“Alienation” is the tenant’s ability to deal with its lease. The starting point is that a tenant has a right to deal freely; in the absence of any wording to the contrary, he can assign it to someone else, grant underleases out of it, create a charge over it and share occupation of the whole or any part of the property. However, in practice landlords want to control who their tenants are and who occupies their property, so alienation provisions are almost always included. Our landlord and tenant team are able to advise on the best way to do this.
The extent of the alienation provisions will vary depending on the length of the lease and the type of property. As a general rule, provisions are likely to be more flexible the longer the lease and the larger the property. For a very short lease of a small part of a property the tenant may not be allowed to alienate at all. Most commonly in a commercial lease, a tenant will be permitted to assign, underlet and charge the whole, but only with the consent of the landlord.
Assignment or underletting: a landlord’s perspective
A landlord will generally want to retain very close control over assignments. If the lease is assigned to an unsatisfactory tenant (who is unable to pay the rent or comply with other covenants) this may reduce the value of the landlord’s reversionary interest. Where a landlord owns a number of local properties, or the property is a unit on an estate or a floor in an office block, there may also be estate management reasons (eg ensuring a good tenant mix) for the landlord retaining control over the identity of the tenant.
A landlord is often more willing to permit an underletting than an assignment and if consent to assign is validly refused it may nonetheless be possible to obtain consent to underlet. The landlord does not lose his current tenant’s covenant: he will continue to be paid rent by the same person and he will be able to enforce the tenant covenants against the same person. However, a landlord will still be concerned to exercise a reasonable degree of control over underlettings, and ensure that he has direct covenants from the undertenant. The degree of control which the landlord wishes to exercise will depend a lot on the length and value of the underlease: he is going to be a lot less concerned about an eight month contracted out tenancy of a small part of the property than a 15 year underlease of a whole office block with security of tenure.
Restrictions on alienation
A standard lease provision will allow the tenant to assign the whole of the lease, but only with the landlord’s consent. An underletting clause may prohibit underletting entirely, or may allow underletting of the whole or specified parts with the landlord’s consent. Charging the whole of the lease will generally be permitted, again with landlord’s consent.
A provision requiring landlord’s consent brings with it a number of statutory duties:
- The landlord must give the tenant written notice of its decision within a reasonable time (the lease will often explicitly require this, but it will implied if not).
- The landlord must give consent unless it is reasonable for him not to do so (again, this may be explicit but is implied if not).
- The landlord must specify any reasonable conditions to the consent.
- If consent is refused, the landlord must give (reasonable) reasons for that refusal.
- The landlord must pass on any application to anyone else whose consent is required (eg a superior landlord or mortgagee).
A failure to comply with these requirements is a breach of statutory duty and the landlord can be sued for damages in respect of this.
Conditions of assignment
In a “new” lease (most leases granted since 1 January 1996) the landlord and tenant can agree in advance to circumstances in which the landlord may withhold consent to assign and conditions which may be imposed in respect of the assignment. This means that when the tenant applies for consent to assign, the landlord will generally be deemed not to be acting unreasonably in withholding consent in the specified circumstances or imposing the conditions, no matter how objectively unreasonable they may be. For the agreement to be valid it must expressly state that it is made for the purposes of section 19(1A) of the Landlord and Tenant Act 1927.
The imposition of factual conditions and circumstance will always be valid but more care is required with regards to discretionary circumstances and conditions (those which cannot be verified objectively, for example a requirement that the assignee is, “in the opinion of the landlord” of equivalent financial standing to the tenant). These conditions and circumstances will be invalid unless there is either a provision for reference to an independent third-party or the landlord is required to be reasonable in reaching the opinion.
Commonly seen circumstances and conditions include:
- That the assignor enters into an authorised guarantee agreement (AGA) and/or that an acceptable guarantee, a rent deposit or a bank guarantee be provided by the assignee.
- That the assignee is of “sufficient financial standing” or of “equivalent financial standing” to the current tenant – tenants should be cautious about accepting the second of these as it creates a “ratchet effect”: if the tenant is of very good covenant strength, it can only assign to someone of equivalent or better strength.
- That the assignee meets a specified profits or assets tests – this is often seen in older leases but should generally be resisted by a tenant: whilst it may be easy to find an assignee which can fulfil the requirements during a period of economic growth, it becomes virtually impossible during a slump.
- That there is “no subsisting breach of covenant”, possibly watered down to “no material breach of covenant”. The main problem with this from a tenant’s perspective is the issue of whether repair obligations have been fully complied with.
