The commercial real estate landscape is currently undergoing a transformation as the UK establishes a new normal in the post-pandemic era.
The impact of previous lockdowns has been well-documented, with widespread remote working becoming increasingly popular due to strict social distancing guidelines. With the culture of flexible working now likely to continue, there will be many business owners looking to reassess their current leases, with an eagerness to include break clauses into agreements.
Of course, negotiating a new and improved lease can be a complex process, and even then it is not always straightforward to trigger break clauses as and when needed. Therefore, it is best practice for business owners to seek professional advice from the outset, so they can prepare themselves for whatever lies ahead.
Uncertainty in the market
Currently, the downturn in real estate letting appears to be widespread, as according to global property experts CBRE, office investment in the first quarter of 2021 was down 65 per cent on the previous quarter and 37 per cent on the first quarter of 2020.
Whilst a wider trend in the acceptance of alternate working patterns was already beginning to emerge in the years leading up to the pandemic, Covid-19 and the resulting lockdowns almost certainly contributed to the decline in demand for commercial property space.
This is the backdrop against which any consideration of the changing nature of commercial leases takes place, with the slump in overall demand for office space impacting on the kind of clauses tenants and landlords will be negotiating.
Negotiating an effective break clause
Understandably, the pandemic has seen more tenants tempted to utilise existing break clauses, whilst others will be keen to insert them into new leases that are being negotiated. Many will be seeking to take advantage of the drop in demand which landlords are experiencing to drive as hard a bargain as possible when negotiating their contracts, and that may include the introduction of a break clause.
As the vast majority of commercial leases run for five to ten years, inserting a break clause into these may offer more flexibility for tenants and landlords as it enables either party to end the lease early so long as certain conditions have been met.
For example, an organisation with a 10-year lease, might seek a clause to be inserted which will give them the option to exit the lease at any point after 4 years as long as six months’ notice is given.
As it stands, there is a lot of uncertainty when it comes to a demand for office space. For this reason, the inclusion of a break clause can be one of the main sticking points during negotiations between tenants and landlords, so it is vital that both parties take the time to understand what it entails.
The impact of a break clause
As a leaseholder, a break clause will enable you to walk away from an agreement if the commercial space is no longer needed or if you need to downsize your office space to save money and protect jobs. Equally, landlords can use them to remove tenants should there be the potential to raise rents or make more money from a new tenant more ideally suited to the space. In the past tenants have been reluctant to give landlords break options, but in the new conversations this could be mutual.
Whilst a break clause can have tangible benefits for the party seeking to utilise it, the process itself is far from simple. As such, it is imperative that both parties consider the clause and mechanics for implementation carefully, because any disagreement about whether the provisions have been met can lead to expensive and time-consuming legal action.
From a tenant’s perspective, the tenant must realise that triggering a clause will leave the landlord with the task of having to re-let the premises at relatively short notice, so the landlord will usually look to resist exercise of any break clause.
The Royal Institution of Chartered Surveyors published a Code for leasing business premises, England and Wales in February 2020, which states that the break clause should only be conditional on “the tenant paying all basic rent payable on any date before the break date, giving up occupation and leaving no subtenants or other occupiers …”.
This sounds relatively simple, but the reality is that many landlords insist on going beyond what is only a voluntary code and imposing stricter conditions. In many cases the landlord may attempt to link the triggering of the break clause with the wider covenants of the lease, such as the requirement to return the property in a specific condition, or to undo any alterations carried out during the lease term.
Disputes between landlords and tenants about the exercise of break clauses are very common. It is very easy for a tenant to get the exercise of even a very simple clause wrong. It would be wise, therefore, for any tenant uncertain of their compliance with conditions to employ the services of a specialist real estate lawyer or surveyor to closely work through the break clause and how it is to be exercised.
If the opinion of a specialist is that the conditions of the break clause cannot be met then the tenant might choose, instead, to negotiate a formal ending of the lease on terms which are agreed with the landlord. Taking advice early before exercise is key.
Triggering a break clause
One aspect of a break clause which all parties must consider are the details of how, when, where and to whom the notice is served, which have to be adhered to precisely. Tenants and landlords need to know that a break clause will be rendered invalid if the precise conditions outlined in the lease are not met. This could include all manner of things from the method used to give notice, down to the person who serves the notice, or to whom that notice is served.
The tenant will also need to ensure that rent payments are made up to and including the break date, even if that means paying for a period which falls after any break will have taken place.
Seeking legal advice
It is important to remember, that once a break clause has been triggered by a tenant, it cannot be legally revoked, even if circumstances change during the notice period. It doesn’t matter if both parties agree to nullify the clause, once it has been triggered, there is no turning back.
Therefore, any tenant needs to think through their decision carefully before they act, and during the drafting process it is crucial that legal advice is taken early on so that both parties fully understand the gravity of the clause and the provisions it contains.
If you need support negotiating a break clause within a new or revised lease, or advice on triggering an existing break clause, then contact an experienced legal team for advice beforehand.
Karen Mason is a highly experienced commercial property lawyer and co-founder of Newmanor Law, a specialist real estate law firm, combining fresh technology with legal insight and compelling service to help property professionals achieve their desired outcomes. The firm deals with acquisitions and sales, construction matters, development, property disputes, landlord and tenant matters, along with debt finance and tax matters relating to property.