Leases and underleases - Code for Leasing Business Premises

Learning Outcomes

This article examines the fundamental principles of commercial leases and underleases, including the distinction between leases and licences, key lease covenants, and the structure of underletting. It also introduces the Code for Leasing Business Premises and its relevance. For the SQE1 assessment, you will need to understand the creation, key terms, and implications of commercial leases and underleases, recognise the purpose and status of the Code, and apply these principles to practical scenarios involving business premises. Your understanding will enable you to answer SQE1-style single best answer MCQs effectively.

SQE1 Syllabus

For SQE1, you are required to understand the practical aspects of commercial leases and underleases, including their structure, key terms, and the impact of the Code for Leasing Business Premises. This includes advising on leasehold transactions and understanding landlord and tenant obligations.

As you work through this article, remember to pay particular attention in your revision to:

  • the distinction between a lease and a licence
  • key leasehold covenants typically found in commercial leases
  • the structure and implications of granting an underlease
  • the purpose and status of the Code for Leasing Business Premises
  • the concept of security of tenure under the Landlord and Tenant Act 1954 (Part II) for business tenancies.

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 key legal test established in Street v Mountford [1985] AC 809 to distinguish between a lease and a licence?
  2. True or false? The Code for Leasing Business Premises is legally binding on all landlords and tenants negotiating commercial leases in England and Wales.
  3. Can a tenant grant an underlease for a term that is longer than the remaining term of their own lease (the head lease)?
  4. Which Act primarily provides security of tenure for business tenants in England and Wales?

Introduction

When advising clients on occupying business premises, understanding the nature of leasehold agreements is essential. Commercial leases form the backbone of property occupation for many businesses. This article focuses on the core principles governing commercial leases and underleases, differentiating them from licences, outlining common obligations (covenants), and introducing the influential Code for Leasing Business Premises. Familiarity with these concepts is essential for advising clients and tackling SQE1 questions effectively.

Leases vs Licences

A fundamental distinction in property law is between a lease and a licence. This distinction carries significant practical implications, particularly regarding statutory protections available to occupiers.

Key Term: Lease
A legal interest in land granting exclusive possession for a fixed or periodic term, usually in return for rent. It creates an estate in land.

Key Term: Licence
A personal permission granted by a landowner (licensor) allowing someone (licensee) to do something on the land that would otherwise be a trespass. It does not grant an interest in land or exclusive possession.

The essential test for distinguishing a lease from a licence was set out in Street v Mountford [1985] AC 809. If an agreement grants exclusive possession for a term certain in return for rent, it creates a lease, irrespective of the label the parties attach to it. Exclusive possession means the right to exclude all others, including the landlord (subject to limited rights reserved in the lease, e.g., for inspection or repair).

Worked Example 1.1

A start-up company, Innovate Ltd, occupies an office suite under a document titled 'Licence Agreement'. The agreement grants Innovate Ltd the sole use of Suite 101 for 12 months, requires monthly payments, and prohibits access by the property owner except for emergencies or agreed maintenance. Does Innovate Ltd have a lease or a licence?

Answer: Innovate Ltd likely has a lease. Despite the document's title, the terms appear to grant exclusive possession (sole use, restricted landlord access) for a fixed term (12 months) in return for periodic payments. Applying Street v Mountford, the substance suggests a lease, not a licence.

Key Lease Covenants

Commercial leases contain numerous covenants imposing obligations on both the landlord and the tenant. These regulate the use, maintenance, and management of the property.

Key Term: Covenant
A promise contained in a deed. In the context of leases, covenants are legally binding promises regarding the property made between the landlord and tenant.

Common tenant covenants include:

  • Paying rent and other sums due (e.g., service charge, insurance premiums).
  • Repairing the premises (the extent varies depending on whether it's a lease of whole or part).
  • Using the premises only for permitted purposes (the 'user' covenant).
  • Not making alterations without landlord's consent.
  • Not assigning or underletting without landlord's consent ('alienation' covenant).

Common landlord covenants include:

  • Granting the tenant quiet enjoyment (undisturbed possession).
  • Insuring the building (often recovering the cost from the tenant).
  • In leases of part, repairing and maintaining the structure and common parts (often recovering costs via service charge).

Worked Example 1.2

RetailCo leases a shop unit under a commercial lease. The lease contains a covenant stating the tenant must "keep the premises in good and substantial repair and condition". The shop front window is cracked due to vandalism. Is RetailCo likely responsible for the repair?