- A condition that all sums due under the lease are paid in full. While a tenant may be willing to agree this for annual rent is should be resisted for sums that are undetermined or that may be the subject of a dispute (eg service charge).
However, just because particular conditions or circumstances have been specified, the landlord is not prevented from giving consent subject to other reasonable conditions or from refusing consent in circumstances where it is reasonable to do so; the purpose of the legislation is simply to allow the parties to pre-agree reasonable circumstances and conditions.
In an “old” lease the landlord was not able to include specified conditions and circumstances which would be deemed reasonable: any condition specified in the lease would be subject to the usual reasonable test (see “reasonableness of conditions and circumstances” below). The exception to this is genuine pre-conditions (for example that the tenant offers to surrender the lease to the landlord before assigning) which do not have to be reasonable. However, as it can be tricky to establish what is a pre-condition and what is simply an attempt to state what is deemed reasonable, consideration should always be given as to the validity of conditions in old leases.
Conditions of underletting
Section 19(1A) of the Landlord and Tenant (Covenants) Act 1995 does not apply to underlettings. This means that conditions and circumstances set out in the lease will not be deemed to be reasonable: while the lease will often set out conditions to underletting, these will have to be shown to be reasonable in the normal way (see “reasonableness of conditions and circumstances” below). As with assignments, genuine pre-conditions are not subject to the reasonableness requirement.
Common conditions to underletting include:
- That the tenant let the property at the same rent that he is paying to the landlord and doesn’t give any rent free period. In a falling market this condition may not be reasonable as it will have the effect of prohibiting any underletting.
- That the underlease rent is reviewed on the same dates and same basis as the headlease rent. This may be reasonable for a long term underlease of the whole property at the same rent as the headlease but probably won’t be for shorter, lower value leases.
- That the underlease be contracted out of the Landlord and Tenant Covenant Act 1954. This is likely to be reasonable in respect of a short term underlease of part of the property but may not be reasonable for high-value longer leases.
- That the underlease contains a prohibition on further underletting. The reasonable of this will depend on the nature of the property.
- That the undertenant provides a direct covenant to the landlord.
- That the underlease provisions are consistent with the headlease provisions. Again, whether or not this is reasonable will depend on the nature of the headlease and the underlease – for a short term lease of a small part of the property it may not be.
Reasonableness of conditions and circumstances
What is a “reasonable” refusal?
Whether or not a landlord has unreasonably refused consent is a question of fact, depending on all the circumstances of the case. A landlord is not entitled to refuse consent on grounds which have nothing whatever to do with the relationship of landlord and tenant in regard to the subject matter of the lease. The landlord cannot impose a condition which will increase or enhance the control he is entitled to exercise under the terms of the lease; however, he is not limited to taking into account only his interest in relation to the particular property, but can instead take into account his property interests as a whole.
Provided that the reason is connected to the relationship of landlord and tenant in regard to the subject matter of the lease, whether consent has been withheld reasonably will be decided on the facts. The obligation on the landlord is to show that the conduct was “reasonable”; this is different from “right” or “justifiable”.
Reasonable on the facts
The question of whether the landlord has been reasonable on the facts depends on the particular case. However, some examples of what is and is not reasonable include:
- Under an old lease, a request for a direct covenant from the assignee for the whole of the residue (not just the period during which the assignee is tenant) is commonly requested but would be unlikely to “survive a serious challenge” as to its reasonableness.
- In relation to an underletting it will not always be reasonable to request a direct covenant from an undertenant.
- In relation to the provision of a guarantor, it will not be reasonable to require that a guarantor remains liable for the whole term (it should be limited to the length of the principal’s liability).
- A reduction in the value of the reversion is not reasonable where the landlord has no intention of selling the reversion. However, it will be reasonable where there is an intention to sell.
- A refusal on the basis that the underlease rent was to be less than market value will not be reasonable where this would not affect the value of the reversion but would affect the value of the reversion in neighbouring properties which the landlord owns (this is a collateral advantage, unconnected with the demised premises).
- While a landlord is entitled to be satisfied as to the financial position of the assignee, a standard requirement of profits at three times annual rent will not always be reasonable. The financial standing of a proposed undertenant is of less significance than the standing of a proposed assignee.
- Unsatisfactory references may be a reasonable ground for withholding consent – the landlord will usually wish to see a bank reference and three years’ audited accounts; if these are not satisfactory he may require a surety to provide the necessary covenant strength. However, the provision of a surety will not always be enough so it may be possible to withhold consent altogether.
- The fact that a guarantor is non-UK based is not in itself a reasonable grounds for refusing consent, but a lack of assets in the UK and the ease with which a UK judgment can be enforced in its home country are relevant.
