Leases and underleases - Rent and rent review mechanisms

Learning Outcomes

Develop the ability to identify the legal and practical characteristics distinguishing leases and underleases, assess the steps and requirements for their grant, and explain the importance of exclusive possession, term, and rent as essential lease characteristics in English property law. Understand the implications of privity of contract and estate, especially regarding assignments, authorised guarantee agreements (AGAs), and the intervention of subleases. Critically explain how rent is determined, apportioned, and collected, including the operation of rent deposits, direct covenants, and scope of rent review clauses.

Interpret and apply requirements for different forms of rent review—fixed, index-linked, turnover, and open market (OMRV)—and analyse the meaning and consequence of "ratchet clauses" (upwards-only reviews), including their effect during a falling property market. Justify the practical and legal role of assumptions and disregards within an OMRV, such as the disregard of goodwill, voluntary improvements, and a tenant’s continued occupation. Analyse the dispute resolution procedures for disagreements relating to rent review, such as expert determination and arbitration, and evaluate the enforceability and fairness of decisions reached through such mechanisms.

Explain the statutory controls and market practices in leasehold transactions, including the importance of formalities (deed, registration), consent requirements for underletting, distinctions between assignments and underleases, and the ongoing liabilities and potential remedies available for breach of lease covenants, including forfeiture and Commercial Rent Arrears Recovery (CRAR).

SQE1 Syllabus

• Legal definition, essential elements, and formalities of leases and underleases, including exclusive possession, term certainty, and rent
• Processes and documentation required for granting leases and underleases, and the impact of registration thresholds at the Land Registry
• Comparison of assignments and underleases, including privity of contract and estate and the continued liability of parties following assignment (pre- and post-1996 leases)
• Construction, types, and operation of rent and rent review provisions in commercial leases, including:
  • Fixed increase/rise arrangements
  • Index-linked increases (e.g. to RPI, CPI, or other relevant indices)
  • Turnover-based rent analysis and calculation
  • Open market rent review mechanisms, with reference to assumptions and disregards
  • Effect of ratchet clauses (upwards-only reviews)
• Structure and content of rent review provisions (including review dates, review process, ratchet clauses, expert determination, and pre-conditions for reference to third parties)
• Procedure and mechanisms for referring rent review disputes to third-party determination (expert or arbitrator), the nature and effect of their decisions, and recourse in the event of manifest error
• Analysis of rent deposit arrangements and guarantees, including the legal function of Authorised Guarantee Agreements (AGAs) on assignments
• Remedies available to landlords in the event of non-payment of rent or breach of covenants:
  • Debt action
  • Forfeiture (including the significance of s146 LPA 1925)
  • CRAR and its restrictions
  • Recourse to subtenant and guarantor liability

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 are the essential legal characteristics of a lease?
2. What is the difference between an underlease and an assignment?
3. Name three common types of rent review mechanisms found in commercial leases.
4. What is typically the effect of a "ratchet clause" in an open market rent review?
5. How are disputes over rent review usually resolved if the parties cannot agree?

Introduction

Leases and underleases are fundamental structures in English land law and commercial property practice, forming the backbone of landlord and tenant relationships. To competently address these under the SQE1 syllabus, it is necessary to distinguish legal and practical aspects of leases and underleases, including the procedural requirements of grant, the operation of rent and its review, and the legal frameworks surrounding rent review dispute mechanisms. A thorough understanding also involves knowing the allocation of risk, the consequences of breach, and remedies available for non-payment or default under these arrangements.

Key Term: lease
A legal estate in land, granting exclusive possession to a tenant for a certain term and usually in return for payment of rent. Must have certainty of term, exclusive possession, and compliance with formalities (usually as a deed).

Key Term: underlease
A lease created by a tenant (not the freeholder), where the new lease is granted out of the tenant's own leasehold estate for a term less than that remaining on the head lease. The underlease sits beneath the head lease; the undertenant holds no legal relationship with the head landlord unless a direct covenant exists.

A valid lease or underlease generally must be (if for more than three years) by deed, signed, and, for terms over seven years, registered at the Land Registry (LRA 2002). Failure to comply may render the lease equitable only or, in certain cases, void as to legal effect.

