The treatment of rent-free periods in commercial lease renewals

When a tenant takes a new lease of commercial premises, very rarely are those premises immediately fit for the purpose of that tenant’s business. More likely than not, the tenant will need to undertake a programme of works to enable it to carry on its business from them. These works are commonly referred to as “tenant’s fit out works”. The period that it can take to properly fit out commercial premises can vary wildly depending upon the nature of the tenant’s business. Take for example the fit-out requirements of a local hairdresser compared to those of a national car manufacturer.

To soften the blow this expense, and the period that the tenant will not be able to trade from the premises while it carries out the works, landlords will often grant the tenant a “rent-free period”. A landlord might also grant a rent-free period to a new tenant as an incentive for it to enter into a lease. A rent-free period is a pre-determined period of the new lease during which the tenant does not have to pay rent.

Rent-free periods are typically granted for three to six months but can sometimes be granted for significantly longer periods if the circumstances require. This is often documented in the lease by including a rent commencement date that falls say three or six months after the term commencement date.

So far so good. But what happens when it comes to renewing the lease at contractual expiry?

To help answer this question we’ll have a quick re-cap

In this series of articles we have been looking at the commercial lease renewal process, which is governed by the Landlord and Tenant Act 1954 (“LTA 1954”). Our articles have covered how a tenant whose lease is protected by the LTA 1954 can remain in occupation following the contractual expiry date and is entitled to a new lease of those premises unless the landlord can establish one or more of seven statutory grounds to oppose the grant of a new lease. We’ve also looked at how the courts will determine the terms of the new lease when the parties can’t agree those between themselves. Which brings us to the subject of this article.

How should a rent-free period be dealt with in a commercial lease renewal under the LTA 1954? This is a discrete point, but it is a common issue, and one for which there is currently no straight answer. The problem arises for two reasons. First because under the LTA 1954, and the caselaw that has developed around it, the general starting point for the terms of the renewal lease are the terms of the existing lease, which may include wording that provides a rent-free period.

The onus is on the party seeking to depart from the terms of the existing lease on renewal to justify to the court why that should happen. The second reason is a result of the comparable evidence (to which the court may have regard) including rent-free periods. This first argument is less likely to succeed. This second argument is unlikely to result in the new lease containing wording that creates a new rent-free period, but it may potentially be taken into account to obtain a discount to the new rent.

A tenant may argue on renewal that the new lease should include a rent-free period or the rent on renewal should be discounted because a rent-free period is offered in all of the comparable evidence, resulting in a discount to the rent over the term of those comparable leases.

If successful it could benefit from a sizeable saving.

A landlord is likely to argue on renewal that the new lease should not include a rent-free period/the rent should not be discounted because the tenant is already in occupation of the premises carrying on business from them and does not therefore need to fit them out again.

It will obviously want to avoid not receiving the rent a second time.

So, what is the answer?

Until relatively recently, the majority of the court decisions on this point favoured tenants.

In those cases the courts were prepared to reduce the rent that was to be paid on renewal where that rent had been established from comparable evidence that included rent-free periods for tenant’s fit out works, and where the new lease that was the subject of renewal would not include express rent free provisions.

In 2021 a key decision was handed down in HPUT Trustee No 1 Ltd v Boots UK Ltd in which the court departed from that train of thought. In HPUT the judge refused to take into account a rent-free period for tenant’s fit out works in a renewal lease.

In making that decision the judge was of the view that:

• The tenant should pay the rent from the beginning of the new lease;
• The LTA 1954 could have included provisions for the consideration of rent-free periods on renewal but it did not; and
• It didn’t make sense to take into account an inducement that the tenant did not actually need on renewal.

However, in 2022 a further key decision was handed down on this issue, disagreeing with the decision in HPUT.

In Old Street Retail Trustee (Jersey) 1 Ltd v GB Healthcare Ltd the judge took the view that the wording of the LTA 1954 allowed the rent payable on renewal to be discounted to take into account comparable evidence that included rent-free periods for tenant’s fit out works.

That was broadly consistent with the view of the courts prior to the decision in HPUT.

Unfortunately, both of the decisions referred to above were made in the county courts, which means neither set any binding precedent. Consequently, we are left with conflicting views from the lower courts with no definitive authority on this point. A decision is required from one of higher courts, on appeal from the county court to establish some certainty.

Until a binding decision is made on this point the treatment of rent-free periods for tenant’s fit out works will remain uncertain. That will require a case of sufficient quantum to arise where the parties have deep enough pockets to fund the litigation and the requisite appetite for risk. In the absence of that, whether to discount the rent on renewal to take into account compatible evidence where rent-free periods have been granted will remain a matter of negotiation between the parties. It will likely come down to the respective parties’ bargaining positions. Landlords will not want to miss out on the rent for a quarter or two, and will want to avoid setting an adverse precedent for any future renewals and/or any wider portfolio that they hold.

Tenants, naturally, will want the opposite. They may very well decide to reach a compromise.