5 legal pitfalls to avoid when taking a leisure lease

Steve Jackson, Commercial Property Partner

Leisure businesses – such as restaurants, gyms and entertainment venues face unique challenges when negotiating commercial leases.  A poorly structured lease can lead to financial strain, operational restrictions or even business failure.  This article highlights the most common legal pitfalls leisure operators should watch out for, including:

1. Service Charge

Service charges will apply, generally, when part of a building is being let by a Tenant.  Their purposes is to ensure that the cost of maintenance of the structural and other common parts of the building are borne by the Tenant’s of the building, even though the maintenance work is actually carried out by the Landlord or a managing agent.  It is critical that, prior to completion of a commercial lease the Tenant understands what will be covered by the service charge and the likely annual cost of the service charge.  Three years accounts are commonly provided for consideration together with a budget for the current year which will tend to provide some comfort as to the levels of service charge.  It is also important for Tenants to carry out some due diligence (preferably with the assistance of a surveyor) to ensure that the building is not going to need significant expense and to understand, prior to committing to the lease, what large expenses are likely to be required during the term of the lease.  The aesthetic state of a building can be a critical factor in determining whether a leisure business succeeds or fails as a well kept property will attract the footfall needed for a business to make profit.

2. Break clauses – unrealistic conditions

It is common for Tenant’s to be given a break clause in a lease.  If the term is 5 years the break will normally be at 3 year, and if the term is 10 years, it will often be at 5 years.  Landlord’s will be keen to ensure that the Tenant is committed to the lease for as long as possible.  It is common to see Landlord’s including conditions in the break clause (examples being that a certain minimum length of notice is given (often 6 months), rent must be paid up to date on the date of the break, that all covenant’s contained in the lease must be satisfied on the break date or that vacant possession must be provided).  The wording of these conditions can prove problematic and, if the conditions are not fully complied with, the break notice will be ineffective and the Tenant will lose their chance to break the lease.  This can be catastrophic for Tenants.  A carefully drafted break provision, without unnecessary conditions, is crucial for Tenants.

3. Dilapidations and repair conditions

At the end of the term of the lease the Landlord can expect to receive their property back in the state of repair and condition required by the Lease.  Where there have been breaches of tenant obligations the Landlord can expect the Tenant to pay to have them put back into the state required by the lease.  In order to mitigate the tenant’s potential liability a Schedule of Condition is a really useful tool for the Tenant.  This is a set of photographs often together with a narrative which show the state of the property at the start of the term and require the Tenant to hand the property back in the same state at the end of the term.  The wording around how the property needs to be handed back at the end of the term, even with a schedule of condition present, can be a challenge to agree.

Leisure tenants tend to have expensive fit outs of their establishments.  They should also be very careful about whether they can be required to leave any of their fit out at the end of the term.  Often, there can be great value in what could a Landlord insists is left so the Tenant needs to be aware, at the start of the term, of the requirements at the end of it.

4. Guarantees on assignment

If the Tenant wishes to transfer a lease to a third party during the term of the lease, they can be asked to guarantee the new Tenant’s compliance with the terms of the lease.  They cannot just “walk away” from their obligations.  The difference between a successful and unsuccessful leisure Tenant can be as simple as personality and experience.  It is key to ensure that a new Tenant is picked carefully to reduce the risk of the Tenant being pulled back into the lease after the assignment has completed.

5. Rent review clauses

The Landlord will often require a review of the rent, often on the same date as the break clause.  There are number of different rent review options for the Landlord but the three most common are:

1. an increase to the open market rent – the wording of such rent reviews can make a material difference to the reviewed rent. Leisure properties can often have niche requirements that need to be taken into account when considering the review provisions
2. an increase in line with RPI and CPI – consideration needs to be given as to whether RPI or CPI will produce the best result for the Tenant and, with this type of review, there will often be a cap (maximum increase) and collar (minimum increase). Again, the wording of the cap and collar provisions can, if not carefully drafted, have a material impact on the level of rent post review;
3. a stepped rent increase – this gives the Tenant some certainty as to what the levels of rent will be in the future but can result in higher than open market and RPI/CPI increases

There are many traps for the unwary when signing commercial leases which can have a material impact on the business of the Tenant.  Specialist legal advice should be sought when negotiating the terms of the lease from an expert whose expertise falls in dealing with Landlord and Tenant matters.  Many solicitors have general commercial experience but here at Kuits, we have team of solicitors whose expertise falls squarely in commercial lease negotiations and who can provide you with the guidance you need to avoid the pitfalls and understand the potential liabilities before signing the lease.