Alienation in commercial property leases – a landlord’s guide

What are alienation clauses in commercial leases? 

‘Alienation’ is an umbrella term for the various ways a tenant of commercial premises may deal with their interest in the property.  

These will be set out in the lease, and the extent of these rights can be negotiated between the landlord and tenant, prior to entering the lease.  

The main forms of alienation are:  

• Assigning the lease  

• Subletting/underletting the premises 

• Sharing the commercial lease 

Another form of alienation is charging the property (i.e. securing a ‘legal charge’ against it) by way of a mortgage, fixed or floating charge, or other debt instrument.   

However, this blog focuses on assignment, underletting, and sharing provisions.  

Assigning the lease 

Assigning the lease involves the tenant transferring the remainder of the lease term to a third party, together with the rights and obligations under that lease. In other words, a lease assignment is a sale of leasehold premises.  

The lease may be assigned i.e. transferred, to an individual or a corporate entity (e.g. a company, limited liability partnership, or joint venture). In either case, this will require the landlord’s consent. Once an assignment has been completed, it must be affected by deed in accordance with section 2 of the Law of Property (Miscellaneous Provisions) Act 1994 and registered at HM Land Registry.  

Distinct from a sublet, a lease assignment will require the outgoing tenant to vacate the premises indefinitely and pass everything over (e.g. tenancy documents, fixtures and fittings, and keys) to the new tenant. From a glance, it can be seen as the tenant getting rid of their interest in the property.  

However, an assignment will not always relieve the outgoing tenant of future liability under the lease. If the incoming tenant breaches the lease or causes damage to the premises, the landlord may be able to hold the outgoing tenant liable for the incoming tenant’s breach, under the terms of an Authorised Guarantee Agreement (‘AGA’). An AGA is often required by the landlord as a condition of the assignment.   

Standard FRI commercial leases typically prohibit assignments of part (meaning tenants will rarely be permitted to sell only part of the premises) and will only permit assignments of the whole lease (i.e. the entire premises), subject to certain conditions.   

Considerations for the landlord  

• Beware that the incoming tenant, akin to the buyer of a freehold property, may try to negotiate the lease terms with the landlord, before taking the assignment. If the landlord does agree to alter certain terms of the existing lease, they would need to enter a deed of variation with the tenant (which they are under no obligation to agree to), to vary those terms. Legal advice should be sought before agreeing to any such variations, as deeds of variations are legally binding documents and can therefore not be backtracked on.  

• Landlords should ensure the incoming tenant is as financially strong as the outgoing tenant. If the lease is assigned to a weaker party, for example, with no trading history or bank references, the strength of the tenant’s covenants (i.e. obligations) under the lease will be diluted, posing a risk to the landlord who may find the new tenant unable to pay the rent as it falls due. The landlord must therefore carry out sufficient due diligence on the incoming tenant, before consenting to the assignment. Unless the landlord knows and trusts the incoming tenant, they will usually require the new tenant to carry out full credit checks, with providers such as Experian, as a prerequisite to an assignment. 

• Some landlords will require a suitable guarantor to be provided by the assignee, and added as a party to the lease, in addition to requiring the outgoing tenant to enter an Authorised Guarantee Agreement. This gives the landlord additional protection if the incoming tenant breaches a covenant in the lease, and fails to remedy it, or becomes insolvent. In those circumstances, the landlord may pursue the incoming tenant’s guarantor, to remedy the breach.    

Subletting or ‘underletting’ 

‘Subletting’ is used interchangeably with the legal term ‘underletting’.  

This involves the tenant renting out part or whole of the commercial premises to a third party, with the landlord’s consent, for the remainder of the lease term. By doing this, the tenant carves a new leasehold interest out of the lease they hold (the head lease), making them the subtenant’s landlord.  

The head landlord will not be a party to the sublease, however they will need to approve the sublease, before it is entered.   

Distinct from an assignment, it does not involve a transfer of the tenant’s rights and obligations under the lease, to the incoming occupier. Rather, the third party takes on all responsibilities outlined in the sub-tenancy agreement, whilst the original tenant continues to be liable to the head landlord, to pay rent and maintain the premises, in accordance with their obligations under the head lease. It follows that any guarantor of the tenant under the head lease (as well as the original tenant), will still be ‘on the hook’ after a sublease is granted.  

The sublease usually mirrors terms of the head lease, save for insurance obligations and the length of the lease term (which will typically be one day less than the remainder of the head lease term, since the sublease must not continue after the head lease has expired).  

