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Leases and licenses: a matter of distinction

  • United Kingdom
  • Real estate

11-06-2018

Licences are used in all sorts of circumstances, sometimes pushing the boundaries and falling outside of the legal parameters for a licence and into those for a lease. It does not matter what a document is labelled, it is a question of substance. To determine whether it is a lease or a licence you need to look at the reality of the situation. As the recent cases of Gilpin v Legg [2017] EWHC 3220 (Ch) and Manchester Ship Canal Company Ltd v Vauxhall Motors Ltd [2018] EWCA Civ 1100 demonstrate, the lease/licence distinction is not a question reserved for undergraduate property law exams, but is alive and well in practice.

The well-known hallmarks of a lease famously struck in Street v Mountford [1985] UKHL 4 are:

  • Exclusive possession.
  • For a term (fixed or periodic).
  • At a rent (although it is possible for a lease to arise without rent).

The key factor of exclusive possession was examined in Gilpin, where the High Court held that owners of five beach huts sited on a landowner's fields were in occupation as periodic tenants. The beach huts always occupied the same space so the landowner was effectively excluded from occupying or using the land on which they were sat. The Court decided that, for all practical purposes, the occupiers were in exclusive occupation of that land and so a lease had been inadvertently created.

We regularly see licences allowing storage units, equipment, substations or data centre racking to be placed in scenarios which are analogous to the beach huts in Gilpin. The licence may contain "lift and shift" provisions (which are seemingly inconsistent with the grant of exclusive possession) but it may not be realistic to dismantle and move the units or equipment until the licence is over. Looking at the substance rather than the form, the units or equipment will occupy the same space during the course of the licence and the landowner will be excluded from occupying or using the land. The apparent exclusive possession results in it being extremely likely that the licence is, in fact, a lease.

Another way landowners have sought to get around the exclusive possession point is to include a provision prohibiting the use of the property for a given period in each day. This could be seen as an indication that exclusive possession has not been granted but, again, when you look at the reality of the situation, the occupiers often remain in occupation during this period and the "licence" will legally fall into the category of "lease".

One of the key points a landowner is often trying to avoid by using a licence is the security of tenure provisions under the Landlord and Tenant Act 1954 (LTA 1954). Licences are sometimes drafted to contain contracting-out provisions which take effect in the event the document is held to be a lease. Whilst this ensures that any lease will be contracted out of the LTA 1954's protections, it flags that the parties had concerns about the true nature of the document.

However, a landlord's full focus should not just be on the security of tenure as there are other issues raised by the lease/licence distinction which should be kept in mind.

In the recent Manchester Ship Canal case we saw the Court of Appeal blurring the boundaries of a licence when it granted relief against forfeiture to a licensee. The case related to a licence to discharge which was held to give possessory but not proprietary rights. Whilst this seems, and is, a very legal point, it does leave open the question of where the courts will draw the line between licences relating to service media and those relating to occupation of land. Manchester Ship Canal brings into focus the risk that a lease is not as easy to end as a licence.

A further pitfall is the grant of building licences or licences to construct to developers. Care must be taken with their use as the nature of the wider business relationship and the structure of the arrangement can be very important. If the building licence is, on the facts of the specific situation, actually a lease, the structure of the deal may result in substantial performance which triggers an SDLT or LTT liability. The building works may then also be seen as chargeable consideration which will go towards the SDLT or LTT calculation. HMRC are starting to take an interest in situations which nudge the boundaries and are looking into whether, on the facts, the document is actually a licence or a lease.

A final trap that landlords may fall into is the ever-pervasive Minimum Energy Efficiency Standards (MEES) regime, which prohibits a landlord from granting a lease of a commercial property with an EPC rating of below an E (subject to certain exclusions and exemptions). As with the other pitfalls, the risk to landlords comes in assuming that a licence is truly that. Whilst licences fall outside of the MEES regime, qualifying leases do not. Extrapolating the case law of looking at substance and not form, it is easy to foresee MEES enforcement authorities and the courts applying the same rules when deciding if a licensor should be caught by the MEES regime and any attendant financial penalties as a landlord.

There may be good reasons for using a licence and landowners may have particular reasons for doing so. For example, some businesses may need more space but have a policy against taking any more leases. The use of a licence may seem a pragmatic solution but care should always be taken and the unintended consequences considered before it’s too late.

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