In this follow up blog (part one can be found here), Jenni Guy and Danny George discuss specific clauses in a commercial lease which landlords and tenants alike should consider in order to regulate tenant trading performance and occupation in a turnover rent based lease.
Keep Open
A landlord will want to ensure that the tenant is adequately trading from their unit and will most likely insist on a keep open clause being included in the lease. A tenant on the other hand should seek to ensure that their obligation to keep their premises open excludes circumstances where the store is legitimately closed. For example, due to a pandemic, epidemic (like covid 19); for repairs, refitting or as a result of damage caused by insured risks/uninsured risks.
The landlord may wish to include a mechanism for determining rent if the premises are closed. Some common methods are to insert an agreed "estimated daily rent" figure or to use the previous year's trading figures to calculate the rent during any closed period. This ensures there is agreement at the outset as to the sum a tenant is expected to pay. The landlord will also want to ensure that the rent returns to the open market rental level if the closure lasts longer than a certain period.
Break Clauses
The initially agreed turnover percentage is usually calculated on the expectation of what the turnover is going to be. If a tenant is not meeting that expectation after say 3 to 5 years, both the landlord and the tenant may want the ability to terminate the Lease. The landlord may want the option to bring in a better occupier or to renegotiate the terms of the lease with the existing tenant. Equally, the tenant may want to be able to terminate if they believe that their turnover is not meeting the expected levels because the centre or development hosting their unit has not been managed how they had envisaged when agreeing the percentage turnover.
A tenant must be clear about what is due to be paid at the break date to ensure that the break is effective. If the break is conditional upon payment of all rent as at the break date, turnover rent should be carved out as it is likely that this sum will not be known as at the break date.
Alienation clause
Due to the collaborative nature of turnover rent agreements, landlords usually look for greater controls over the alienation of a tenant's interest in a lease.
Assignation
A landlord may look to prohibit assignation completely but there are alternative, more flexible and tenant favourable structures to consider.
Firstly, on completion of an assignation, the rent payable could simply revert to an open market rent. So, if the turnover rent was, for instance, 80% of the open market rent this will simply be a mathematical calculation. In some circumstances, this may not be known, and a landlord might look to incorporate provisions for a rent review on assignation.
Alternatively, the landlord could retain a degree of control but cannot withhold their consent to an assignation where the tenant can evidence that there will not be a significant drop in turnover following completion of the assignation.
A tenant lawyer should however watch for the implications if the lease requires that a then open market rent needs to be calculated at the time of the assignation. Provisions requiring the agreement or third-party determination of that rent before the assignation can be completed could delay the completion. That said, even if the new rent can be calculated subsequently, it would seem unlikely that an assignee would be persuaded to formally complete the assignation when there is uncertainty over the level of rent.
Pre-emption
It is common for turnover leases to include a right of pre-emption so that the tenant must first offer to renounce or assign the lease back to the landlord before assigning to a third party. The lease should still permit the tenant to assign where the landlord fails to complete the renunciation after a certain period.
A tenant lawyer may also wish to consider whether these potentially restrictive rights of pre-emption should apply when the tenant is disposing of several stores as part of a sale of its business or to a group company.
Sub-letting
Sub-letting of whole would normally be completely prohibited. A landlord wants to ensure that the party that they contracted with is the one trading from the property. This though reduces the tenant exit options during testing trading periods.
As a compromise, a landlord may agree that a tenant is permitted to sub-let with their consent but only where the rent payable under the lease reverts to an open market level on the grant of the sub-lease. In the circumstances, this may lead to the tenant paying higher fixed rent than they had originally anticipated but should ensure that they are able to recover this higher rental sum in full from their new sub-tenant.
This two part blog has provided a brief overview of key considerations for both landlord and tenants when negotiating a turnover rent lease. Should you have any questions or concerns regarding turnover rent leases, please do not hesitate to contact Danny George, Jenni Guy or your usual Brodies contact.
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