Comparing Leases in the U.S. and U.K.

Charlie Ferrell practices in commercial real estate law in the Minneapolis office of Faegre & Benson. John Duffy practices in commercial property law in the London office of Faegre & Benson.

This is the second in a series of articles comparing common U.S. business terms and practices with related issues overseas. For a comparison of U.S./U.K. corporate finance terminology, see "Two Nations Divided by a Common Language."

U.S. businesses looking for space to accommodate their operations in the U.K. find a very different leasing environment than is customary back home. While just about everything is negotiable in the U.S., U.K. landlords are far less willing to depart from standard lease terms.

That's no surprise: U.K. leases tend to be heavily weighted toward the landlord. Over the years, attempts have been made to standardize U.K. lease documentation and make it more "tenant-friendly," but without much success. Instead, a prospective tenant is likely to be presented with an "institutionally acceptable" lease that is consistently "landlord-friendly." While it may be possible in some cases to negotiate a "mid-Atlantic" form of lease, the negotiating position of the parties usually forces tenants to accept the customary U.K. institutional lease. Most U.S.-based tenants end up signing, as long as they are satisfied that the deal is in accordance with U.K. market practice.

Deal Terms

Here are some of the standard U.K. deal terms that many U.S. tenants (and even some U.K. tenants) often find surprising. They tend to limit a tenant's flexibility and give substantially more power to the owner.

Lease Length. U.K. lease terms for prime property are commonly 10-15 years, with little opportunity (other than in subleases) to negotiate for a shorter term. In the U.S., terms ranging from 3 years to 15 years are generally available.

Renewal Rights. U.K. business leases enjoy statutory rights of renewal, but these can be excluded by agreement between the parties. Even if the statutory right to renew is not excluded, landlords can regain possession when the term expires in exceptional circumstances, the most common of which are "bad tenant" grounds (i.e. regular late payment of rental or persistent breaches of covenant) or if the landlord wishes to occupy or redevelop. If the tenant wants option(s) to renew, it is best to add them expressly in the lease.

Leasehold Improvements. The property is unlikely to be fitted out by the U.K. landlord at the start of the lease, and the tenant will need to do so at its own cost. However, some rent concession is usually negotiable to offset the cost.

"Dilapidations." The tenant's obligation to restore the premises upon lease expiration is substantially more stringent in the U.K. There will invariably be a dilapidation bill at the end of the term to cover redecoration and reinstatement to an "as new" standard.

Rent Adjustments. U.K. rent reviews are upwards only. The government is currently considering legislation to outlaw this practice but the U.K. market has adjusted to upward –only rent reviews. There will still be a market for subleasing ("underletting") and assigning the lease if the documentation is negotiated carefully.

Environmental. If environmental issues are important, the tenant will want to conduct its own investigation. The landlord is unlikely to provide sufficient information to satisfy the concerns of a U.S. business.

Some deal terms, however, tend to be equivalent in the U.S. and U.K.:

Operating Expenses. The tenant will pay its share of all the variable expenses of maintaining the building through a service charge so that the landlord enjoys a guaranteed income of the rent clear of any such expenses.

Assignment. If the lease is assigned, then the assignor tenant will have to guarantee the obligations of the assignee tenant until the assignee tenant itself assigns or until the end of the term.

Forfeiture. In both systems the landlord will insist upon the right to re-enter and bring the lease to an end in the event of breaches by the tenant.

Investigation of Title

In the U.K., lawyers investigate title to satisfy themselves that their clients will obtain good title. This is different than the U.S. approach, where in most leases the tenant relies upon a covenant of quiet enjoyment without any title investigation. If the tenant does investigate title, it generally does so through title insurance.

Timetables

Negotiating lease terms and investigating title requires time. In the U.K., a landlord will not usually allow occupation until the lease is fully negotiated and executed, the landlord is completely satisfied regarding the financial strength of the tenant, and the opinion letter, references and board approval are complete and approved.

However, there are steps that can keep delays to a minimum for tenants that anticipate U.K. practice. For example:

• Get an opinion letter early. The opinion letter required will be a letter from the U.S. corporation's outside attorneys that the U.S. corporation can properly enter into the transaction, and that any claim for breach of terms of the lease will be enforceable. Opinion letters usually take a little while to negotiate, because U.S. lawyers are often unwilling to provide the wording that U.K. landlords request.
  
  
• References obtained from the U.S. may look slightly different, and it may be necessary to "translate." In addition, more information on the covenant strength of the proposed tenant may be needed.
  
  
• Consider how any additional security (if required) is to be provided. This will be either by means of a parent company guarantee/bank guarantee or rent deposit.
  
  
• Ensure that the individual from whom you take instructions is duly authorized to "sign off" the deal and liase with other advisers as necessary. We often find that once a deal is negotiated, board approval is not forthcoming or takes a considerable period of time.

U.K. / U.S. LEASING TERMINOLOGY

U.K. Term / U.S. Equivalent

the "Act" (or 1954 Act) / no U.S. counterpart -- the Landlord and Tenant Act of 1954

clear rent / net rent

full repairing and insuring (FRI) / net lease

good and substantial repair and condition / no U.S. counterpart -- this term of art designates a very high standard of repair

headlease / prime lease

headline rent / face rate

institutional lease, (i.e., a lease acceptable as an institutional investment) / no U.S. counterpart

open market value / U.S. equivalent terminology varies: market rent, fair rental value

option to tax / no U.S. counterpart – affects applicability of Value Added Tax

outgoings / utility charges

rent cesser / rent abatement

service charges / operating expenses

turnover rents / percentage rent

underlease / sublease

uniform business rate (UBR) / no U.S. counterpart – this is the rate used for allocating utility costs

VAT / Value Added Tax

water rates / no U.S. counterpart – this is the rate used for allocating utility costs

works / a generic term that includes both leasehold improvements and tenant alterations