- A belief that the assignee will commit substantial breaches of covenant is a reasonable ground for withholding consent but the existence of minor outstanding breaches or disputes is not.
- The fact that the use will be detrimental to the property or inconsistent with the landlord’s “tenant mix” policy is a reasonable ground (provided that the policy is known to the tenant and is rational).
- A requirement that the underlease be contracted out when the headlease is not may be unreasonable, depending on the surrounding circumstances.
- A request that the tenant pays anything more than “reasonable” costs is unreasonable: consent should not be charged for.
Landlord must show that conduct is reasonable
It is not necessary for the landlord to prove that the conclusions which led it to refuse consent were justified as long as they were conclusions that would have been reached by a reasonable person in the circumstances. The reasons do not have to be justified by reference to an objective standard of correctness but they must be genuine and not unfounded. It does not matter that a different landlord might take a different view, so long as the actual landlord’s refusal is reasonable. However, if the landlord relies on advice when making its decision, a refusal based on the advice will be unreasonable if the advice itself is unreasonable.
What is “a reasonable” time?
The landlord’s decision must be given in a reasonable time. What this actually means depends on the circumstances but it will generally be measured in days or weeks rather than months. The period may be affected by the actions of the tenant following its application, such as how long it takes to respond to requests for information and whether any attempt is made to communicate particular urgency. For more complex situations a longer period will be permissible.
If you need any assistance with drafting alienation provisions or dealing with an application please contact Martin Billings or or speak to any of our landlord and tenant or property litigation solicitors.
The information set out in this briefing note is provided free of charge for information purposes only to clients and prospective clients of this firm. We make every reasonable effort to check that the information is accurate and up to date but we cannot accept any responsibility for its accuracy or correctness or for any consequences of relying on it. Please note that the information does not and is not intended to amount to legal advice and you are advised to obtain specific personal advice from us or another lawyer about any case or matter and not to rely on the information or comments in this briefing note.
© BSDR 2013
Q&A – Assignment or Underletting?
Q. We took a lease in 2013 of two floors of an office building in London. Our company has downsized, and we no longer require such a large space. There are six years remaining on our lease term, and there is no break clause in the lease. We have found another company who might be interested in taking office space. Is there any way in which this new company can take the lease off our hands?
A. Yes, subject to the provisions of your lease. The alienation provisions in your lease will set out whether or not you can assign or underlet the premises, and any conditions attached to such rights.
An assignment transfers the benefit of the lease from you to the incoming tenant (the assignee). The assignee will covenant to observe and perform the tenant covenants in the lease. As your lease was granted post 1995, it is a “new” lease meaning that once you have completed the assignment you will be automatically released from any liability under the lease. However, tenants are often required to provide an authorised guarantee agreement (AGA) to the landlord by which you guarantee the performance by the assignee of the tenant covenants until the assignee is itself released (either by the lease term coming to an end, or on a further assignment).
An underletting creates a new lease entered into between yourself and the new company (the undertenant). If you underlet, you will remain liable to observe and perform all of the tenant covenants in the lease until the end of the lease term. Leases commonly provide that any underlease must be granted with no fine, premium or rent free period, the rent must be no less than the open market rent, and the provisions of the underlease must be no less onerous than those in the lease (usually underleases are on similar terms to the lease, save for the term which must expire before the end of your term).
In deciding whether assignment or underletting is the better option for you, you should consider the following:
- What are your company’s plans for the next six years? Is there a possibility that you may expand and want the space back? If so, an underletting may be preferable as you can negotiate a break clause in the underlease allowing you to take back occupation of the premises at a specified time. If you assign the lease, then you have transferred your interest entirely. You could always take an assignment back from the assignee, but you would potentially need to pay SDLT.
- Are you interested in keeping a part of the premises (e.g. one floor)? If so, you could underlet just one floor, and remain in occupation of the other, provided this is permitted by your lease. Leases generally prohibit assignment of part.
- Is the new company of good covenant strength? Your lease is likely to contain a right for your landlord to withhold consent to assignment if the proposed assignee is not of sufficient standing to enable it to comply with the tenant obligations in the lease. Leases often include further conditions that (if reasonably required by the landlord) the assignee provides a guarantor to guarantee the assignee’s performance of the tenant covenants, and/or a rent deposit (usually not more than six months’ rent). On an underletting, your landlord may be less concerned about covenant strength because you will still be liable for all tenant covenants under the lease. However, you need to consider whether the undertenant is likely to be able to meet its obligations under the lease, as you will still be directly liable to your landlord.