The court’s approach in commercial lease renewals
How the courts determine the terms of a renewal lease
As part of our campaign taking an in depth look at the commercial lease renewal process, in this article we explain how the courts will determine the terms of a new business tenancy where the parties are unable to agree those terms between themselves.
First things first
Firstly, it’s important to note that a new lease benefitting from the statutory protection of the Landlord and Tenant Act 1954 (the “LTA 1954”) can include any terms upon which the landlord and tenant agree.
In practice, and while it may be necessary to for a party to issue lease renewal proceedings, the terms of a renewal lease are usually agreed between a landlord and tenant without the need for a Court hearing.
For guidance on the lease renewal court process, from issue of a lease renewal claim through to trial, please see our detailed guide HERE.
The court’s powers
In the event that the Court is asked to determine some of the terms of the renewal lease, its discretion is limited by the parameters specified in section 32 to 35 of the LTA 1954. Case law shows us how the LTA 1954 has been applied in practice and helps to give us an indication of what a Court’s view on a particular term might be.
The Court’s ability to determine the terms of a renewal lease also tends to heavily influence the parties’ approach to agreeing the terms of a renewal lease, whether lease renewal proceedings have been issued or not.
As is the case in all litigation, there is always an element of risk with regard to what terms the Court may order. We set out below details of the approach that the court will take when it is asked to determine the key terms of a renewal lease.
The property comprised in the new lease - Section 32 LTA 1954
A tenant can only apply for the grant of a new tenancy of “the holding”. This is usually an uncontentious issue as a tenant will in most cases apply for, and be granted, a new lease of the area demised by its current tenancy. Under section 32 LTA 1954, the court must grant a renewal lease of the holding, save for two exceptions, which we’ll look at soon.
The “Holding”
However, what the “holding” actually comprises can sometimes be a difficult question to answer.
Section 23(3) of the LTA 1954 defines the “holding” as follows:
“…the property comprised in the tenancy, there being excluded any part thereof which is occupied neither by the tenant nor by a person employed by the tenant and so employed for the purposes of a business…”
The holding can therefore be considered the part of the property granted by the original tenancy that the tenant occupies for the purpose of its business.
Therefore, the holding that a tenant can request a renewal lease of might be smaller in size than the area demised to it by the original tenancy if, for example, the tenant has sub-let parts of it to a third party.
Those sub-let parts will be excluded from the holding, as the tenant is not in occupation and carrying on business from them.
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Exception 1
In circumstances where a tenant has sub-let part, the landlord can still ask the court to order the tenant to take a renewal lease of the entirety of the property originally demised by the existing tenancy, and the court has the power to make that order.
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Exception 2
The court also has the power to grant a new tenancy of part of the holding if the landlord has opposed the grant of a new lease on grounds that it intends to redevelop the property and the tenant will accept a new tenancy of part only.
In all other circumstances, under section 32 LTA 1954, the court must grant a new lease of the holding.
The duration of the new lease – Section 33 LTA 1954
While the parties could agree a renewal lease with a term of any duration, section 33 of the LTA 1954 provides that the Court can only order the grant of a new lease for a term of up to 15 years.
If asked to determine the term of the renewal lease, the Court must order a term that it considers is “reasonable in all the circumstances”.
Factors that might be considered by the Court in exercising its judgment on this include:
- The length of the term of the existing lease;
- The amount of time that the tenant has been “holding over” under Part II of the LTA 1954;
- Whether the tenant has occupied the premises under a series of previous leases;
- The nature of the tenant’s business;
- Any future intention of the landlord to redevelop the premises;
- Any future plans that the landlord might have to occupy the premisses itself;
- The parties’ reasons for requesting the respective lengths of term that they are seeking; and
- Any hardship that might be caused to one of the parties by granting a particularly long or short lease.
A note on break options in renewal leases
Although it is open to the parties to agree to the grant of a renewal lease and the length of its term, it is possible for one of the parties to seek to include a break option in that lease.
A break option gives one or both parties the ability to terminate the lease early, subject to complying with any specific requirements that are required in the lease to exercise that option.
A break option might be sought if, for example, a landlord is not ready to oppose the grant of a renewal lease when the tenant makes its request, but nonetheless anticipates that it may wish to redevelop the property during the term of the renewal lease.
Conversely, a tenant might wish to include a break option in the renewal lease to provide flexibility should it wish to relocate to alternative premises during the term.
Although successfully exercising a break option would bring the new lease to an end early, whether or not to include one does not fall to be determined under section 33 of the LTA 1954.
Instead, it is considered under the principles of section 35, regarding the “other terms” of the new lease, which we’ll look at a little later.
The rent to be paid under the new lease – Section 34 LTA 1954
The level of rent to be paid under the new lease, for obvious reasons, is often one of the trickiest terms for the parties to agree. The tenant will want to pay as little as it can for the space that it occupies, and the landlord will want to be paid the most that it can for the space that it provides.