Granting Leases and Underleases

The process for granting a lease or underlease typically involves:

• Drafting and negotiation of lease terms: including parties, rent, term, break options, covenants, and landlord/tenant obligations
• Deduction and thorough investigation of title by the landlord’s solicitor (registered and, where relevant, unregistered land; includes official copies or epitome of title)
• Pre-contract searches and enquiries (by the tenant's solicitor), to identify adverse rights, third-party interests, local land charges, planning constraints, or latent defects
• Obtaining all necessary consents (notably: superior landlord’s licence to underlet, lender’s consent if the property is mortgaged, or from management company in case of flats or managed property)
• Execution as a deed and, if required, registration at the Land Registry

Key Term: licence to underlet
The formal written consent from the superior landlord (or otherwise the property owner entitled to enforce restrictions), as may be required by the head lease, authorising the tenant to grant an underlease. Failure to obtain can result in breach and risk of forfeiture.

Lease documentation will clarify allocation of risk (including insurance, repairs, and use), outline landlord and tenant covenants (both positive and negative), and specify forfeiture provisions for breach of covenant, which are not implied by law and must be expressly included.

Distinguishing Underleases from Assignments

An assignment differs fundamentally from an underlease: where an assignment, with necessary consents, transfers the tenant’s entire legal estate to an incoming tenant, an underlease carves out a lesser interest from within the term held by the tenant, resulting in a new and subordinate landlord-tenant relationship. The outgoing tenant remains liable under the head lease and becomes landlord for the subtenant (unless released).

Key Term: assignment
The transfer of a lease by the current tenant to a new tenant (assignee), usually for the balance of the remainder of the term, subject to the landlord’s consent where required.

Key Term: privity of contract
The relationship that exists between the original parties to the lease, such that each is liable to the other on the covenants agreed, unless subsequently released.

Key Term: privity of estate
The relationship between the person for the time being entitled to the leasehold (as tenant) and the reversioner (landlord), such that covenants which "touch and concern" the land will be enforceable between them.

Rent in Leases

Rent is the economic consideration for the grant of a lease and secures the tenant’s continued right of occupation. It must be:

• Identified in the lease (if absent, the lease may still be valid, but payment of rent is strong evidence of a lease rather than a licence)
• Stated as to amount at commencement (subject to subsequent rent review)
• Scheduled as to frequency and method of payment (e.g., in advance by standing order on quarter days, monthly, or as contractually agreed)
• Capable of apportionment on grant if the lease commences part-way through a rent period
• Express as to inclusion of VAT or exclusive (the lease should clarify VAT if the landlord has opted to tax; see VAT 1994)

Key Term: rent
The periodic monetary payment due from the tenant to the landlord, as a condition of ongoing possession under the lease. May include, in the wider sense, other periodical sums reserved as rent—such as insurance rent, service charges, or other sums defined in the lease.

Security for rent may be provided, especially in commercial lettings, by a rent deposit or personal/parent company guarantee. Rent deposits are often held on trust, with clear procedures for withdrawal, top-up, and repayment defined by the rent deposit deed.

Worked Example 1.1

A commercial lease is granted for 5 years, rent payable quarterly in advance on the usual quarter days. The lease is signed and dated on 18 February, but the first quarter day is 25 March. How is the initial rent apportioned?

Answer:
The tenant pays a proportionate part of the annual rent for the period from 18 February to 24 March upon completion, and thereafter full quarterly rent on each quarter day.

Rent Review Mechanisms

Modern leases—particularly commercial leases—nearly always incorporate a rent review clause, enabling periodic adjustment of rent to reflect inflation, market value, or changes in trade at the premises. Such clauses are strictly construed: unless expressly provided, the landlord cannot increase rent (nor can rent be decreased).

Key Term: rent review
A mechanism within a lease to assess and adjust the rent at specified intervals, using an agreed method, formula, or external reference such as market value or an index.

