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Eversheds Sutherland property column: October 2020

  • United Kingdom
  • Corporate Real estate
  • Real estate
  • Real estate sector

15-10-2020

Complications of reversionary leases

Time and time again, we English real estate lawyers are asked to vary a lease to extend its contractual term. While our Scottish colleagues are able to do this, the variation of a lease to extend the term amounts to a surrender and regrant under English law. We must proceed by way of reversionary lease instead.

Short-term reversionary leases have been granted in abundance over the summer, usually as a quid pro quo for a landlord providing rental payment assistance to a COVID-19 compromised tenant. Typically, we have seen a rent-free period granted immediately, in return for the tenant entering into a reversionary lease for an additional period to commence at the end of the existing lease. A laudable COVID-19 compromise and concession, but not without its legal complications.

For starters, reversionary leases are usually drafted as leases by reference, incorporating the terms of the existing lease with suitable deletion, addition and variation. (Just occasionally, the existing lease itself may already be drafted as a lease by reference, making its interpretation and further variation and extension an even more challenging prospect). The draughtsperson will need to give thought to, and reflect in the drafting, a number of important considerations when incorporating the existing lease terms, including the need to remove reference to historic provisions, update statutory references and reflect changes in case law, carry forward prior alterations into reinstatement clauses and rent review disregards, and carefully double-check the timing and frequency of those incorporated provisions which occur on a periodic basis, such as decoration or rent review. Additional complications will arise if (perhaps unusually nowadays) the existing lease is a pre- Landlord and Tenant (Covenants) Act 1995 (LTCA 1995) tenancy, in which case consequent variations to the alienation clause will be required.

It is usual when granting a reversionary lease to make provision for the existing and reversionary leases to be tied together so that one lease may not be assigned without the other, and both leases must be assigned simultaneously to the same assignee. Fortunately, it is possible in the case of any post-LTCA 1995 existing lease, for both landlord and tenant to agree additional circumstances in which it would be reasonable for a landlord to refuse its consent to assign, or conditions which may be imposed on such a consent, for the purposes of section 19(1A) of the Landlord and Tenant Act 1927, in a document entered into after the date of the original existing lease (so long as these additional circumstances and conditions are agreed before any application by the tenant for a consent to assign). This means that drafting included in the reversionary lease can act as a variation to the terms of the existing lease and tie the existing lease to the reversionary lease, without the need to separately vary the existing lease. The alienation provisions in the reversionary lease as to the reversionary lease itself can then also operate to tie the reversionary lease to the existing lease.

If the tying together of the two leases is the only variation being made to the existing lease at the time the reversionary lease is entered into, then for the reasons set out above there may be no need for a separate deed of variation to vary the existing lease. However, it is often common when granting a reversionary lease for the terms of the existing lease to be varied simultaneously. For example, the tenant may sometimes give up a tenant’s break right under the existing lease as part of a commercial deal which also involves receipt of an immediate rent-free period and the grant of a reversionary lease.

Complications can often arise in specifying the rent to be payable at the commencement of the term of the reversionary lease, particularly where there are still many years left to run under the existing lease. Commonly, the landlord may require a first day rent review, and here those drafting must proceed with care. On rent review, the annual rent is most usually reviewed to the higher of the annual rent reserved under the lease immediately before the relevant rent review date, and the open market rent as at the relevant rent review date. But if the relevant rent review date for the reversionary lease is the very first day of the term of the reversionary lease, there will have been no annual rent payable "immediately before" the relevant rent review date by reference to which the rent review can operate or be construed. Care should therefore be taken in the drafting to structure the first day review under the reversionary lease so that it is calculated to the higher of the open market rent, or the rent reserved on the last dayof the contractual term of the existing lease. RPI rent review clauses are also a fertile ground for risk and error, care being essential to import across correctly the correct base values against which any RPI uplift is to be construed.

Once the annual rent has been determined, care should also be taken when specifying the date from which the annual rent will be payable under the reversionary lease. It used to be the case that a rent free period at the commencement of the term of a reversionary lease was rarely seen, but in these turbulent times many landlords might agree a rent free period at the commencement of even a reversionary lease, in order to secure a potentially longer reversionary lease term.

Finally, where a short-term reversionary lease is to be granted to extend the term of an existing lease which falls within the security of tenure provisions of the Landlord and Tenant Act 1954 (LTA 1954), it is especially important for the landlord and tenant to consider the effect of section 28 of the LTA 1954. Pursuant to section 28, the existing lease (with its LTA 1954 protection) continues until the commencement date of the reversionary lease but for no longer, and from the commencement of the reversionary lease the existing lease will cease to be a tenancy to which the security of tenure provisions of the LTA 1954 applies. The question of whether the reversionary lease should fall within, or be contracted-out of, the LTA 1954 therefore becomes key. If contracted-out, the tenant will need to consider whether the benefit of a short rent-free period now, in return for an obligation to take a short-term reversionary lease, is worth giving up the LTA 1954 protection that it presently enjoys. Contracting out a short-term reversionary lease is by far the most preferable for a landlord. If granted within the LTA 1954 the Landlord may run the risk of the tenant seeking a LTA 1954 renewal of the reversionary lease on similar terms, and thus making a case for the recurrent re-granting of sequential short terms leases. This could be highly detrimental to the value of the landlord’s reversion. The approach of incorporating drafting into the reversionary lease whereby landlord and tenant invite a court to have reference to the combined term of the original lease and the reversionary lease on renewal, remains untested.

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