Granting a lease or underlease - Drafting the lease

Learning Outcomes

This article outlines the drafting of leases and underleases, including:

• Essential operative clauses, covenants, and termination provisions
• Statutory and practical requirements for valid leases
• The relationship between headleases and underleases
• Common drafting errors and their avoidance
• Interrelation of repair and insurance provisions
• Alienation controls compliant with statutory constraints on consent
• Rent structure and rent review machinery, including VAT and SDLT/LTT implications
• Priority and title protection through prescribed clauses and registration
• Application to SQE1-style scenarios

SQE1 Syllabus

For SQE1, you are required to understand the process and requirements for granting a lease or underlease, and the technical aspects of drafting the lease, with a focus on the following syllabus points:

• The essential clauses and structure of a commercial lease or underlease
• The legal requirements for a valid lease and the consequences of non-compliance
• The relationship between headleases and underleases, including restrictions and limitations
• The main covenants and obligations of landlords and tenants
• Practical drafting issues, including rent, repair, insurance, alterations, user, and termination provisions
• Alienation (assignment, underletting, sharing occupation), landlord’s consent, and conditions on consent
• Security of tenure for business tenancies under the Landlord and Tenant Act 1954 and contracting out
• Registration rules for leases and assignments, prescribed clauses, and priority protection

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the difference between an absolute, qualified, and fully qualified covenant in a lease?
2. What must an underlease not do in relation to the headlease?
3. Name three essential clauses that must be included in a commercial lease.
4. What is the effect if a lease is not executed as a deed?
5. True or false? A tenant can grant an underlease for a longer term than their own lease.

Introduction

When a client wishes to grant a lease or underlease, the lease document must be carefully drafted to ensure it is legally valid and clearly sets out the rights and obligations of the parties. The lease is the central document governing the relationship between landlord and tenant (or tenant and subtenant), and errors in drafting can have serious legal and commercial consequences. This article explains the main requirements and practical considerations for drafting a lease or underlease for SQE1. It also highlights linked areas that frequently arise in practice, such as landlord’s consent procedures, insurance versus repair responsibilities, security of tenure for business tenants, rent review assumptions and disregards, and registration and prescribed clause requirements.

The Structure and Key Clauses of a Lease

A well-drafted lease or underlease will follow a logical structure and include certain essential clauses. The main sections are outlined below.

Parties, Date, and Property

The lease must clearly identify the parties (landlord and tenant, or in the case of an underlease, tenant and subtenant), the date of the lease, and the property being demised. The property should be described precisely, often by reference to a plan. Plans must meet HM Land Registry requirements (scale, colouring, clear edging) if the lease will be registrable.

Key Term: demise
The grant of exclusive possession of defined premises for a specified term.

Key Term: institutionally acceptable lease
A lease on full repairing and insuring terms at market rent, with appropriate control provisions, suitable for investment (e.g., by a pension fund).

Term and Rent

The lease must specify the length of the term (start and end dates) and the rent payable. Rent clauses should state the amount, payment dates, and any rent review provisions. Commercial leases typically state payment “quarterly in advance” on the usual quarter days; residential ground rents may be annual.

Consider VAT and SDLT/LTT. Commercial rent is often subject to VAT if the landlord has opted to tax. SDLT (England) or LTT (Wales) may be payable on both the premium (if any) and on the net present value (NPV) of rent for leases; returns must be filed within statutory deadlines.

Key Term: rent review
A mechanism for adjusting the rent during the lease term, usually at fixed intervals, based on market value or an agreed formula.

Common rent review types include open market rent, index-linked, fixed-step, and turnover-based (for retail). Open market rent reviews rely on detailed “assumptions” and “disregards” to prevent windfalls or penalising breaches. Index-linked reviews often include caps and collars to manage volatility.

Rights Granted and Reserved

The lease should set out any rights granted to the tenant (such as rights of way or use of common areas, and rights to services) and any rights reserved to the landlord (such as entry for inspection, repair, and rights to lay or maintain services). Define common parts and the building carefully in multi-let properties to avoid uncertainty about responsibility and access.

