Overseas retailers coming to the UK – a legal guide

Background

For foreign retailers coming to the UK, the legal process can seem very complicated. It will invariably be different to the process and procedure they are used to and there will be many different documents – Heads of Terms, Agreement for Lease/Lease/Licence to Alter/Rent Deposit Deed etc. What do all these documents do and why are they needed? This note will:

• provide a broad outline of the various legal documents needed; and
• list some of the other advisers who will be needed to ensure that the project proceeds smoothly.

The main purpose of the legal documents is to commit both parties to the transaction and to set out the basis on which the tenant occupies the property, and the obligations which each party owes to the other.

The precise form of the documents will vary depending upon the type of property and the location of property. For example, documents for a retail unit in a shopping centre will contain some different provisions to a lease of a unit on a high street or in an out of town retail park. However, the main provisions will be standard. This guide assumes that the documents we are dealing with relate to a typical retail or restaurant unit in a high street location. There will be some slight differences where the unit is in a shopping centre.

The main documents are:

• 1. Heads of Terms
• 2. Agreement for Lease
• 3. Lease
• 4. Licence to Alter
• 5. Rent Deposit Deed
• 6. Legal Opinion Letter

1. Heads of Terms (HOT)

This does exactly what it says. It is a document agreed between the landlord and the tenant which summarises the main commercial “Heads of Agreement” in the deal – eg the parties, term, extent of premises, rent, permitted user, assignment provisions, basis of rent review etc, conditions to be satisfied (planning/licensing etc). The HOT will generally be negotiated by the parties’ appointed property agents.

One of the first issues the landlord will wish to clarify is the legal identity and status of the tenant. This is very important to the landlord because this is the entity which will pay the rent and the landlord will wish to ensure that the entity (together with any guarantor) can pay the lease rent. As a general rule, a landlord will normally wish to see at least 3 years audited accounts showing profits sufficient to pay the lease rent. The main options are for the tenant to trade as:

• (a) a newly formed UK company. This company will generally have no assets and no profit history. In this case the landlord will normally require the tenant to provide additional security – for example (i) a 6 month rent deposit or (ii) a third party guarantee; or
• (b) an established UK company. This will only really be an option if the foreign retailer already has a UK presence and can provide adequate accounts. If it can, the landlord will probably not want any further rent deposit or guarantee; or
• (c) a foreign company. The landlord will still wish to check its accounts etc. In addition, an “Opinion Letter” will be required – see Paragraph 6 below.

Unlike the other documents referred to below, the HOT is not a legally binding document and either party can withdraw at any time until the Agreement for Lease is signed. Once the HOT are agreed between the parties the landlord’s lawyers will then draft the transactional documents and send these to the tenant’s lawyers. The transactional documents will be:

3. The lease

The main document in any leasing transaction will be the lease itself – a lease is a contract and, like any other contract, it sets out the terms which have been agreed between the parties. The subject matter of the contract is the premises being leased and virtually every lease will contain the same basic provisions – some leases will of course be longer than others. Every retail lease will contain the following main provisions:

a) Premises

The lease will contain a detailed description of the premises. Why is this important?

The reason is that the lease will contain an obligation on the tenant to repair the premises. It is therefore of vital importance that the full extent of the premises is adequately described in the lease.

If only part of the building is included in the lease (for example, the retailer is taking a lease of the ground floor, and there are offices above which are not included) then the lease will invariably be a “non-structural demise”. This means that the area being demised will be described by reference to a plan (e.g. showing the extent of the shop unit edged red) but also the lease will describe what else is included as part of the premises.

