The events of recent years have led to change for many businesses. For some, the change has been positive and promoted growth, leading them to acquire bigger premises as part of their expansion. Others have struggled financially or changed their ways of working and now require to re-assess their footprint in a bid to downscale. One potential option for those looking to save on expenditure is the prospect of 'sub-letting' all or part of their premises to another business.
This article considers when commercial tenants in Scotland need consent from their landlord before entering into a sub-lease and the circumstances in which landlords can refuse consent.
What is subletting?
Subletting is where a tenant of a commercial lease grants a sublease in favour of another party (the 'sub-tenant') who will occupy in their place. Subletting allows the original tenant (the 'head tenant') to let all or part of the property to someone else, enabling them to 'pass on' the financial burden of paying rent (and other sums) to the sub-tenant. In some circumstances, the original tenant may even be able to sub-let the premises at a higher rent than under the existing lease, making a profit.
This does not affect the contractual relationship between the head tenant and the landlord. The head tenant remains liable to meet its obligations under its lease, including paying rent to the landlord, whether or not the sub-tenant meets its own obligations.
Landlord's consent
Almost all commercial leases in Scotland will stipulate that where a tenant wishes to sublet, the tenant must obtain consent, in writing, from the landlord to do so.
Whether a landlord can refuse to grant consent to sub-lease will depend on two things: the terms of the lease and the specific facts and circumstances of the proposed sub-lease.
Unless the lease says otherwise, the landlord will have an absolute right to refuse consent and need not give reasons for its refusal. However, most commercial leases will provide that the landlord's consent is not to be unreasonably withheld. That begs the question: when is it reasonable for a landlord to withhold its consent to a proposed sub-let?
In the leading case of Burgerking Ltd v Rachel Charitable Trust, the Outer House of the Court of Session set out some of the key principles which apply when considering whether a landlord is entitled to refuse an application to sub-let:
- The landlord cannot withhold consent on grounds which do not relate to the relationship between the landlord and tenant, nor can the landlord withhold consent to gain a collateral benefit.
- The landlord must give reasons for its decision so that the tenant can ascertain whether consent has been reasonably withheld. The landlord cannot later rely on reasons that it did not give at the time, even if those other reasons would have been reasonable.
- If the landlord provides more than one reason for refusing to consent, then it will normally be sufficient to show that at least one of the reasons is valid. However, where the different reasons provided by the landlord are not truly independent of one another, or if the basis of the landlord’s decision is an accumulation of reasons, the court may find that the invalidity of one of the reasons renders the whole of the landlord's decision unreasonable.
There are a number of reasons a landlord might give for refusing consent. In Burgerking, the court held that it was reasonable for a landlord to withhold consent on the basis that a reverse premium to be paid to the sub-tenant might have reduced the market rent for the property when it came to be re-let in future. Other reasons upon which a landlord may seek to rely include the financial standing of the proposed sub-tenant and the nature of the sub-tenant's business (e.g. if this would interfere with the trade mix at a shopping centre or retail park).
Comparison with assignation
Subletting differs from assignation, where a lease is transferred from one to tenant to a new tenant. In an assignation, the rights and obligations under the lease move from the outgoing tenant to the incoming tenant meaning that, unlike in a sub-letting arrangement, the landlord has no recourse against the original tenant. This has an impact when it comes to landlord's consent: in general terms, it is less likely to be reasonable for a landlord to refuse consent to sub-let on the basis of the sub-tenant's financial strength because the head tenant is still liable to the landlord for the rent and other sums due under the head lease. For more information on assignation of commercial leases, please see our previous blog.
Risks and benefits to landlords
There are both risks and benefits to a landlord when consenting to subletting.
The main benefit is that by allowing the tenant to pass the burden of paying rent onto another party a landlord can ensure that the premises remains occupied. If the head tenant struggling financially to meet their existing obligations under the lease, the alternative may be that the landlord is forced to irritate the lease for non-payment of rent. From a landlord's perspective, a subletting arrangement allows them to maximise their income from the property by reducing the likelihood of having any vacant space within the premises.
However, there are risks associated with sub-letting. The landlord loses some control over the leased property; it is not a party to the sub-lease and cannot enforce its terms. The sub-tenant may be previously unknown to the landlord and may prove not to be as good an occupier as the head tenant. And if the rent under the sub-lease is less than the rent under the head lease then this can have an impact on the rental value of the premises in future.
Key takeaways
Landlords in Scotland should be aware that for a sub-lease to be valid, the tenant usually must obtain consent from the landlord first. Landlords should consider requests for consent carefully, having regard to the lease terms and the particular circumstances of the case, and seek legal advice where appropriate. Should the landlord decide to refuse consent, it should set out its reasons fully and carefully to minimise the risk of challenge.
If you require any further information or advice on sub-letting, please do not hesitate to get in touch with our Real Estate Litigation team or your usual Brodies' contact.