Key Term: easement
A right benefiting one piece of land over another, such as a right of way.

Covenants and Obligations

The lease will contain covenants (promises) by both landlord and tenant. These are usually divided into:

• Tenant covenants (e.g., to pay rent, repair, yield up, not to assign or sublet without consent, comply with user, statutory compliance, and insurance obligations)
• Landlord covenants (e.g., for quiet enjoyment, to insure or repair if applicable, to provide services where service charge is payable)

Service charge machinery is typically included in leases of part, enabling recovery of costs of repairing and maintaining structure, exterior, and common parts.

Key Term: covenant
A legally binding promise in a lease or deed, either to do something (positive) or not to do something (restrictive).

Key Term: quiet enjoyment
The tenant’s right to use the premises without interference from the landlord or anyone claiming under the landlord.

Types of Tenant Covenants

Tenant covenants restricting assignment, subletting, alterations, or change of use may be:

• Absolute: total prohibition (e.g., "The tenant shall not assign the lease")
• Qualified: permitted only with landlord’s consent (e.g., "The tenant shall not assign without landlord’s consent")
• Fully qualified: permitted with landlord’s consent, not to be unreasonably withheld (e.g., "The tenant shall not assign without landlord’s consent, such consent not to be unreasonably withheld")

Statute influences these covenants. Section 19(1)(a) Landlord and Tenant Act 1927 implies a requirement that consent to assignment is not unreasonably withheld in qualified covenants. Section 1 Landlord and Tenant Act 1988 obliges a landlord to deal with applications for consent within a reasonable time and give written reasons for refusal. For commercial leases granted after 1 January 1996, s19(1A) LTA 1927 permits parties to agree defined reasonable circumstances for refusal and conditions (e.g., provision of references, rent deposit, or an Authorised Guarantee Agreement).

Key Term: fully qualified covenant
A covenant where the landlord’s consent is required and cannot be unreasonably withheld.

Key Term: Authorised Guarantee Agreement (AGA)
A guarantee by an outgoing tenant of the immediate assignee’s performance under a “new” lease (post-1995) as a condition of landlord’s consent to assignment.

Repair and Insurance

The lease must allocate responsibility for repair and insurance. In a full repairing and insuring (FRI) lease, the tenant is responsible for all repairs and for reimbursing the landlord’s insurance costs (often via “insurance rent”). Leases of part typically limit tenant repair to the interior, with service charge contributions funding structural and common parts repair.

Key drafting points:

• Avoid “put and keep in repair” for tenants unless intended; “keep in repair” is less onerous.
• Exclude liability for fair wear and tear and for damage by insured risks (unless the tenant has vitiated the policy).
• For older buildings, annex a schedule of condition to cap obligations at the documented state.

Key Term: full repairing and insuring (FRI) lease
A lease where the tenant is responsible for all repairs and for insuring the premises (or reimbursing the landlord’s insurance premium).

Key Term: schedule of condition
A detailed record of the property’s state at grant, used to limit repair obligations to restoring at least that condition.

Insurance provisions should require landlord to insure to full reinstatement value against a comprehensive list of insured risks, including demolition, site clearance, professional fees, and VAT. Often, the landlord covenants to apply insurance proceeds to reinstate and rent is suspended while the premises are unusable due to insured damage.

Key Term: insured risks
The specified perils against which the landlord insures (e.g., fire, flood, storm, explosion, escape of water, impact, riot, malicious damage, and any other risks reasonably required).

Key Term: rent suspension
A clause suspending rent (or a fair proportion) while premises are unusable due to damage by an insured risk, typically limited to the loss-of-rent insurance period.

Interplay between repair and insurance is important: tenants should not be liable to repair insured damage; landlords should be obliged to reinstate using insurance proceeds and to carry adequate loss-of-rent cover; termination rights may be included if reinstatement proves impossible or if rent suspension ends without reinstatement.

