Business premises and the Landlord and Tenant Act 1954

This is a brief overview of the statutory rights enjoyed by some tenants of their business premises under Part II of the Landlord and Tenant Act 1954 (the ‘Act’). The Act applies to England and Wales.

To keep this overview as succinct as possible it has been necessary to deal briefly with some points that are in reality quite complex, and specific legal advice should always be obtained as to how the principles set out below apply in any given situation. A more comprehensive note on the mechanics of lease renewal/termination is available on request.

The Act is primarily intended to provide business tenants with the right, if they wish, to renew their lease on the expiry of the contractual term of their lease on essentially the same terms, subject to a review of the rent to open market rent. Although a landlord is entitled to oppose lease renewal on certain specified grounds (such as redevelopment), if it chooses to do so it is likely to have to pay the tenant compensation if the tenant vacates the premises. If the tenant contests the issue the matter is referred to court, giving rise to potentially significant uncertainty, costs and delay.

This is an important issue for an investor to understand if it is considering purchasing a commercial building in England and Wales because, if the tenants occupying the building for the purposes of their business enjoy such rights, it can have an adverse effect on the value and the potential future uses of that building. For instance, such rights can impede the ability and/or cost of getting vacant possession of the building for redevelopment.

Accordingly it is necessary to clarify at an early stage whether any of the business tenants occupying the building enjoy such rights. This is something which may be addressed in the marketing material but it will in any event be dealt with as part of the usual due diligence by the investor’s legal adviser.

The rights granted to business tenants automatically by the Act can be excluded by agreement between the parties prior to the grant of a lease of business premises. This is known colloquially as a ‘contracted out lease’. If the rights are to be excluded validly, then the parties must follow a strict procedure specified by the Act prior to the grant of the lease. This involves the proposed landlord serving a formal notice on the proposed tenant and the tenant giving a declaration that it is willing to give up its rights. This agreement must then be recorded expressly in the lease itself.

If the lease is not contracted out and the tenant remains in occupation of the premises for the purposes of its business, the lease will not automatically terminate on the expiry of its contractual term (as it would if the lease is contracted out). The lease will continue automatically on the same terms until the necessary notice is served to implement the formal lease renewal/termination process specified by the Act.

The lease renewal/termination process is commenced either by the landlord serving a ‘section 25 notice’ or the tenant serving a ‘section 26 request’. The earliest that the notice can be served is 12 months before the lease is due to expire. The notice must specify a termination date that falls between 6 and 12 months after it is served and which is not earlier than the expiry date of the lease.

Whether the landlord or tenant takes the initiative to commence the lease renewal/ termination process by serving a notice is likely to depend primarily on

• Whether the landlord wishes to obtain vacant possession in order to, for instance, redevelop the building
• Whether the rent under a new lease is likely to exceed the present passing rent under the current lease.

An interim rent (effectively the new market rent) will become payable from the latest of

• The date six months after service of the requisite notice
• The expiry of the term of the existing lease.

Therefore if the new market rent is likely to be more than the passing rent, the landlord has a commercial incentive to ensure that a notice is served no later than six months prior to lease expiry, so that the interim rent applies from lease expiry. Conversely, if the new rent is likely to be less than the passing rent, the tenant will wish to ensure that the interim rent applies from lease expiry. In practice however both parties usually wish to obtain the certainty of a new lease for a further fixed term, rather than allow the old lease to simply roll on for an uncertain term.

If the landlord chooses to take the initiative by serving a section 25 notice and it wants to oppose renewal altogether, it must specify one of the statutory grounds of opposition (such as redevelopment) in its notice (‘an opposed notice’).

If however it is happy to grant the tenant a new lease then it must simply set out the basic terms on which it is willing to do so, including the new proposed term of the lease and the rent (‘an unopposed notice’). Similarly, if the tenant commences the process by serving a section 26 request, it must set out the terms of the new lease which it proposes. Following receipt of a section 26 request, if the landlord wishes to oppose the grant of a new lease, it must serve a counter notice within two months specifying its grounds of opposition.

Normally, following the service of the requisite notice and assuming that both the landlord and tenant are happy to agree the terms of a new lease, the lease can be negotiated (including the level of the new market rent) and completed within a few months, usually back dated to take effect from the term expiry date of the old lease. However the tenant will lose its statutory right to a new lease unless it protects its position by issuing an application at Court for a new lease prior to the expiry of the notice period specified in its section 26 request or the landlord’s section 25 notice.

In the unlikely event that the parties cannot agree the terms for the new lease, these will be determined by the Court in due course.

As explained above, if the landlord wants possession of the premises following expiry of the tenant’s current lease, the first step is to serve an opposed notice specifying one or more of the seven statutory grounds. If the landlord specifies one of the most common grounds, such as ground (f) — redevelopment, and the tenant vacates the premises voluntarily or by Court order, the tenant will be entitled to compensation from the landlord. This is calculated at the rateable value of the premises if the tenant (and any predecessors to its business) has been in occupation for less than 14 years, or twice the rateable value if longer.

Following service of the landlord’s opposed notice there usually follows a period of negotiation, and it is common for the parties to agree that the tenant will surrender its lease and vacate the property, subject to payment of compensation. If the parties cannot agree terms for the tenant to vacate the property, either one of them will have to apply to the Court. In the landlord’s case, this will be for an order that the tenant’s tenancy is terminated on one or more of the statutory grounds and the tenant is to vacate. In the tenant’s case this will be for an order that the statutory grounds have not been satisfied and that the tenant should be granted a new lease of the property.

At trial the landlord will have to establish any grounds of opposition it relies upon. So, for instance, if the landlord proposes to redevelop it will have to be able prove that it has ‘a firm and settled intention’ to carry out significant structural works to the tenant’s premises in the short term that will necessitate vacant possession. This is not purely a subjective test of the landlord’s intentions but it also involves demonstrating that those intentions are viable/ achievable so that, for instance, evidence that planning consent and financing are available is important.

It can take in the region of a year for the Court to resolve the issue (and longer if the tenant appeals), so the potential uncertainty, delay and costs associated with the legal process needs to be factored into the landlord’s development programme.