Holding over (contracted out tenancies)

Friday 29 August 2014

At the expiry of a contracted-out lease¹relating to commercial premises, the tenant has no automatic right to remain in situ. Whereas, if the provisions have not been excluded then the tenant will be entitled to remain unless one of the parties has sought to determine the tenancy by a prescribed method. For the purposes of this update, we are focussing exclusively on contracted-out leases.

The risks

Determining the status of a tenant that has remained in occupation after expiry of a contracted-out lease may not be straight forward, particularly if the occupier has paid rent and the landlord has accepted it. Doing so may create an implied periodic tenancy – which gives rise to an automatic right of renewal (even through the tenant didn’t previously have those rights), meaning that it is very difficult for the landlord to recover possession from the tenant.

The alternative (and frequently preferable) position is for the tenant to occupy under a tenancy at will, which is terminable upon short notice. A tenancy at will also does not confer security of tenure upon the tenant (if properly drafted). The flexibility can be very useful for both parties² .

Guidance

However, the recent case of Barclays Wealth Trustees (Jersey) Limited –v– Erimus Housing Limited now offers some reassurance to landlords and tenants as the Court of Appeal held that it will not lightly infer the existence of a periodic tenancy.

The factors which the court will consider in determining whether a periodic tenancy or tenancy at will exists after expiry include:

• The intentions of the parties (i.e. did they intend to create a periodic tenancy?);
• Whether the old lease was contracted-out; and
• Whether the parties are negotiating over terms for a new lease and, if so, the terms which are being negotiated.

How to avoid the risks

As the adage says, prevention is better than the cure.

1. Plan early. The parties should each plan ahead to avoid being burdened with a tenancy on terms which they find to be undesirable. Parties should be liaising with one another 6 to 8 months before expiry to ascertain each other’s intentions. If the parties wish for the tenant to remain, it is prudent to commence negotiations over terms so that all of the documentation can be drafted in good time.

2. Dilapidations. However, if the tenant intends to vacate, on account that the Dilapidations Protocol³ states that a landlord should serve a schedule of dilapidations within a reasonable time (usually 56 days) after expiry of the lease, the landlord should engage a surveyor to carry out an inspection at an early stage.

A second reason for dealing with dilapidations early is that the Protocol will give rise to costs sanctions if the landlord fails to adhere to the timeframes.

Thirdly, The Code for Leasing Business Premises in England and Wales 2007 imposes similar sanctions if the landlord does not inform its tenant of its “requirements for alterations/reinstatements at least six months before the termination date.”

3. Demand possession. If the landlord is desirous of retaining flexibility in how it deals with the premises, and the tenant is refusing to indicate whether it wishes to remain after expiry, the landlord must indicate that it is desirous of recovering possession of the premises at expiry of the term. This should be a written demand sent, ideally, several weeks or months before the lease expires. The reason being that the court will bear in mind whether the landlord wishes to recover possession upon expiry or not. If it is ambivalent then a periodic tenancy is likely to be inferred from the circumstances.

4. Agree an express tenancy at will. If there’s a reasonable chance that negotiations will fail or the landlord has a difficult tenant, rather than leave matters to chance, our Commercial Property department can draft an express tenancy at will, which will prevent a periodic tenancy being implied.

5. Rent stop. Alternatively, if the tenant won’t sign up to an express tenancy at will, yet the landlord wants to keep its options open in the short-term, it should consider putting a rent stop in place immediately after expiry of the lease.

A rent stop makes the situation easier to manage as it does not cloud the issue of whether there may be a tenancy at will or a periodic tenancy. Although the courts have held that there is no rule that the tender of rent by a tenant that remains in occupation (and the landlord’s acceptance of the same) raises a presumption of a periodic tenancy, it does give the former tenant more ammunition to argue that it has a periodic tenancy.

A rent stop is not going to be a particularly popular choice for landlords, but it may be the only option available in some instances.

It should be noted that a rent stop won’t prevent the tenant from having a liability to the landlord because mesne damages will be payable (i.e. a payment in lieu of rent), which would be paid retrospectively (subject to the tenant’s ability to pay) prior to the completion of the new lease.

6. Undertenants. Many leases permit the head tenant to underlet with the superior landlord’s consent. Although the superior landlord may have granted a licence to underlet in respect of a contracted-out underlease, the licence will have ended on the expiry of the contracted-out underlease and so an undertenant that remains in occupation after expiry of its underlease will be doing so without the superior landlord’s consent.

If a superior landlord is aware that there is an undertenant remaining in occupation, it should put a rent stop in place in respect of the headlease to reserve its position in connection with any breach of alienation covenant by the head tenant.

The superior landlord must be careful that it does not waive its right to forfeit the headlease by accepting rent when it knows that the undertenant has remained in occupation following expiry of its underlease. A breach of covenant against sub-letting is known as a “once for all breach”. Waiver of the right to forfeit for a once for all breach precludes the landlord from ever forfeiting for that breach.

For further advice on contracted-out leases and other aspects of commercial property, please contact a member of Blacks’ Commercial Property team, who will be pleased to assist you.

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1. i.e. a lease which excludes the security of tenure provisions of the Landlord and Tenant Act 1954
2. but the lack of long term interest can also be problematic for the tenant’s business and landlord’s asset management.
3. Full name: Pre-Action Protocol for Terminal Dilapidations Claims for Damages