Answer: Yes, most likely. A covenant to "keep" in repair generally implies an obligation to put into repair if necessary. Even though the damage was caused by a third party, the repairing covenant usually places the obligation on the tenant, unless the damage falls under an insured risk for which the landlord is responsible for reinstating (which vandalism might not be).

Underleases

A tenant holding a lease (the 'head lease') may grant a lease of part or all of the property to a third party. This creates an underlease (or sublease).

Key Term: Underlease
A lease granted by a tenant (who becomes the 'intermediate landlord' or 'mesne tenant') to a subtenant. The term of the underlease must be shorter than the term of the head lease.

Key Term: Head Lease
The original lease granted by the freeholder (head landlord) to the first tenant (who becomes the mesne tenant if they grant an underlease).

The grant of an underlease creates a new landlord-tenant relationship between the mesne tenant and the subtenant. However, the mesne tenant remains bound by the covenants in the head lease to the head landlord. There is typically no direct contractual relationship (privity of contract) or landlord-tenant relationship (privity of estate) between the head landlord and the subtenant.

Worked Example 1.3

TechFirm holds a 10-year head lease of an office building from LandlordInvest plc. TechFirm grants a 5-year underlease of the top floor to DesignStudio Ltd. DesignStudio fails to pay its rent to TechFirm. Can LandlordInvest plc sue DesignStudio directly for the unpaid rent due under the underlease?

Answer: No, generally LandlordInvest plc cannot directly sue DesignStudio for the rent due under the underlease. There is no privity of contract or estate between the head landlord and the subtenant regarding the underlease obligations. LandlordInvest plc's recourse for rent is against TechFirm under the head lease. TechFirm must pursue DesignStudio for the underlease rent. (Note: Sometimes a direct covenant is created via a licence to underlet).

The Code for Leasing Business Premises

The Royal Institution of Chartered Surveyors (RICS) publishes the Code for Leasing Business Premises. It sets out expectations for fairness and clarity in negotiating commercial leases.

Key Term: Code for Leasing Business Premises
A professional statement issued by RICS setting out mandatory requirements and best practice recommendations for RICS members (like surveyors) involved in commercial lease negotiations in England and Wales.

While the Code is not law and does not override lease terms or statute, its mandatory provisions must be followed by RICS members, and departures from best practice require justification. Non-RICS members are encouraged to follow it.

Key objectives and provisions include:

  • Negotiations: Must be constructive and collaborative.
  • Heads of Terms: Should be comprehensive, clear, and cover key points like premises, term length, rent, rent review, repair, permitted use, alienation rights, and break options.
  • Rent Reviews: Should ideally allow for upward or downward review based on market conditions, not be restricted to upwards-only reviews unless specifically negotiated.
  • Break Clauses: Conditions attached to break rights should be reasonable and solely within the tenant's control.
  • Assignment/Subletting: Landlord's consent should not be unreasonably withheld or delayed. Circumstances for refusal should be specified where possible (s.19(1A) LTA 1927).
  • Repairs: Obligations should be appropriate to the lease length and property condition. Schedules of condition are recommended for older properties.

Revision Tip

Remember the Code's status: it's a professional standard, primarily for surveyors, not statute. However, its principles often reflect what courts consider reasonable, particularly regarding landlord's consent for alienation or alterations.

Security of Tenure

Many business tenancies benefit from 'security of tenure' under the Landlord and Tenant Act 1954 (Part II). This grants tenants the right to remain in occupation after the contractual term ends and the right to apply for a new lease, unless the landlord can establish specific statutory grounds for opposing renewal (eg, tenant breach, landlord intends to redevelop or occupy). Parties can agree to exclude ('contract out') these provisions before the lease is granted, following a strict statutory procedure involving notices and declarations.

Key Point Checklist

This article has covered the following key knowledge points:

  • A lease grants exclusive possession for a term certain, distinct from a licence which is mere permission.
  • Street v Mountford established the test based on substance (exclusive possession, term, rent) not label.
  • Leases contain covenants outlining landlord and tenant obligations (e.g., rent, repair, user, alienation).
  • An underlease is granted by a tenant out of their own lease (head lease) for a shorter term.
  • The Code for Leasing Business Premises promotes fairness and clarity in commercial lease negotiations, setting standards for RICS members.
  • The Code influences areas like rent reviews, break clauses, and alienation clauses.
  • Business tenants often have security of tenure under the Landlord and Tenant Act 1954, providing rights to renew the lease, unless validly contracted out.

Key Terms and Concepts

  • Lease
  • Licence
  • Covenant
  • Underlease
  • Head Lease
  • Code for Leasing Business Premises
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