The pandemic has forced us to make fundamental changes to the way we all live and work which has in turn, created new challenges but also opportunities for businesses of all sizes to think about how and where they do business. Many of us have got used to working from home but for most retail, manufacturing, hospitality and even some service industries, this is simply not an option, so business premises will be needed.
In order to ensure your commercial property transaction (whether it be the grant of a lease, transfer of an existing lease, purchase of a freehold or anything related) is as streamlined as possible, well-drafted Heads of Terms are essential.
In this article Jane Winfield, Partner and expert commercial property lawyer, highlights how Heads of Terms can bring clarity and focus for both parties in the transaction, as well as provide the basis for subsequent negotiations.
What are Heads of Terms?
Heads of Terms are also known as a Letter of Intent, Memoranda of Understanding, Notice of Sale or Term Sheet. Heads of Terms are essentially a document which sets out the terms of a commercial transaction that are agreed in principle between the parties involved.
As commercial property lawyers, if we are provided with comprehensive Heads of Terms, this will enable us to create a legal document that accurately reflects what each party is looking to achieve in the transaction and the parties can then agree how to proceed by way of a definitive agreement.
What makes good Heads of Terms?
There are a number of items you will need to consider; you may need to take advice from a number of different sources including your legal adviser, surveyor, bank (if loan finance is needed), building contractor, architect or accountant.
Such items include:
- Property – What are its boundaries? Are you taking on responsibility for the interior and exterior under a lease? What about air space above? Do you need rights of access over adjoining property or the landlord’s property? Where will you be able to park? Are you expecting the have the benefit of any other areas outside of the property boundary? Do you want to be able to build upwards?
- Title to the property - What legal estate or title are you acquiring? Does the freeholder have a good title to the property? If you are being granted a lease, does the “owner” own the freehold or itself have a leasehold title? If the latter, does the consent of another landlord need to be obtained? Will there be a need to enter other separate documents with third parties, for example, deeds of covenant?
- Length of term of a lease – How long are you likely to want to remain in that property? Do you want to have the ability to stay at the end of the length of the term of the lease? Do you expect to be able to vacate easily at the end of the term or do you want the right to remain at the property and to build your business and goodwill?
In commercial property leases it is common for the parties to agree a term of, say, 10 years but to include a right for the tenant to break the lease after the first five years of the term. This is called a “tenant break right”.
If you want flexibility, should you be thinking about requesting a break right? Is it reasonable for the landlord also to be granted a break right? If so, what is the quid pro quo for the landlord having flexibility? What conditions are to be attached to the exercise of the break right? How often would you want to have the break right available and on what period of notice should it be exercised? Is the break right to be personal to you as the tenant or to anyone who may take the lease from you in the future?
- Repair - What part of the property are you responsible for in terms of repair and other tenant covenants? Is it the interior only or the entire building? If the latter, is there a service charge? If the property is not in a great state of repair, do not assume that you have to give it back to the landlord in a similar state of repair!
- Assignment and subletting - Can you transfer the lease to a third party or sublet either the whole or part to a third party? Please note that even if you can, you will be responsible for the landlord’s costs.
- Alterations and fit-out – Do you have plans to carry out fit-out works at the property when you move in? If so, you should get those details agreed with your prospective landlord as part and parcel of the lease negotiations so that you can avoid having to make a separate application to the landlord for consent at a later stage. Do you want to have the ability to carry out general alterations without landlord’s consent (and thus having to pay the landlord’s legal and professional costs)?
- Rental - What is the agreed level of rental? You will need to take specialist advice on this. Will there be a rent review and how will that rent review be dealt with? Is it on an open market “upwards only” basis or an RPI increase linked basis? Should you be seeking a rent-free period?
- Other security – Will the landlord expect other security, for example, the payment of a rent deposit or the provision of guarantors? How long will the landlord hold the deposit for? Who could stand as guarantor if the landlord requires this?
- Service charge – Even if you believe that you will only be responsible for the repair of the interior of a property as a tenant, it is possible that you will also have to contribute towards the repair of the exterior and any other facilities under a service charge. Do you know enough about the potential service charge before you enter into the lease negotiations? Is it appropriate to request a service charge cap or a carve out of service charge liability in the Heads of Terms Agreement?
- Insurance – Who will be insuring the premises and what is the cost of the premium? What risks are covered?
- Permitted use – What can you use the property for and will this give you enough flexibility to be able to transfer the lease in the future? What is the impact of the permitted use on rent review provisions?
- Costs – Is each party to be responsible for payment of its own costs in connection with the preparation of the legal documentation? A tenant might be asked to make a contribution towards the landlord’s costs or to give an undertaking to be responsible for the landlord’s costs if the tenant withdraws from the transaction. Have you allowed for this within your cashflow?
Are Heads of Terms legally binding?
It is important that all correspondence relating to any proposed property transaction is marked “subject to contract” so that there is no possibility that the heads of terms become legally binding and therefore constitute a contract in themselves. Also, be aware that a contract or a lease does not have to be written for it to be binding.
Here to help
At Tees, we are very happy to advise you on Heads of Terms once they have been drafted, outlining any particular concerns and identifying any areas where further clarification is needed. We’re here to ensure you’ll be well set up for the property side of your exciting new venture.