Brexit - relocating out of the United Kingdom - a note for corporate occupiers

The question as to whether or not the United Kingdom will remain a member of the European Union has been answered.

The result of the referendum is a political mandate for the UK Government but has no immediate effect on the UK’s membership of the EU. There will be a period of transition for the UK to negotiate with its EU partners the terms of the UK’s exit. There is no precedent for a member state’s exit from the EU and so the agreement will take some time to negotiate.

In parallel with those negotiations, many corporate occupiers will want to review their leases and premises strategies and seek legal advice as necessary. For example, many financial institutions may need to relocate certain operations in order to exploit “passporting” rights so that investment funds can be approved for sale in EU member states.

A freehold owner may want to consider marketing its real estate assets and revisiting any plans to acquire new property. This note focuses on leasehold space and summarises a few of the downsizing options available to a corporate tenant in the UK with premises that are surplus to requirements. The feasibility of each option depends on the terms of the lease in question.

Assignment

The lease is sold to a third party who becomes the new tenant under the lease. The sale will normally require the prior consent of the landlord but, where the lease permits assignment with consent, the law provides that the landlord cannot withhold consent unreasonably.

The landlord will take into account the financial standing of the proposed new tenant when deciding whether or not to grant consent. The landlord will want comfort that the third party can pay the rent and meet the other tenant obligations under the lease, and may require a rent deposit or parent company guarantee from the new tenant.

A lease will often allow the landlord to impose reasonable conditions in return for granting consent to assign. Where the lease was granted on or after 01 January 1996, an assignment releases the outgoing tenant from future liability under the lease. However, the conditions imposed by the landlord may include a requirement for an authorised guarantee agreement (AGA) from the outgoing tenant guaranteeing the new tenant’s performance of the new tenant’s obligations under the lease. The outgoing tenant remains liable under an AGA until the new tenant assigns the lease to a third party or until the lease expires.

Virtual Assignment

The tenant’s obligations, as well as the economic benefits and burdens of the lease, are transferred to a third party without the landlord’s consent being required. The lease itself is not assigned and the occupier of the premises does not change.

A virtual assignment is useful (a) if the landlord may not consent to an assignment of the lease, eg because of concerns about the financial standing of the assignee, or may not grant consent in time for the transaction to be completed on the scheduled date, (b) in removing lease liabilities from the tenant’s balance sheet, (c) in releasing capital for investment elsewhere, (d) as part of a group restructuring, or (e) if the tenant wants to outsource its management responsibilities under the lease.

Whether or not a virtual assignment breaches the alienation provisions in a lease depends on the terms of the lease and of the virtual assignment itself.

Subletting

The lease stays in place but the tenant grants a sublease to a subtenant to occupy the premises. Subletting of the whole of the premises is normally permitted but is likely to require the prior consent of the landlord which, as for assignment, may be granted subject to conditions. Subletting of a part of the premises may also be permitted subject to conditions.

The existing tenant’s obligations to pay the rent and comply with the other lease covenants continue, but the tenant will collect rent from the subtenant and seek to ensure that all lease obligations are passed on to the subtenant by way of the sublease. In a falling market the rent payable by the subtenant to the tenant may be less than the rent payable by the tenant to the landlord. A breach of the sublease will often result in a breach of the original lease, but if the sublease is properly drafted and the landlord takes action against the tenant, the tenant should be entitled in turn to take action against the subtenant.

Surrender

The lease is terminated early by agreement with the landlord. In this case, the tenant is released from its lease obligations but the landlord will often ask for a lump sum payment in return. Negotiating a surrender can be challenging in a falling market but the landlord may be willing to accept a surrender, and may even offer a lump sum payment to the tenant, if the landlord wishes to redevelop the building, for example.

Lease Expiry

The lease may be due to expire within a relatively short period of time. If so, the costs involved in securing an assignment, subletting or surrender may exceed the liabilities falling due during the balance of the lease term. The tenant may simply choose to continue to pay the rent and comply with its other obligations under the lease and wait for the term to expire.

If the lease is due to expire earlier than the tenant would prefer, most commercial leases have the protection of the Landlord and Tenant Act 1954 and will continue beyond the contractual term until terminated in accordance with the Act. A tenant should consider its strategy and the optimal timing for service of notices under the Act, which could buy a few extra months’ occupation for transition purposes at relatively little cost and without the need to attempt to negotiate a short-term renewal with the landlord.

Break Option

The lease may contain a contractual right for the tenant to terminate on or after a pre-agreed date. There are usually formalities to be complied with in order to exercise the right, eg as to the form of notice, the addressee(s) and the method of delivery, and the tenant must take care to observe these fully.

If the tenant occupies under a number of different leases, eg multiple floors of the same building let under separate leases, the tenant may elect to terminate only some of those leases and achieve a reduction in footprint in that way.

A tenant may also use the existence of a tenant break option as a bargaining tool. The landlord may be prepared to offer improved terms in return for a commitment from the tenant not to exercise the break option, so a tenant should diarise carefully the deadlines for the service of break notices.

Other Considerations

Rent Review: the rent under a lease often falls to be reviewed on a quarter day such as 24 June. Given the possibility of a falling real estate market since the vote to leave the EU, a tenant may be well advised not to rush to agree the new rent immediately but to wait until relevant comparable market rental evidence becomes available.

Stamp Duty Land Tax (SDLT): SDLT is payable by a tenant on the grant of a lease (a point for a subtenant to consider in the event of a subletting). The amount is based on the gross rent (inclusive of VAT) and the length of the term. SDLT relief is available in certain circumstances, eg where a company transfers property or grants a lease to another company within the same group. However, relief can be withdrawn and SDLT clawed back by HM Revenue & Customs in certain circumstances, eg where the buyer leaves the group of companies within three years after the date of completion of the intra-group property transfer.

Other Taxes: the tenant should take specialist tax advice but, for example, any lump sum payment received by the landlord or the tenant in connection with a surrender would be subject to tax.

Insolvency: an occupier may consider putting the company that is the tenant under the lease into insolvency. Specialist advice will be needed and the outcome will depend on the type of insolvency but, for example, the moratorium that comes into effect when an administration order is made in respect of a company prevents a landlord from forfeiting a lease without the permission of the court or the consent of the administrators. Alternatively, if a tenant goes into liquidation, the liquidator can disclaim the lease, bringing to an end all of the tenant’s rights and liabilities.

Change of Control Provisions: leases will occasionally include provisions dealing with change of control of the tenant or the transfer of the lease as a result of corporate restructuring, particularly where ownership or control of the tenant is an important factor for the landlord.

Dilapidations: the lease will set out the tenant’s obligations in relation to the condition of the premises and any reinstatement works that must be carried out on or before lease expiry. These apply equally on earlier termination of the lease, eg as a result of exercising a break option. A surveyor should be engaged to assist in reaching agreement on dilapidations as part of any surrender.

Occupational Costs: an occupier may identify opportunities to reduce the cost of occupying the balance of its campus, eg by commissioning an audit of service charges to ensure costs are being allocated correctly and the landlord or its managing agent is operating efficiently and offering value for money.