Types of Rent Review

• Fixed Increase Rent Review: The rent increases to pre-determined figures or by a fixed percentage at stated intervals. While administratively simple and providing certainty for budgeting, fixed increases may fail to track actual market movements and can over- or under-compensate in a volatile market.
• Index-Linked Rent Review: Rent is tied to the movement of an external economic index, most commonly the Retail Prices Index (RPI) or Consumer Prices Index (CPI). Leases often include cap and collar provisions, capping any increase and setting a floor (collar) for minimum increase.
• Turnover Rent Review: Part or all rent is calculated by reference to the tenant’s business turnover at the premises. Most common in retail/restaurant leases, it incentivises landlord support for tenant success but introduces variability. The lease should clarify the turnover calculation period, reporting requirements, and method for auditing the tenant’s accounts.
• Open Market Rent Review (OMRV): The most prevalent mechanism in commercial leases. Rent is re-assessed at intervals (often every 3–5 years) to reflect the hypothetical open market rental value ("OMRV") of the premises at the review date, assuming a willing landlord and tenant, vacant possession, and subject to the terms of the lease (save for the rent amount and review provisions):

Key Term: open market rent review
A rent review based on the market rent at the review date, for letting on the same terms as the existing lease (excluding the rent and typically disregarding the existence of the current tenant’s occupation, improvements, and goodwill).

Worked Example 1.2

A lease's rent is reviewed every five years on an open market basis with an upwards-only ("ratchet") clause. The property market declines, and the market rent at review is below the rent previously payable.

Answer:
The ratchet clause prevents rent from falling: the rent remains the same as before the review since the market rent is lower.

Key Term: ratchet clause
A rent review provision which ensures that, on review, rent can only remain the same or increase but never decrease (i.e., "upwards-only" rent review).

Structure of Rent Review Clauses

A comprehensive rent review clause will typically include:

• The review dates and frequency (e.g., every third or fifth anniversary of the term commencement or lease date)
• The method of review (fixed, index-linked, open market, turnover)
• Upwards-only (ratchet clause) or upwards/downwards arrangements
• Express reference to the assumptions to be made by the valuer (e.g., the property is in good repair, the tenant has complied with all lease covenants, the premises have not been damaged)
• Express disregards (e.g., the effect of the tenant’s own improvements, the tenant’s goodwill, the tenant’s occupation)
• Procedure for proposing and agreeing the reviewed rent, including time limits for notices and counter-notices, and default provisions for reference to third-party determination

Key Term: assumptions and disregards
Prescribed elements for the valuer conducting an open market rent review, directing that certain facts must be assumed (e.g., property is in repair, tenant is compliant) and other facts must be disregarded (e.g., tenant occupation, goodwill, improvements), to ensure a fair and market-reflective assessment.

Common Assumptions

• The premises are available with vacant possession
• The tenant has complied with all lease covenants (e.g., is not in breach of repair or user clauses)
• The lease is for the unexpired residue of the term, on the same terms as the actual lease except as to rent
• The rent will be reviewed according to the same rent review provisions

Common Disregards

• Any impact on rent from the existing tenant’s occupation (so as not to "bid up" the rent artificially)
• The tenant’s goodwill or customer base
• Any improvements voluntarily carried out at the tenant’s own expense (beyond those required by the lease or by law)

Worked Example 1.3

A tenant makes extensive improvements at its own expense which increase the premises' rental value. The lease's review clause provides that voluntary improvements by the tenant are to be disregarded. How does this affect the rent review?

Answer:
The valuer will disregard the effect of the improvements, so the rent cannot be increased to reflect any enhancement in value they cause.

Upwards-Only Review and Tenant Protections

The overwhelming market practice in institutional leases is for upwards-only rent reviews, reflecting landlords' need for income certainty throughout the term and to maintain property investment values. Downward reviews are rare but occasionally found, and are more tenant-friendly.

Exam Warning: Rent review clauses, particularly with ratchet provisions, are interpreted strictly. If the lease states rent can only increase or remain static, tenants cannot benefit from a fall in market rents.

Worked Example 1.4

A retail tenant leases premises with a turnover rent of 8% of gross receipts, with base rent of £10,000 per month. In a month with sales of £120,000, what is the rent due?

Answer:
The turnover element is £9,600 (8% of £120,000). If the lease provides for the greater of the base rent or turnover rent, the rent due is £9,600, exceeding the base rent.

Rent Review Disputes and Resolution

Where parties cannot agree on the reviewed rent, the lease should set out the procedure for dispute resolution. The default, absent agreement, is reference to a third-party—either an independent expert or an arbitrator. The precise mechanism depends on lease drafting:

Key Term: independent expert determination
Referral of the dispute to a neutral property expert (often a chartered surveyor) who determines the rent, typically using their own experience and without strict recourse to formal evidence. The decision is usually final and binding unless manifest error.

