Most property transactions of any significance start life with Heads of Terms (aka HOTS) being a memorandum or summary of the main terms agreed between the parties. Whilst not legally binding, HOTS are important as they constitute the foundation of the deal. Poorly drafted or incomplete HOTS can often lead to unwelcome surprises further down the line, nearly always creating delay and sometimes causing the transaction to fail altogether with wasted professional fees on all sides. As such, some extra care at the beginning of the process in preparing a decent set of HOTS is time well spent.
Accordingly, please indulge me as a transactional property lawyer (of more years than I care to admit) to give a few tips borne out of bitter experience. I will concentrate on HOTS dealing with a commercial lease transaction. I hope that what follows might be helpful to tenants or agents acting for tenants in particular. I make no apologies for being tenant biased in this note; landlord’s (especially of the institutional variety) usually know the form, whereas for a tenant it might be their first time in the property arena.
Lease or underlease
Sounds basic, but can be overlooked at the HOTS stage. Make it clear if an underlease and whether superior landlord’s (SP) consent is required. This should prompt early dialogue with the SP and hopefully avoid later delays. Who is to be responsible for the SP’s professional fees? That item should also be agreed and recorded at the outset; my personal view is that the landlord should pay!
Premises extent
Another fundamental which should be clear day one. Make express references if relevant to ancillary accommodation such as rear yards or essential facilities such as parking spaces, loading areas or bin store.
Term of the lease
The term of the lease should normally run from the date the lease is granted/completed or earlier tenant occupation of the premises. Tenants should be wary of a fixed date in the HOTS for term commencement which could be prior to either of those times meaning tenant liability for rates etc. might then arise sooner than the tenant should reasonably expect.
Breaks
Another area ripe for later disagreement or delay. Make sure any conditions for a break are clear and couched in precise language; expressions such as “vacant possession” as a condition for the break are to be avoided. Further, there should also be no ambiguity as to whether a break is a fixed one-off opportunity or can be operated on a rolling basis.
Landlord and Tenant Act 1954
Specify whether lease is to have statutory renewal protection or is to be excluded from the Landlord and Tenant Act 1954. If the latter, make sure tenants are advised at an early stage of what this means in practical terms. This is an aspect that is crucial for retail tenants for example.
Rent and rent-free periods
Is the rent fixed or does it rely on pre-lease measurement of the proposed lease area. If the latter, the basis of calculation and who will conduct the measurement survey, need to be established. There should be no confusion over when rent-free periods start (RCD) and/or finish. Avoid a fixed RCD in the HOTS which might fall prior to legal completion or earlier tenant occupation as this will dilute the benefit of the rent-free period for the tenant. State whether VAT is payable on rent, insurance contribution and service charge. Further, make it clear whether business rates, water rates, and utility charges are included or excluded from rental so tenant can calculate its global cost of occupation from the outset.
Rent review
Will it be the cherished upward only basis and will it be an open market formula or inflation linked to RPI or similar? Should there be caps in either case to limit tenants’ future exposure. Proposals for reforming this cherished sacred cow are in progress, but for the moment another area rightly demanding clarity in the HOTs.
Rent deposit
Avoid “a quarters rent” or similar expressions and expressly state the exact amount payable. Furthermore, confirm whether “notional VAT” is to apply to such amount so that the tenant is fully aware of his initial outlay at the beginning. Explain and expressly state the inability to recover such notional VAT. Ensure that repayment events such as lawful assignment and lease expiry by break or effluxion of time are formally clear in the HOTS. Ditto any other release mechanisms such as tenant satisfying specified financial asset or profit tests should be clearly set out and defined.
Service charge and insurance rent
Make clear whether the same applies and if so give basis of calculation (for example square footage) and specify reliable (if only approximate) amounts for both items for at least the first year of the lease term. If service charge is ad hoc (rather than a regular fixed liability) the HOTS should say so.
Repair obligations
Avoid lazy jargon such as “full repairing” or “FRI” – if applicable state the normal position that premises “must be kept in good and substantial repair” (regardless of current condition) and delivered when the lease ends in that state. This may initiate early discussions around whether a Schedule of Condition is appropriate for older premises or those clearly in an existing state of disrepair.
Alienation
Clearly state what tenant can and cannot do as regards assignment and subletting in particular. State whether dealing restrictions are absolute or qualified in clear language such as tenant is not permitted to assign or sublet at all or can do so with the landlord’s prior written consent, such consent not to be unreasonably withheld or delayed. In addition, make clear what principal conditions are required on assignment and if an AGA is to be given; state expressly what this essentially means for tenant; namely further potential liability after assignment.
Alterations
Ascertain what fit out works for example are needed by the tenant so that early landlord consent can be organised, and landlord’s requirements fully appreciated during the early stages of the transaction. Establish who is to pay legal costs of any License for Alterations – this should be borne by each respective side in my view, but I did say this piece was tenant slanted!
Further, if the landlord (and the tenant agrees) expects re-instatement of tenant’s works at the end of the lease, then the HOTS should state this; this item should not be buried in the small print and perhaps misunderstood by the tenant who will then have a nasty and potentially very costly surprise when vacating at lease expiry or break date.
Third party consents
Are any required for the new lease apart from SP Consent referred to above? A frequent source of later delay is consent from a landlord’s bank or other mortgagee. Get this process going early as it can take longer than you might expect.
How Moore Barlow can help
I appreciate that making HOTs reflect the above may be viewed as a counsel of perfection, it will certainly require greater initial effort and make them longer! However, that level of clear and comprehensive detail will give transactions a “head start” and increase the prospects of a successful and earlier completion of the Lease.
Our extensive experience as commercial property lawyers means that we understand how to achieve the right result, whatever the transaction. We do this by becoming your business partner, understanding your objectives, and dedicating ourselves to the transaction as if it were our own. We pride ourselves on adding value, and ensuring that we approach each transaction with pragmatism and efficiency.
