Exit Series part 4: Navigating lease surrenders

Why surrender?

Unlike an assignment or subletting, a surrender typically brings the tenant’s liability to an end, as the lease no longer subsists. Surrenders can be entered into at any time (unlike break rights which are often fixed to a specific break date or dates) and so can be a useful way for a tenant to move on.

Bargaining Strength

The first thing to consider when contemplating approaching a landlord to ask for a surrender is the hand the tenant has to play; the strength of its bargaining position. There are numerous permutations to factor into this assessment, including external market forces - which a good property agent will be able to advise on - but the main ones are:

• Whether the property is under-rented: if this is the case, a landlord may be eager to take the premises back and re-let it at market price.
• The landlord’s plans for the building: perhaps there are plans to redevelop the building, or to use it for its own purposes. The local authority’s planning portal will indicate whether applications have been made, or permissions granted, but you might also want to scour the local area for public notices posted on lampposts and the like, or check whether any public consultations have been, or are to be, held.
• The remaining duration of the term: surrender premiums (which will be covered more fully below) are likely to be lower if you are only talking about the rump-end of a lease.
• Any interested parties waiting in the wings: there may be a marquee tenant wanting the space who the landlord is keen not to lose.

Once a deal has been struck, attention turns to the practical and legal aspects of the surrender.

If you are looking to dovetail the exit from your current space with the occupation of new premises, you might look to enter into an agreement for surrender to bring the parties under contract and fix a surrender date, or even to peg the exit to the date on which the new lease is completed. A landlord is unlikely to agree to an open-ended completion without having a backstop date by which the completion must take place. This will be something to negotiate.

An agreement may be needed, or desirable, for dealing with any balancing payments due or owed under the lease. If the surrender date is to take place midway through a quarter for example, the tenant is likely to have paid the full quarter’s rent and service charge and so will be anxious to ensure this is reimbursed as part of the overall settlement. There may also be a rent deposit due back on, or shortly after, completion. If there is to be a surrender premium payable by the tenant to the landlord, the parties may wish to net the payments off against one another for cash-flow purposes.

The parties will need to consider the VAT treatment of the various payments: VAT may be payable depending on who is making the premium payment. If dilapidations payments are being paid by the tenant to the landlord, HMRC has confirmed that these are outside of the scope of VAT: instead these amounts are treated as damages. One should bear in mind, however, that if the landlord has carried out the reinstatement works itself and incurred VAT on them, the VAT element may be recoverable from the tenant under the lease terms. Overall, it is important to consult with a solicitor to advise on the legal position behind the documents, and possibly also a specialist dilapidations surveyor – who will assist with the quantum and advise where savings might be made. A landlord’s reinstatement estimate is likely to be higher than a tenant’s and so a middle ground compromise position should be sought.

Careful consideration should be given to dilapidations: they can be a costly item and so a schedule of dilapidations should be prepared at the earliest opportunity and used as evidence for the overall settlement. The alternative is for the tenant to carry out the reinstatement works itself, though this may not be practical or desirable: the tenant is unlikely to be able to continue in occupation during any works period and, unless the surrender is guaranteed, there may be wasted costs if it failed to complete for any reason.

The landlord’s intentions here are key. Dilapidations payments are calculated by reference to the diminution in value of the landlord’s interest in the property, meaning the amount by which the works - or more specifically, failure to carry out the reinstatement works - have lowered the valuation of the space. If the landlord has a clear and fixed intention to knock the building down or to gut and refurbish the tenant’s premises, there may be little, or no, dilapidations payable as there is no ‘loss’ to speak of. Indicators of this might be a planning application having been made, or the landlord having left other floors of a building vacant. This is a highly specialised and complex area and so expert advice should be sought. The same point applies at lease expiration.

Other points to think about

Indemnities: if the tenant is an assignee and has given an indemnity to its assignor when it took over the lease, it should make absolutely clear that the deed of surrender releases not only the current tenant, but also previous tenants. The implication of failing to do so is that the landlord may otherwise be able to pursue the previous tenant (post-surrender) for any breaches, with that previous tenant then claiming under the indemnity against the current tenant.

Service charges: the figures for this may not be ascertainable until some months after the surrender. Typically, service charges are reconciled after the end of the service charge year once the final figures are known. Any overpayment or underpayment should then be reimbursed by the landlord or paid by the tenant respectively, and the surrender deed should account for this reconciliation process. Rent and insurance rent should be ascertainable on completion though and so should form part of the completion statement.

Underleases and mortgages: both will survive the surrender and become a landlord’s liability (as lessor and mortgagor respectively) and so the landlord is likely to raise enquiries on this point and require the sublease to be determined and the mortgage redeemed on or prior to the surrender. There may be reasons for the subtenant to remain however – it may be a strong covenant or big name for example. If so, this will become part of the settlement and surrender process and further discussions around dilapidations should be held.

Guarantors: if the lease is guaranteed, the guarantor should ordinarily be a party to the surrender deed and release wording should be included to release the guarantor from its liabilities under the guarantee.

Telecoms: what, if anything, needs to be actioned by the tenant in respect of any equipment on site and any supply contracts? Wayleave operators have wide-ranging statutory powers and so can prove tricky to remove. The landlord may ask for the tenant to take actions it cannot comply with and so care should be given to what, if anything, will be done.

Inspections and surveys: the tenant should keep a record of the state and condition of the premises prior to the exchange and surrender dates to make sure there is no disagreement as to repairing liability. This should also flush out any unauthorised occupiers in the property – especially if it has been vacated prior to surrender.

Handover: it will not just be the tenant who carries out the inspection. A landlord will look to assess the condition of the property and also address what needs to be handed over by the tenant. The tenant’s replies to standard enquiries (CPSE5) will ordinarily flush out the information and documentation the landlord will need on taking back the premises. A well-prepared tenant should collate as much of this in advance to avoid delay: health and safety file (including up to date fire risk assessments); EPC, asbestos reports, original deeds, operating manuals and warranties of any kit remaining in situ and keys, fobs and passes. There may be other items, but these serve as a guide.

Utilities: take meter readings and close accounts on the surrender date. It is much harder to deal with any outstanding liabilities or payments without physical access to the property.

Landlord: make sure that the landlord remains the right person to take the surrender (i.e. that it has not transferred its reversion to a group company, or granted an intermediate lease to a third party). The tenant should check the landlord’s title to the property and Companies House to make sure it has not gone into liquidation or administration.

Capital Allowances: a final note – a little dry, but valuable nonetheless. Capital allowances might be available to either landlord or tenant, depending on the situation, and the figures could be significant on either part and so close attention should be given to the position. Your solicitors and accountants will be able to offer more guidance on this, and you should seek it.

Get in touch with our Real Estate team if you have any questions about navigating your lease surrender.

Now you’re up to speed with lease surrenders, click here to explore the first instalment in this series. It discusses factors to consider when leaving your office space to reduce stress and stay on track.