This detail is important because the tenant will be under an obligation to repair the premises and therefore the premises needs to be adequately described so that the tenant knows what it needs to do to comply with the lease terms. If the whole of the building is included in the lease then the premises description will be much simpler and shorter – it will refer to the whole building and the tenant will then be liable to repair, maintain and insure the whole building. If the building is less than 12 years old (mainly relevant to a unit in a shopping centre), there may be construction warranties available to the tenant – eg from the contractor and professional team. If not, what protection is the landlord offering to the tenant in respect of any defects in the building?

b) Term

The term of the lease is simply the period of time that the tenant is committed to the lease. The term can vary – e.g. 5/10/15 years. Historically much longer terms were granted (e.g. 25 years) but the modern trend is for shorter terms.

The lease can either be “inside” or “outside” the provisions of the Landlord and Tenant Act 1954. If the lease is “inside” the 1954 Act, this means that the tenant will have an automatic right to a new lease at the end of the term. The landlord can oppose this right, but only on certain specific and quite narrow grounds – for example if the tenant has been in default under the lease or if the landlord wants the premises back in order to re-develop.

If the lease is “outside” the 1954 Act then the tenant has no right to a new lease at the end of the lease term and must vacate the premises if the landlord does not agree to a new lease. Most modern shopping centres have leases which are “outside” the 1954 Act because this gives the landlord maximum flexibility in terms of being able to manage the tenant mix/tenant profile within the centre. This is also the case for leases in the main London historic estates – for example Crown Estate (in and around Regent Street), De Walden Estate (Marylebone), Grosvenor Estate (Mayfair), Cadogan (Kensington and Chelsea).

Sometimes the lease will contain a break option, which will allow either the landlord or the tenant the right to break the lease at certain points during the term (e.g. on a 10 year Lease, a break option after year 5). The tenant will wish to ensure when negotiating the break option that apart from the tenant paying the main rent up to date, there are no other conditions attached to the exercise of the break option.

c) Rent and review provisions

There are a number of different variations on the rent to be paid under the lease. The main ones are:

• open market rent
• turnover rent

In an open market rent lease, the rent agreed at the start of the lease will be the open market rent and that rent will then be reviewed on specified dates during the lease term to an “open market rent” – generally at the end of each 5 year period. Alternatively, the rent may be reviewed on each review date to reflect increases in the RPI (i.e. inflation) in that 5 year period.

In a turnover rent lease, the tenant pays a basic rent (which is normally at a level equal to or slightly less than open market) but also pays a top up rent , called a “turnover rent” which is linked to the turnover derived by the tenant from the unit. The turnover rent is normally calculated by reference to a percentage of turnover, and can change depending upon turnover – e.g. turnover rent = 10% on turnover up to £1,000,000 and 12% on turnover over £1,000,000, less basic rent.

d) Tenant covenants

Why are these needed?

Answer: to enable the landlord to exert control over what the tenant does in the premises, how the tenant conducts its business in the premises, and to whom the tenant may assign the lease.

The following are the main tenant covenants:

(i) Payment of rent:

Rent is invariably payable quarterly in advance on the standard “quarter days”, which are 25 December, 25 March, 24 June and 29 September in each year.

In addition, if the lease is only of part of the building, the tenant will be required to pay a contribution towards the cost incurred by the landlord in insuring and repairing the building (see below).

(ii) Repair:

The tenant will generally be obliged to keep the premises in good repair and condition. It is of vital importance that the tenant arranges a full survey of the unit, so that any existing defects can be identified and excluded from the repair liability. For “new” buildings, are warranties available?

(iii) Re-instatement:

The tenant will normally be obliged to remove all fixtures, fittings and alterations at the end of the term and return the premises to the landlord in a “shell” specification. This could be an onerous obligation and the tenant should therefore consider whether to water this down.

(iv) Assignment:

The tenant will normally be allowed to assign, but only with the consent of the landlord. Sometimes there will be a bar on assignment for the first 2 or 3 years.

The lease will normally contain a number of tests which the incoming tenant must satisfy – e.g. the incoming tenant must be of sufficient financial strength to be able to pay the lease rents and must have sufficient experience to operate the proposed user

The lease may contain offer back provisions, under which the tenant must offer the premises back to the landlord at the same premium as that which the incoming tenant has agreed to pay.