Determination of the rent can also be heavily influenced by the other terms of the new lease. Consequently, the court will often determine the rent to be paid on renewal after all of the other terms of the new lease have been determined.
If the parties cannot agree on the level of rent, the Court will determine the rent payable for the holding using the valuation formula set out in section 34 of the LTA 1954.
The rent ordered by the Court must:
- Be determined by having “regard to” the terms of the tenancy;
- Be the rent at which the holding might reasonably be expected to be let in the open market, and by a willing lessor;
- Disregard certain matters, including:
- Any effect on the rent caused by the fact that the tenant/its predecessors have been in occupation of the holding;
- Any goodwill attached to the holding by reason of the tenant’s occupation of the holding or by a predecessor of the tenant’s business; and
- Subject to prescribed caveats, the valuation impact of a tenant’s improvements to the property.
In applying this formula, the court will have regard to the valuation evidence presented to it by valuation experts acting for each party.
Those experts will have previously submitted reports to the court setting out the rent at which they consider the holding might reasonably be expected to be let in the open market having regard to comparable evidence of new lettings and lease renewals in the local area.
Determination of the rent to be paid under the new lease is a matter of valuation, so instructing an experienced valuation expert with good knowledge of the local rental market is highly advisable.
The other terms of the new lease – Section 35 LTA 1954
When determining any other terms of the renewal lease upon which the landlord and tenant cannot agree, the 1954 Act provides that the Court must have regard to both:
- The terms of the currency tenancy; and
- All relevant circumstances.
The leading case on how the Court should approach the determination of the other terms of the new tenancy is O’May v City of London Real Property Co Ltd.
In O’May, the House of Lords discussed the following principles to be applied by the Court when making its decision:
The party who is seeking to change a term of the existing tenancy must persuade the Court why the Court should make an order in its favour.
- The party trying to vary the term of the current tenancy contrary to the wishes of the other party is also obliged to give a reason for doing so based on essential fairness between the parties. This means that a party is unlikely to persuade a Court to make an order in its favour if the new term proposed only really benefits one party.
- Whether the party opposing the change could be adequately compensated by the consequential adjustment of open market rent under section 34 of the LTA 1954. If so, as the rent is the last matter to be decided by the Court, the Court will consider whether the term should be varied in the new lease, and the rent consequentially amended.
- Whether the proposed change would materially impair the tenant’s security in carrying on its business. The court is unlikely to approve an amendment that could compromise a tenant’s security of tenure.
- After considering all relevant matters, is the proposed change to a term fair and reasonable? The Court might consider here, for example, the relative bargaining positions of the parties.
Examples of some “Other Terms” that the court might be asked to determine include:
- Break Options clauses
- Permitted Use clauses
- Alienation provisions (clauses dealing with assigning, subletting etc.)
- Service charge provisions
- Rent suspension provisions (in case of pandemic for example)
In each case, the onus will fall on the party seeking to depart from the terms of the existing lease to convince the court that the change should be made.
Key takeaways
It is relatively unusual for disputes regarding the terms of a renewal lease to reach Court.
Most disputes of this nature settle, particularly following the input of good professional advisors from a relatively early stage who can help with a clear strategy which best matches the party’s business objectives.
In the event that a dispute were to reach Court and the Court orders that the renewal lease includes a term against the tenant’s wishes, then it will still be open for the tenant to decide not to sign the renewal lease and to bring its tenancy to an end.
It should not overlook the fact that it may, however, face an adverse costs order for doing so.
How we help
We always help our clients to avoid going to court.
However, if court proceedings are required, we help our clients to prepare evidence to give them the best possible chance to achieve their goals.
In relation to the rent to be paid under a renewal lease, we always advise our clients to instruct experienced lease advisory professionals who are familiar with the local market at an early stage, both to manage expectations, and to ensure that their valuation evidence is in good order for the court.
In relation to the property to be compromised in the new lease, the duration of it, and any other terms that the parties can’t agree on, we work with our clients to put forward the strongest possible case in support of their position.
Further resources
For an in-depth look at some of the other key issues that arise in commercial lease renewals, please see our detailed guides below on:
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An Overview of the Commercial Lease Renewal Process
A summary in one handy guide everything that commercial landlords and tenants need to know about this process.
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The initial stages of the commercial lease renewal process
where we look at every stage of the court process from service of the claim to witness statements, experts reports and trial.
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The court’s approach to unopposed lease renewals
on how the courts determine the terms of a new tenancy where the parties are unable to agree them.
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Professional arbitration on court terms (PACT)
where we look at the process of referring determination of the outstanding terms of a renewal lease to a third party.
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Interim rent applications
where we look at what interim rent is, how it is calculated and when to apply for it to be determined.
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Opposing the grant of a new tenancy
where we look at the seven grounds upon which a landlord can reply to oppose the grant a new lease to a tenant.
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