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Commercial Question

Changing gears

updated on 06 February 2018

Question

Is lease regearing win-win for landlords and tenants?

Answer

The opportunity to change or extend an existing lease can be a valuable opportunity for a landlord and a tenant to cooperate to agree new, more agreeable terms and to gain longer-term security and commitment.

What is lease regearing?

Regearing a lease means either replacing one lease with a new one or varying a current lease, in either case on newly negotiated key terms. The parties are free to do this at any time during the term of a lease, but the general trend is that this tends to happen towards the end of a term.

There are three ways in which a lease can be regeared.

Deed of variation

This ensures that the current lease stays in place and it is simply varied by a supplemental document. Deeds of variation are typically used when the changes to the lease are such as increases (or reductions) in the rent and changes to a break option.

Both landlords and tenants must be extremely wary when amending a lease by way of deed of variation because of the risk of inadvertently effecting a surrender and regrant by operation of law. A surrender and regrant can have significant implications for both a tenant and a landlord.

If it is deemed that a new lease has been entered into, a tenant might incur a new liability to pay stamp duty. A concern for a landlord is that the new lease would not be excluded from the security of tenure provisions of the Landlord and Tenant Act 1954 (assuming that the original lease was excluded).  In simple terms, this means the landlord might be unable to terminate the lease, and the tenant may have a statutory right to a renewal of it.

Express surrender and regrant of a lease

Where changes to a lease are more fundamental, the better way to effect changes may be by express surrender and regrant so that the original lease comes to an end and a completely new lease is granted – but on terms that the parties have thought about and planned for. When the surrender takes place, all future liabilities under the old lease come to an end and so if the tenant has advanced any money to the landlord by way of security for its liabilities, it will expect to receive that back unless new security is negotiated.

Reversionary lease

If the reason for regearing the lease is for a simple extension of the term, a reversionary lease may be the best way to regear. A reversionary lease means is a lease that takes effect in the future – usually at the end of the term of the existing lease. In this way, the current lease remains in place until the new lease starts, but both the landlord and the tenant have the certainty of the future letting.

Why regear?

There are many commercial reasons why both a tenant and a landlord may wish to regear a lease.

The tenant may have taken a lease some years ago and since then, the terms of the original lease may no longer suit the tenant’s needs. There may have been onerous provisions in the lease against assignment. If the tenant’s business has grown, it may want to think about selling the business, which means it would have to sell its interest in the lease. Therefore agreeing a change in the terms with the landlord would place the tenant in a stronger selling position. Similarly, the lease may also contain restrictive underletting provisions. The tenant may wish to regear the lease to enable it to underlet the spare space in order to generate income.

Another commercial reason for a tenant requesting a regearing of a lease is if it wants to spend money altering the premises. If it only has a few years left on its term and it is a reliable tenant, it might be advantageous for a landlord to agree a new lease term. By doing this (i) the landlord benefits from a longer stream of rental income from that tenant, and (ii) the tenant receives the benefit of the premises it has invested in for a longer period of time.

A tenant may also choose to regear a lease in order to address cashflow issues. For example, at the outset, the landlord may have required a substantial rent deposit from the tenant. As the tenant’s business has grown and it is in a strong financial position, it may be able to agree a regear of the lease in order to retrieve some of that rent deposit back in exchange for a longer term.

A landlord will look to increase the value of its portfolio. A landlord with a number of property interests will have them valued. Part of the way in which the portfolio will be valued will depend on the length of the tenant’s lease. As such, a landlord may wish to offer the tenant an extension of its lease in order that it can improve the value of its return. Alternatively, a landlord may offer to vary the lease to remove the tenant’s right to break the lease, in exchange for a rent-free period in favour of the tenant.

Summary

Regearing a lease generates opportunities for both the tenant and the landlord.

Typically, in a falling market, a landlord might prefer to renegotiate a lease to a lower rental value for a longer period rather than be left with empty premises incurring business rates. Conversely, a tenant happy with its premises, is likely to prefer a longer-term commitment and security than risk the uncertainty and fees incurred in searching for and moving to new property.

Beth Jenkins is a trainee solicitor in the real estate department of Shoosmiths Reading office.