Alterations and User

The lease should state whether the tenant may make alterations or change the use of the premises, and if so, on what terms. Internal, non-structural alterations often require fully qualified consent; structural/external alterations may be absolutely prohibited unless s3 LTA 1927 statutory procedure applies to improvements (which a court may authorise where they add to letting value, are suitable to the character, and do not diminish other property’s value). Alterations likely to be required for Equality Act 2010 compliance are treated as improvements and a landlord cannot withhold consent unreasonably.

Key Term: licence to alter
A formal consent document for alterations, typically setting standards of work, compliance with laws, supervision, reinstatement, and costs.

User clauses should align with planning use classes, often allowing variation within a class with consent. Very narrow user wording can depress rent on review; excessively broad wording may inflate it. Draft with care and consider planning permissions and Article 4 Directions.

Termination and Forfeiture

Termination clauses set out when and how the lease may end before expiry, such as by break clause or forfeiture for breach of covenant (e.g., non-payment of rent).

Key Term: forfeiture
The landlord’s right to terminate the lease early for tenant default, usually after following a statutory procedure.

For breach of non-rent covenants, service of a section 146 Law of Property Act 1925 notice is required, specifying the breach, requiring remedy (if capable), and compensation. Relief from forfeiture may be granted by the court. For non-payment of rent, forfeiture may be exercised (often by peaceable re-entry or court claim) without a section 146 notice, subject to contractual terms and relief considerations.

Commercial rent recovery alternatives include debt action, Commercial Rent Arrears Recovery (CRAR) by authorised enforcement agents, and drawing down on rent deposit deeds. These remedies carry practical and relational implications.

Break clauses (tenant, landlord, or mutual) require strict compliance with conditions (e.g., vacant possession, payment of rent and sums due, notice periods).

Key Term: break clause
A provision allowing early termination by notice, often subject to preconditions.

Security of tenure for business tenancies under the Landlord and Tenant Act 1954 may limit termination. A protected tenancy does not end at expiry; statutory procedures apply. Parties may contract out before grant using the prescribed notice and declaration process.

Key Term: security of tenure
Statutory right of business tenants to remain and seek a new tenancy under LTA 1954 unless validly contracted out or opposed on statutory grounds.

Worked Example 1.1

A tenant holds a 10-year headlease and wishes to grant an underlease to a subtenant for 12 years. Is this possible?

Answer:
No. The underlease must be for a term less than the headlease. If the underlease is for 12 years, it will operate as an assignment of the headlease, not as an underlease.

Drafting an Underlease: Special Considerations

An underlease (sublease) is a lease granted by a tenant out of their own leasehold interest. There are additional requirements and risks when drafting an underlease.

• The underlease must not grant a longer term than the headlease (even by one day), or it will operate as an assignment of the headlease.
• The underlease must not demise more extensive premises than the tenant holds or grant wider rights than the headlease allows; rights reserved to the head landlord should be preserved.
• The underlease should require the undertenant to comply with relevant covenants in the headlease, often by incorporating mirror covenants. Leases commonly mandate that any underlease be drafted on no less onerous terms than the headlease (other than rent).
• Align rent review dates and bases with the headlease where required; some headleases require market rent and parallel rent reviews to maintain income levels.
• Business underleases often require exclusion of LTA 1954 security of tenure (contracting out) and a licence to underlet from the head landlord to create privity of contract with the undertenant.
• Check whether the superior landlord’s mortgagee consent is needed; restrictions may be on the register and can affect registration of the underlease.

Key Term: underlease
A lease granted by a tenant (the head tenant) out of their own leasehold interest, for a term less than the headlease.

Key Term: headlease
The original lease granted by the landlord to the tenant, out of which an underlease may be granted.

Key Term: licence to underlet
A tripartite document in which the head landlord consents to the underlease and the undertenant covenants directly with the head landlord to observe relevant tenant covenants.