As a condition of the sublet, the landlord may require the subtenant to appoint their own guarantor, and they may agree to the head tenant’s guarantor being released, on this basis. However, where only part of the premises is sublet, the landlord will only agree to release the head tenant’s guarantor, in respect of the sublet areas. The landlord may even insist on keeping both guarantors to provide cover in the event the head tenant and/or subtenant breach the lease. 

Considerations for the landlord 

• When considering whether to permit a sublet, the landlord should consider the circumstances of the current tenant, and reasons for the sublet. If the tenant is facing financial difficulties, consenting to a sublet of even part of the premises to a financially stronger party, could benefit the landlord from a cash flow perspective, sparing them a period with no rental income and preventing the tenant from falling into the hands of an administrator.  

• Notwithstanding, the tenant continues to be bound to the head lease after a sublease is granted, the landlord should still consider the covenant strength of a subtenant, before agreeing to the sublet. If for some reason the head lease is forfeited, such as, due to insolvency of the head tenant, the subtenant may be granted relief from forfeiture by the courts, entitling them to continue occupying the premises, even after the head lease has fallen away.    

• Where the proposed sublease is of the whole premises, it may make more commercial sense to proceed with an assignment of the lease of the whole, instead. This would avoid the complications that can arise from subleases (which are inevitable where more than one tenant has rights and obligations in respect of the same premises), and may be more desirable to the head landlord, who will be better able to enforce their rights, where there is only one lease in place.   

Sharing possession  

In addition to restrictions on assigning or underletting the premises, commercial leases often contain prohibitions against a tenant’s parting with or sharing possession or occupation.  

Sharing possession or occupation may be absolutely prohibited by the lease, meaning the landlord is not required to give consent to it (although they may decide to do so at their discretion). If the landlord does consent to a sharing arrangement in the face of an absolute prohibition, they would be entitled to charge the tenant for this, which would be a matter of negotiation.  

Alternatively, the lease may stipulate specified circumstances in which sharing occupation is permitted, and conditions that the tenant will need to satisfy, to do this. Typically, these provisions will permit the tenant to share the premises with a company that are part of the same group as the tenant, or, to share the premises as part of a franchise arrangement or with concessions, for example, in a department store. The latter would be relevant to larger properties.  

There are competing statutory definitions of a ‘group’ company, but in this context, section 42 of the Landlord and Tenant Act 1954 provides that companies will form a group where one company is a subsidiary of the other, both companies are subsidiaries of a third company, or the same person has a controlling interest in both companies. 

Where sharing is permitted with a company of the same group, the lease will specify that the group sharing must not establish a relationship between landlord and tenant. This is a way of the landlord retaining control over the premises, as it prevents the incoming group company from acquiring the statutory rights of tenant under the Landlord and Tenant 1954, known as security of tenure. Additionally, it prevents the lease from being disposed of (i.e. sold), without the landlord’s consent. 

Considerations for the landlord 

• Understandably, landlords are often reluctant to agree to the premises being shared, beyond group sharing. This is because the introduction of a new occupier (or business) to the premises, may compromise the landlord’s control over their real estate asset, the commercial property. However, where group sharing is permitted as part of a wider franchise arrangement, well-represented landlords will seek to negotiate conditions in the lease, as to the identity of the concessionaires, permitted square footage of the area that may be shared, and the trades that may be carried out from the shared premises (which will usually be separate to that of the tenant’s), to safeguard against the risk of undesirable occupiers, taking possession.  

• The landlord will usually want to include a notification of dealings clause in the lease, and draft this widely, to ensure that the tenant is required to give notice to the landlord of any sharing of occupation arrangement.  

Conclusion

Whether the term of the lease is five years or 999 years, it is of vital importance that the commercial lease anticipates an assignment, underletting, or sharing of occupation request by the tenant, and has been carefully drafted to set out what happens in these scenarios.  

Whilst FRI leases are drafted based on precedent leases with boilerplate provisions, no one party to a commercial lease will have the same interests and objectives, nor is all commercial property identical. For these reasons, forward-thinking and forensic drafting of alienation provisions is imperative for landlord and tenant, before entering a commercial lease.  

Hanne & Co are here to help

The considerations in this article are by no means exhaustive. For more information on the implications of alienation provisions in your existing or proposed commercial lease, please contact our property team on +44 (0) 207 228 0017 or via the form below.