What is an underlease and how can it help your hospitality business?

An underlease (or ‘sublease’) is a lease that is held not directly from the freeholder of the property, but from a tenant. A tenant grants the underlease out of its existing lease. The tenant of the existing lease would then become the landlord of the underlease.

An underlease offers greater flexibility to use your space, helping to offset ongoing costs including utilities and service charges.

A further benefit is the potential to attract more customers and improve the customer experience, strengthening both businesses. ToniqLife and The Columbian Company are a perfect example as to how this works in practice.

Yes, you need to ask permission from your landlord if you wish to grant an underlease of whole or underlease of part of your property. Depending on the terms of your lease, failure to obtain permission from your landlord will most likely constitute a breach of your lease. The landlord’s consent is usually granted by a deed called a Licence to Underlet. You should expect to pay the costs of the landlord for the grant of the Licence to Underlet.

The Landlord and Tenant Act 1988 (“the Act”) imposes statutory duties on a landlord which a landlord must adhere to when considering a tenant’s request for consent to underlet. The Act states the landlord must not unreasonably withhold its consent to underlet; the landlord must:

• give consent (except where it is reasonable not to do so) within a reasonable time
• give the tenant written notice of its decision, including any specific conditions the consent
• serve on the tenant written notice of his decision whether or not to give consent specifying:
• if the consent is given subject to conditions, the conditions,
• if the consent is withheld, the reasons for withholding it.

The provisions of your lease will usually determine the conditions the landlord may impose in order to grant its consent to underlet. Some examples of conditions include:

• making sure the underlease has been validly excluded from the provisions of the LTA 1954
• making sure the term expires no later than three days before the contractual term of the lease expires
• ensuring the undertenant has entered into a direct covenant (i.e direct contract) in favour of the landlord to ensure the undertenant observes and performs the tenant covenants in the underlease.

Your landlord may also request a person of standing acceptable to them enters into a guarantee and indemnity of the tenant covenants of the underlease. The landlord will usually require any underlease has to reserve a market rent, and provisions for rent review at the same time and date and on the same basis as the review of the annual rent in the lease (if applicable).

The heads of terms set out the key terms between the landlord and tenant and are usually agreed before lawyers are appointed. As a tenant, you should try to ensure you have provision in the heads of terms in relation to alienation, i.e the ability to assign, underlet or share occupation of the property, to allow you greater flexibility during your lease term. If your lease prohibits underletting, you may be able to come to an arrangement with your landlord to vary the lease, but the landlord does not have to agree to this and it is best to have the flexibility at the outset.

There are some circumstances which may result in an underlease ending, but they are all dependent on specific circumstances and the contents of the heads of terms:

• The superior lease is forfeited which will mean that the underlease will fall away (subject to the undertenant’s right to apply for forfeiture)
• The underlease is forfeited by the superior landlord
• The underlease could be surrendered
• A break right in the superior lease is exercised
• If the underlease has security of tenure then the 1954 Act procedures will need to be followed which means that if there is a landlord break clause then the landlord will not only have to serve a break notice but will also have to serve a s.25 notice and establish one of the statutory grounds of opposition under s.3091) of the 1954 Act.

The action the landlord can take depends on the nature of the breach and the lease terms. The landlord could take steps to ensure that the undertenant rectifies the breach or it might take steps to forfeit the underlease (bring it to an end).  By way of example, underleases typically contain a forfeiture clause which set out the circumstances when a landlord may re-enter the property and determine the lease if the undertenant is in breach of its obligations in the underlease or on the occurrence of certain events specified in the underlease. These circumstances usually include if undertenant fails to pay any of the sums reserved as rent or is in breach of condition or covenant in the underlease or upon the insolvency of the undertenant or any guarantor. It should be noted that the undertenant’s breach could cause the landlord to be in breach of its lease with its landlord (the superior lease). This is why a underlease often contains an obligation on the undertenant to comply not only with the terms in the underlease but also to comply with the terms contained in the superior lease.