Completely Retail

Demystifying “Heads of Terms” jargon

Taking a lease – a stitch in time

Completely Retail recently caught up with David Johnston, partner at the leading law firm Wedlake Bell. This blog uncovers the legal jargon for retailers taking out their first lease on a retail property.

Taking a lease for your first shop to rent is a journey that the property industry fills with jargon.  Often the phrase “heads of terms” is thrown around – some paying no attention to it and others giving it almost mythical legal status.

Heads of terms record the deal reached between a landlord and a tenant which will then allow the lease documents to be prepared.  There is no standard form for heads of terms – you may find them set out in an email or a more official looking document. 

Although heads of terms should not normally be legally binding, since they show the intentions of the landlord and the tenant but don’t legally force them to go on and actually complete the lease, it is normal to state that they are “subject to contract”.

You should remember that either party can still change their mind and not enter into the lease. 

So what are the key points that should be thought about in the heads for a retail property lease.

1.Who is who?

The legal entities who will be signing the retail property lease (whether a company or an individual) should be set out in the heads of terms.  If a tenant is a new business it should expect the landlord to want information on its finances to be comfortable before the lease is granted. This will be to checking the tenant will be able to pay the rent and other liabilities that it is signing up to. 

If the landlord has an issue with the financial strength of a retail tenant, it may ask for a guarantor or money up front, called a rent deposit, that it will hold to protect itself against the risk of the tenant defaulting.  If the landlord requires a rent deposit the heads should state the amount and when it should be paid back to the tenant.

2. What is being let?

The heads will set out the details of the retail premises which are being let including any additional rights that will need to be granted such as a car parking space, access to bin stores or cycle storage etc.

3. What is the rent?

Traditionally commercial leases have been let at “market” rents on a yearly basis paid either monthly or quarterly in advance.  In these more uncertain times, retail landlords have been forced to accept other deals such as turnover rents or provisions that allow the rent to increase during the term as the tenant’s business becomes more established. 

It is also normal for there to be a rent-free period at the beginning of the retail property lease to allow the tenant to have the cash flow to fit-out the shop and get established before its rental obligations kick in.  Please note that there is not normally a rent-free period in relation to the payment of any service charge (where the property is part of a building) or for a proportion of the building insurance if, as is usual, the landlord is insuring the building.

4. What is a service charge? 

A new retail property tenant should always understand what they are obliged to pay in respect of a service charge if it is taking a lease which forms part of a building.  On short term leases a landlord may include the service charge in the rent (an inclusive lease).  More commonly , the service charge will be a fair proportion of the service costs (i.e. the maintenance of the building in which the premises sit).  The estimated service charge costs should be made clear to the tenant prior to the lease being granted and if the tenant has any views on whether that is a fair and/or reasonable cost it should take advice from a qualified surveyor

5. Are there other costs a tenant should be aware of?

A new tenant should also factor in any potential additional costs under the lease such as contributions to the landlord’s insurance premium and cost of utilities (where the landlord is providing them).

There are also business rates, SDLT on the grant of the lease and VAT that may also need to be taken into account.  It is very unusual to see all-inclusive rents in a lease of a shop – although you may see them in more temporary or flexible deals. 

6. How long should a retail property term be for?

The term, in other words how long the lease will run, will need to be clearly set out.  You may also want to consider whether there should be an earlier break which will allow either the landlord and/or the tenant to terminate the lease by giving notice. 

There are some key legal issues to be considered on the negotiation of break clauses.  If one is being considered then the parties should take legal advice and really understand what they mean.

7. Can the tenant sell the lease on or sub-let?

This is sometimes called “alienation”.  Basically, these provisions will set out whether a tenant is allowed to pass its lease on to a third party or allow all or part of the lease to be sub-let during the term. 

An assignment allows the tenant to pass on the obligations of the lease to a third party (but may still retain an obligation to guarantee the obligations of that third party).  A retail property’s sub-lease means that the tenant is still fully obliged to ensure that the lease covenants are complied with but allows a third party to occupy the whole or part of the property.

This is where you will also find restrictions on the tenant’s ability to charge the lease.  If the tenant has existing bank borrowing it should check whether that arrangement requires it to charge any property interests.

8. What can the property be used for? 

The permitted use of the property will be set out in the lease.  It is normal for it to be the tenant’s responsibility to ensure that the permitted use complies with whatever the relevant planning permission allows the property to be used for.  This can usually be checked at the Local Authority.

9. What does “excluded from the Act” mean?

English law includes a concept called “security of tenure”.  A short term lease will normally be “excluded” from the statutory right to a new lease when the current lease ends.  Longer leases may be “inside the Act” which gives the tenant more protection at the end of the term.

10. Fit-out and re-instatement at the end of the term

The parties should be clear on what the tenant is allowed to do to fit-out the retail property.  They should also check whether any alterations such as external signage or ventilation (especially where a kitchen is being installed) need further approvals from the local authority.

Tenants should also be aware that the normal arrangements in a lease require it to give the landlord the property back with any alterations removed and made good at the end of the term.  If that is not the deal then it should be agreed up front.

Conclusion

Retail property leases are often the longest term and financially most expensive contract a new retail business will ever enter into.  I would always advise a tenant to take legal advice.  The extent of how much legal advice a tenant wants will depend on the length of the lease and the financial obligations that it is signing up to.  However, getting it right at the outset will prove beneficial in the long term as disputes are expensive and time consuming to solve. 

It really is a case of a stitch in time saves nine.

David Johnston is a partner at the leading law firm Wedlake Bell – https://wedlakebell.com/people/david-johnston/ – with 25 years experience in retail leasing.  When he isn’t doing that he will probably be riding a bike at the back of the peloton with https://clubpeloton.org/!

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