Key Term: arbitration
Referral to a neutral arbitrator (again, commonly a surveyor), who acts in a quasi-judicial capacity, usually hearing evidence and submissions before issuing a legally binding award on the review rent.

The difference is significant: an arbitrator may be more constrained by the rules of natural justice and process, whereas an independent expert may rely (unless restricted by the lease) on their knowledge and experience. The lease may also specify who nominates the expert or arbitrator (for example, the President of the Royal Institution of Chartered Surveyors or the relevant Law Society panel). The process, formality, and costs will be determined by the relevant contract term or, failing that, the Arbitration Act 1996 or the expert's terms of appointment.

Worked Example 1.5

The lease provides for open market rent review with disputes to be determined by an arbitrator if not agreed. The parties cannot agree at review. What happens next?

Answer:
Either party can activate the mechanism in the lease to refer the matter to arbitration. The arbitrator will determine the market rent, and the decision will be binding.

Practicalities: Suspension of Rent and Backdating

Where determination of the reviewed rent takes time, commonly the lease provides that the tenant continues to pay the pre-review rent until the new rent is established. A balancing payment (or repayment, extremely rare) will be made to adjust for the period from the review date to the determination. The lease may provide for interest on arrears or overpayments.

Worked Example 1.6

Rent review is due on 1 July, but the new rent is determined on 1 November. The lease stipulates backdating with interest. How are payments treated?

Answer:
Once the new rent is determined, the tenant pays the difference (plus any specified interest) for July–October. If the reviewed rent is lower (unusual and only possible if the lease permits downward review), the landlord would refund the overpaid amount, usually without interest unless specified.

Statutory Rent Review (Landlord and Tenant Act 1954)

If a commercial tenant has statutory security of tenure, on renewal the rent for the new lease is set by reference to open market value, disregarding tenant improvements, occupation, and goodwill (LTA 1954, s34). This legislated method aligns with open market rent review in standard leases.

Remedies for Non-Payment and Breach

If rent (including any reviewed rent) is not paid, landlords may have recourse to several remedies:

• Debt Action: Standard court proceedings to recover arrears of rent, subject to the six-year limitation period for action in debt (Limitation Act 1980).
• Forfeiture: If expressly reserved, the landlord may forfeit the lease for rent arrears or breach of covenant (subject to statutory notice requirements for breaches other than non-payment of rent).
• Commercial Rent Arrears Recovery (CRAR): Allows landlords of commercial premises to enter, seize, and sell the tenant’s goods to recover unpaid principal rent (not service charges or insurance rent), subject to at least seven days’ arrears. Strict procedural regulations apply, including notice, use of certified enforcement agents, and exemptions for tenants’ essential business equipment up to £1,350.
• Recourse to Guarantors and Rent Deposit: If a rent deposit is held or a guarantor stands behind the tenant, the landlord may call on these to recover arrears.
• Subtenant Rent: Under certain conditions, landlords of head leases may serve notice on subtenants to pay subrent directly to discharge arrears (after fourteen days' notice).

Key Term: rent deposit
A sum of money paid by the tenant and held (usually by the landlord) as security for the payment of rent and/or the performance of lease covenants. Drawdown, top-up, and repayment terms will be specified in a rent deposit deed.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• Legal definition and requirements of leases and underleases, and the distinction with assignments
• Key formalities for the grant of leases and registration triggers (especially over seven years)
• Privity of contract and estate, AGAs, and liability following assignment (pre- and post-1996 leases)
• Consent requirements and consequences of unauthorised underletting
• Main types of rent review mechanisms and their operation, including fixed, index-linked, turnover, open market, and the use of assumptions and disregards in open market rent reviews
• The effect and operation of ratchet (upwards-only) clauses and their implications during market downturns
• Procedures for dispute resolution regarding rent review—independent expert determination and arbitration—and rules on binding effect and challenge
• Mechanisms and remedies for non-payment of rent and other breaches, including debt actions, forfeiture, CRAR, use of rent deposits, and guarantor recovery

Key Terms and Concepts

• lease
• underlease
• licence to underlet
• rent
• rent review
• open market rent review
• assumptions and disregards
• ratchet clause
• independent expert determination
• arbitration
• rent deposit
• assignment
• privity of contract
• privity of estate