Worked Example 1.2

A landlord and tenant agree the terms of a 5-year lease, sign a simple contract, but do not execute a deed. What is the status of the lease?

Answer:
The lease is not valid at law, as it was not executed as a deed. However, if the contract is in writing, signed, and contains all agreed terms, it may take effect as an equitable lease.

Execution and Statutory Requirements

A lease (or underlease) for more than three years must be executed as a deed to be valid at law (LPA 1925 s52). The deed must be signed, witnessed, and delivered as a deed by the parties.

Key Term: deed
A formal legal document that must be signed, witnessed, and delivered, used to create or transfer legal estates or interests in land.

Key Term: execution
The act of signing and completing a legal document, such as a deed.

Short leases not exceeding three years at best rent can be created without deed (and may be oral) under LPA 1925 s54, but best practice is to record even short terms in writing for clarity and evidence. Electronic execution may be acceptable in accordance with HM Land Registry practice (see Practice Guide on execution).

Prescribed Clauses and Registration

Leases granted out of registered land for more than seven years must include prescribed clauses at the front of the lease, as required by HM Land Registry, and must be registered with their own title number. Assignment of a registered lease is always registrable; assignment of an unregistered lease triggers first registration if more than seven years remain.

Key Term: prescribed clauses
Standard information required at the start of a registrable lease, including parties, property, term, and rent, to facilitate Land Registry registration.

Key Term: registration
The process of recording a legal interest (such as a lease over seven years) at HM Land Registry, giving it legal effect and priority.

Prescribed clauses include LR1–LR14 (date, title numbers, parties, property description, term, premium and rent, restrictions on disposition, renewal/acquisition rights, landlord covenants on other land, easements granted or reserved, rentcharges, standard restrictions, and trust declarations). Omitting mandatory clauses can delay registration and affect completeness of the title record.

Alienation: Assignment and Sharing Occupation

Commercial leases usually permit assignment of the whole with landlord consent and restrict sharing or parting with possession. Drafting should reflect statutory constraints on the reasonableness of consent and timing of responses. For leases dated before 1996, privity of contract means original tenant liability remains unless released; for leases dated after 1995, the Landlord and Tenant (Covenants) Act 1995 provides automatic release on assignment, subject to AGA conditions.

Key Term: licence to assign
Landlord’s formal written consent to assignment, often including conditions (e.g., AGA) and a direct covenant by the assignee to observe tenant covenants.

Security of Tenure: LTA 1954

Protected business tenancies continue beyond contractual expiry unless terminated using LTA 1954 procedures. Landlords may serve a section 25 notice (proposing renewal or opposing on statutory grounds), and tenants may initiate renewal via section 26 request. Opposed renewals rely on s30 grounds (e.g., persistent delay in rent, substantial breaches, suitable alternative accommodation, redevelopment, landlord’s own occupation subject to five-year ownership). Contracting out before grant requires the prescribed warning notice and a tenant’s declaration (or statutory declaration).

Rent Review: Assumptions and Disregards

Open market reviews typically include assumptions (e.g., the premises are available with vacant possession, on the same terms excluding rent and including review provisions, tenant has complied with covenants) and disregards (e.g., tenant’s occupation and goodwill, voluntary improvements, and any damage caused by insured risks). Well-drafted clauses manage fairness and avoid double counting.

SDLT/LTT and VAT

• SDLT (England): Leases may attract SDLT on any premium and on the NPV of rent. SDLT returns must be filed within 14 days of completion; SDLT is calculated on VAT-inclusive amounts where VAT applies.
• LTT (Wales): Different bands apply; there is no first-time buyer relief for leases. LTT returns must be filed (deadline currently similar in practice).
• VAT: Commercial property supplies are generally exempt unless the landlord opts to tax or the sale is of “new” commercial buildings (standard rated). Lease rents may be subject to VAT if the option to tax has been exercised. Drafting should state whether rents and sums are exclusive of VAT.

