest opportunity. Relocating offices is such an important process in a company’s lifecycle and the implications of getting it wrong are massive.
Click here to read part two of this series which delves into the next steps for a corporate tenant who’s decided to make an office move.