Many will be familiar with the content of heads of terms (HoTs) for Scottish commercial leases. Whilst the detail is addressed during negotiation of the legal documents, a degree of additional information in HoTs helps focus both landlords and tenants to ensure the key commercial issues are addressed at the outset.
It may come as a shock, but lawyers are sticklers for details! To ensure that the transaction moves swiftly when it is passed to solicitors to document, it is helpful for HoTs to address some additional detail to enable the solicitors to reflect the agreed terms in the drafts. In particular:
The Parties
It almost goes without saying but being clear as to who the contracting parties will be at the outset is crucial to ensure the smooth sailing of the deal. Landlords should take care to establish who the actual tenant will be, as this impacts on the landlord’s assessment of the tenant’s financial covenant strength. A simple but effective way to ensure that everyone is on the same page is to include the registered company name and number of the tenant in the HoTs.
Covenant Strength
Once the tenant is identified, landlords should consider whether they require additional financial protection in the form of a rent deposit or a guarantee.
- Rent deposit: it’s helpful for the HoTs to be clear as to the amount of the deposit (particularly the exact £ amount if there is a stepped or reduced rent with the deposit being X months’ rent); and the triggers for returning the deposit to the tenant in the future.
- Guarantee: as with the checks on the tenant entity discussed above, the company name and number of the guarantor should be included in the HoTs. This ensures the landlord can check the guarantor’s covenant. It also enables the tenant’s lawyer to assess whether they can act for both the tenant and guarantor, or whether the guarantor needs separate solicitors. That is likely to have timing implications.
‘Subject to…’ (conditionality)
It is important to be clear if there is any conditionality attached to the letting. For example, is the lease conditional on the landlord securing vacant possession, or the tenant obtaining a building warrant for its proposed fit out?
If the lease is conditional, it is important to set out the timescales to purify (satisfy) the condition; as well as any interim timescales (e.g. submit the building warrant application within 1 month of exchange of the agreement for lease). The timescales should be reasonable to allow time to fulfil the conditions, without tying the parties into the agreement for an excessive period. When agreeing those, the parties should be mindful of external factors, e.g. timescales for the local authority granting building warrants, timescales under an existing lease for vacant possession.
Date of Entry
Has a fixed date of entry been agreed or is the date of entry tied to an event, e.g. the date falling 1 week after the tenant obtains its building warrant? If the date of entry is linked to an event, it is prudent to include a “drop dead date” (longstop) in the HoTs by which the tenant is obliged to take entry. As with the conditionality timescales, that ensures that neither party is tied into the agreement for an excessive period before they can terminate and walk away from the letting.
Break Options
HoTs should detail any break options including:
- who can exercise the break option (i.e. is it mutual or only for one party?)
- what is the notice period?
- when can the break option can be exercised - is it a fixed date or is it a rolling option?
- and any conditions attached to it (including any payment to be made when exercising the break).
Rent
The parties should be clear as to the initial rent. If turnover rent is payable, HoTs should document (i) how the turnover rent will be calculated and (ii) when it will be payable. If the lease is to provide for a rent review, the parties should agree which form of review (e.g. open market, index-linked) should be used at the outset of the transaction.
We discuss the monetary considerations for Scottish commercial lease HoTs in detail in our second blog on heads of terms.
Concessions
If the tenant is receiving any concessions or incentives (e.g. rent-free periods or financial contribution to its fit out), the HoTs should be clear as to whether or not the concession is personal to the tenant.
Landlords should consider the interface between personal concessions and assignation. For example, if the tenant assigns to a group company, is the group company to get the benefit of that concession? Where the concession includes a landlord payment or capital contribution to the tenant, setting out the key timescales is helpful (e.g. on completion of the tenant works?).
Assignation and subletting
Landlords should be clear as to on what basis the tenant is permitted to deal with their interest in the lease. Most leases will include assignee financial covenant tests, but if the landlord is looking for any specific test setting that out in the HoTs is prudent (e.g. where the initial tenant has a substantial covenant and assignees should be measured against that). In addition, any other specific landlord requirements should be set out too, e.g. by having a right of pre-emption/ first refusal on assignation. Considerations as to the suitability for partial sublets could be considered too, if relevant, and any terms attached to those.
Alterations
Being clear in the HoTs as to the tenant’s right (if any) to make both external and internal alterations is helpful, particularly if there are specific considerations for the premises or for the tenant’s proposed use.
Green Lease Provisions
Where landlords look to include green lease provisions within new leases, which is increasingly common, it is helpful for these provisions to be summarised in the HoTs. Many tenants – particularly retailers – have their own specific green lease clauses which they would look to use. Ascertaining that at HoTs stage, and agreeing whose clauses are to be used, can save time when negotiating the lease itself.
Key takeaways
Whilst HoTs summarise the key terms of the letting, adding a degree of detail to those in the HoTs helps ensure that the parties reach agreement on the drafts quickly; and avoids reopening commercial discussions.
Contributors
Senior Solicitor
Legal Director
