This is the first in a series of blogs looking at landlord considerations with tenant works. In this first one, we look at the lease implications of tenant alterations.
When drafting a Scottish commercial lease, a landlord needs to reach a position on alterations that balances its own concerns about maintaining an asset's value with a tenant's desire to maximise the space let to it. Whilst tenant fit out at lease start may be known at the time of drafting the lease, the lease does need to be 'future proofed' to cover off the position should the tenant wish to refurb or do other changes during the term of the lease.
Structural alterations v non-structural alterations
As is often the case in Scotland, the position as set out in the lease is final. Generally, a lease will look to prohibit structural alterations by a tenant – a landlord does not want the tenant to be able to make any alterations to the property that could negatively affect its value.
At the other end of the scale, a landlord may be relaxed about minor tenant alterations and a tenant will not want to have to go through the rigmarole of obtaining a landlord's consent every time they want to make such minor changes. For example, it is typical to see that the installation of demountable partitioning does not require the landlord's consent so long as the tenant removes it at lease expiry and makes good any damage caused.
This leaves us with non-structural alterations. A lease will typically require that non-structural alterations need the landlord's consent, such consent not to be unreasonably withheld or delayed. Depending on the extent of the tenant's lease demise, this might be restricted further to internal non-structural alterations, with external alterations also being prohibited or subject to landlord consent.
The process for a tenant obtaining landlord's consent is considered in further detail here.
Documenting the works – licence for works
Where landlord's consent is required, this will usually be dealt with by way of a licence for alterations (a 'licence for works' in Scotland). The licence generally takes a standard form and will include, amongst other things, a timescale for completion of the works; the tenant's obligations prior to, during and following completion of the works; and any insurances which must be put in place.
The licence will usually attach the detailed plans and/or a specification showing the alterations. The benefit in doing so is that all the works are clearly documented in one place for the parties (and potential future purchasers) to refer to. But that can come with challenges: where the tenant is undertaking significant works at the property, this can result in potentially hundreds of drawings having to be annexed to the licence, which can cause administrative headaches – and sore wrists – for those having to sign.
Alternative options are available although any reference to a drawing list in a historic licence for works will strike fear in the commercial lawyer being asked to undertake a due diligence exercise for a potential purchaser. Plans often go missing (especially if the property has changed hands more than once) and reference to the drawing list can often be where the trail goes cold. It can sometimes therefore be difficult to know what works have actually been undertaken by the tenant.
Advancements in technology have thankfully now made that process easier and some clients have reverted to referring to a drawing list – especially where the number of plans annexed to a licence for works are considerable or are too large to allow accurate scanning of the same. In those circumstances, the parties and their lawyers can agree to retain a full suite of drawings each.
In addition, the introduction of electronic signing in Scotland will, going forward, make the process quicker and smoother for clients and bring the position in more in line with England and Wales.
Statutory consents
Tenant alterations to a building may require, amongst other things, a building warrant, planning permission or, if a building is listed, a listed buildings consent.
The licence for works will typically ensure that the obligation to obtain any such statutory consents is the responsibility of the tenant and will include a general indemnity against any claims raised against the landlord as a result of the carrying out of the tenant alterations. The landlord is likely, however, to want to approve the terms of the application for consent or permission (acting reasonably) to ensure the tenant does not over-reach and the permission or consent does not affect other parts of the landlord's building.
Rent review
Where a tenant has funded the alterations to the property, the licence for works will normally exclude the effect that these works have on any future rent review. That makes sense and is equitable. The tenant should not be made to pay twice: once when paying for the works and then, if the alterations improve the property, again by virtue of an increased rent.
Similarly, the expectation is that any tenant works funded by the landlord will be included for the purposes of any future rent review. The same equitable approach applies: if the landlord has paid for the works, it should get the benefit of them by way of any future rental uplift.
That leaves the slightly more contentious position where the landlord has partially funded the tenant's works, perhaps by way of a capital contribution. Unless the position is already clear, the landlord should look to clarify both (a) what works that capital contribution will be used towards and (b) a fair position on rent review that reflects the reality for both parties.
It's therefore key to ensure the lease demise is clearly defined and described in the lease, so that it's clear (a) what has been let by the landlord (the lease demise) and (b) what has been carried out since lease start (most likely to be tenant alterations). See our blog on demises for more discussion - Demise: getting it right.
Environmental considerations
With sustainability now at the heart of both landlords' and tenants' agendas, the impact that tenant alterations can have on the environmental performance of a building are a key consideration for landlords when giving its consent.
Please see our recent blog on green leases which considers this point – and others – in more detail.
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