Worked Example 1.3

A tenant under an FRI lease covenants to “keep the whole of the property in good repair and condition, save for damage caused by an insured risk.” A fire (an insured risk) renders part of the property unusable. Who repairs and what happens to rent?

Answer:
The landlord is responsible for reinstatement under the insurance covenant, applying insurance proceeds, and rent (or a fair proportion) is suspended under the rent suspension clause until the property is fit for use, provided the tenant has not vitiated the policy. The tenant should not be liable to repair insured damage.

Worked Example 1.4

A tenant seeks consent to assign a “new” commercial lease (granted in 2018). The landlord agrees but requires an AGA and a direct covenant from the assignee lasting for the entire residue of the term. Is this acceptable?

Answer:
The landlord may reasonably require an AGA as a condition of consent. Any direct covenant by the assignee to the landlord should be limited to the period while the assignee is tenant; the Act releases tenants on assignment, and indefinite privity of contract is inconsistent with the statutory regime.

Worked Example 1.5

A lease of registered land for 15 years omits prescribed clauses LR11 concerning easements granted and reserved. What are the consequences?

Answer:
Omission can delay registration and reduce clarity of the register entry. HM Land Registry will generally require complete prescribed clauses; without accurate LR11 entries, the register may not reflect granted or reserved easements, affecting notice and future dealings.

Worked Example 1.6

A landlord intends to let a shop for five years but wishes to exclude security of tenure. What must be done and when?

Answer:
Before the lease is entered into, the landlord must serve the prescribed “health warning” notice. The tenant must make a declaration (or statutory declaration if served less than 14 days before grant) confirming acceptance. The lease must refer to the notice and declaration. Failure renders the tenancy protected.

Worked Example 1.7

An open market rent review clause assumes the tenant has complied with its covenants. The tenant has under-repaired, causing dilapidations. Can this reduce the reviewed rent?

Answer:
No. The assumptions neutralise tenant default; under open market review, the rent is assessed as if the tenant had complied, and dilapidation-related reduction is disregarded to avoid rewarding breach.

Worked Example 1.8

The headlease requires any underlease rent to be at least market rent at the time of underletting and reviewed on the same dates and basis as the headlease. Why might this be required?

Answer:
It preserves rental levels and review parity, avoids erosion of income if the headlease falls away leaving the underlease in place, and maintains investment value and comparability.

Exam Warning

For SQE1, be alert to questions where an underlease is for a longer term than the headlease, or where the lease is not executed as a deed. These are common traps.

Revision Tip

When drafting an underlease, always check the headlease for restrictions on subletting, covenants to be imposed, and the need for head landlord’s consent.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• The essential structure and clauses of a commercial lease or underlease
• The legal requirements for a valid lease, including execution as a deed and prescribed clauses
• The main covenants and obligations of landlords and tenants, and the difference between absolute, qualified, and fully qualified covenants
• Statutory overlay on consent to assignment/underletting (LTA 1927 s19; LTA 1988) and use of AGAs under the 1995 Act
• The special requirements and risks when drafting an underlease, including term, rights, and headlease restrictions, and the role of licences to underlet
• The interaction of repair and insurance, including insured risks, rent suspension, reinstatement, and termination options
• Rent review structures, assumptions, and disregards; VAT and SDLT/LTT implications for premiums and rent
• Security of tenure for business tenancies under LTA 1954 and contracting out formalities
• The importance of registration for leases over seven years and for assignments, and completing prescribed clauses accurately

Key Terms and Concepts

• demise
• rent review
• easement
• covenant
• quiet enjoyment
• fully qualified covenant
• full repairing and insuring (FRI) lease
• forfeiture
• underlease
• headlease
• deed
• execution
• prescribed clauses
• registration
• institutionally acceptable lease
• schedule of condition
• insured risks
• rent suspension
• licence to alter
• licence to underlet
• licence to assign
• Authorised Guarantee Agreement (AGA)
• security of tenure
• break clause