Rent apportionment on investment acquisitions

Most people in the investment industry will likely be familiar with the standard Scots law commercial sale and purchase contract. It is intended to be a reasonably balanced contract for the sale of multi-let properties. It includes standard provisions relating to the rent apportionment at completion. Whilst standard, those provisions should not just be adopted without consideration: it is important to ensure that rents are apportioned appropriately, as failure to do so can have cost and income implications for both seller and purchaser.

What is the usual 'starting' position?

The standard starting position is that the purchaser gets the rent on an assumed paid basis for the period from and including completion to but not including the next rent payment date under the leases. That therefore leaves the income risk with the seller: they may not have received in the funds for that full quarter. If rents are being apportioned an assumed paid basis, then there are two key action points / follow up points:

1. well in advance of completion, ensure that the seller's managing agents are invoicing and chasing payments of rent to minimise the potential shortfall between rent received and rent due for that quarter that completion falls in; and
2. ensure that the seller reserves the contractual right to pursue arrears due to it post completion. That will be subject to usual restrictions (e.g. not putting a tenant into insolvency or terminating a lease) but the ability to recover the arrears should be preserved. That ensures the seller can recover all rent due to it, to minimise that income shortfall.

The alternative to an assumed paid basis is apportioning rents on an as paid basis. Whilst less common in Scotland, some transactions will complete on that basis. Here, the seller will not take the risk as only the rents it has actually received from tenants (i.e. the actual money it holds in its bank account) are apportioned. The purchaser then takes on the arrears and the risk of non-payment. The right to recover the arrears should then be passed to the purchaser at completion – points 1 and 2 above essentially falling to the purchaser rather than the seller.

Irrespective of whether rents are apportioned on an assumed paid or as paid basis, there are some key practical considerations to take into account.

Apportionment on the day of completion

One must consider what happens for the day of completion itself. Usually the purchaser gets the rent for the whole of the completion day. However in some transactions it may be split 50/50, or may rest with the seller. That then has a knock-on implication for the number of days (or half day) included in the rent apportionment. It's a commercial point, but important to ensure it's checked prior to running the rent apportionment calculations.

Informal arrangements

The rent apportionment is done on the rent payable. In the vast majority of cases that is documented in the lease, most recent rent review or lease variation, or a side letter. However, purchasers should be alert to any informal, undocumented arrangements in place permitting, for instance, certain tenants to pay rent on a monthly basis.

If this does apply, whether or not to apply the rent as per that informal arrangement or stick to the lease is a commercial decision for the seller. It may agree to apportioning on the basis of that informal arrangement, but that should be done after careful consideration. If a seller does so, it may be seen as formally accepting or acknowledging the informal arrangement. A tenant may then use that to argue that, as the incoming landlord, the purchaser has acquiesced (i.e. accepted / acknowledged) the informal arrangement notwithstanding that the lease documentation itself sets out a different position. The purchaser may then be stuck with that informal arrangement as being the agreed position.

Turnover Rent

Most common with retail premises, tenants may be paying a fixed base rent plus percentage turnover, or just a percentage of turnover as rent. The lease will set out when turnover is payable. Whilst we do not go into all of the possible permutations of turnover rent, with turnover rent there is usually a reconciliation at a certain point in time. That may be six monthly or annually. If so, the turnover rent due as at completion may not be fully known for a number of months – or close to a year.

Tailored rent apportionment provisions will therefore be required depending on the nature of those turnover provisions, to deal with apportionment of that element. Ordinarily, base rent will be apportioned at completion as that is ascertainable and likely payable on specified set dates.

Rent Review

There may well be an outstanding rent review. If so, the standard position is that the passing rent is apportioned at completion. Once the rent review is settled and if it results in an uplift in rent, a further apportionment backdated to completion will be calculated. The usual position is that the seller gets the uplift from rent review to completion, with the purchaser getting the uplift from completion onwards.

Key takeaways

While it may be easy to skim over such clauses as being 'standard' or 'boilerplate', consideration must always be given to the specifics and practicalities of (i) each asset, (ii) each set of leases and (iii) the commercial points in the transaction.