The tenant’s lawyer must ensure that as far as possible these tests are as fair as possible, so as to make it as easy as possible for the tenant to assign.

(v) User:

The main retail uses in the UK are set out in what is known as Class E of the “Use Classes Order” and can be summarised as follows:

• Class E(a) sale of goods other than hot food (shops)
• Class E(b) restaurants and cafes (consumption on premises)
• Class E(c) financial/professional services (e.g. a bank)
• Sui Generis (meaning ‘in a class of its own’): nightclubs, public houses and wine bars, drinking establishments with food, “take-aways”, live music and concerts

In most shopping centre locations and some high street locations (e.g. London’s Regent Street/Carnaby Street/Marylebone High Street) where the landlord is a large property owner, the landlord will wish to exert a substantial degree of control over the use. This is especially important in a turnover rent scheme, where the landlord will wish to ensure that the various uses are complimentary, but not competing.

Therefore, those leases will normally contain a detailed description of the use permitted, but will normally allow the tenant to change the use to a use within Class E or Sui Generis (as the case may be), but only with the consent of the landlord and subject to various tests in the lease. As in the case of assignment, the tenant’s lawyer must ensure that as far as possible these tests are fair.

(vi) Alterations:

The tenant will normally be permitted to carry out internal non-structural alterations, subject to obtaining the consent of the landlord. Structural alterations will normally be prohibited.

e) Landlord covenants

These will not be as extensive as the tenant covenants. Where the tenant is only taking a lease of part of the building the main obligations which the landlord will undertake are:

• to insure the building; and
• to repair and maintain the building and any common areas.

f) Service charge/Insurance provisions

The lease will normally contain a list of services which the landlord agrees to provide – including repair, maintenance and decoration of the building etc. In a shopping centre lease the list of services is more detailed, and will include items such as security, provision of heating/air-conditioning, cleaning, landscaping etc.

In return, the tenant must pay the service charge. Normally this is collected quarterly in advance (with payment being made on the same quarter days as the rent), with a “top up” payment being made by the tenant at the end of the year, once the landlord produces a detailed account of exactly what it has spent. The landlord will also insure the building against specified insured risks. In return, the tenant will pay a contribution towards the insurance premium, normally calculated by reference to the area of the premises. For “new” buildings, are warranties available?

Insurance is very important area for the tenant’s lawyer to focus on – in particular what happens if the building is damage by a terrorist act? Is “terrorism” an insured risk? – i.e. so that rent will cease to be payable if the building is damaged by terrorism so that the unit is not capable of being occupied. If it is, what happens if terrorism ceases to be an insured risk? Depending on the location of the unit, does the tenant require protection against other “uninsured risks”?

g) Energy efficiency, ‘Green Leases’ and ‘Climate Clauses’

UK Government policies are obligating developers, landlords and occupiers to focus on the environmental performance and sustainability of buildings. The UK Government’s objective to meet “net zero” and “Paris Agreement” goals means an increased focus on this area. Landlords are now producing ‘green leases’ that incorporate clauses with specific responsibilities on landlord/tenant in respect of energy consumption, waste reduction, emission of greenhouse gases and water efficiency. “Climate Clauses” are being developed and included in a wide range of legal documents in areas such as employment, infrastructure projects, construction and corporate/commercial. We already see these in a basic form in some leases and believe the clauses/obligations will become more sophisticated as the practice matures.

It is important that a tenant is properly advised on sustainability clauses in a lease to ensure there are no hidden costs or restrictions on how the tenant intends to runs its business.

h) Pandemic clauses

During the COVID-19 pandemic, so called ‘Pandemic Clauses’ in leases were a frequent request from tenants, including rent suspension or reductions if they are forced to close again due to COVID-19 regulations. As we emerge from COVID restrictions, we are seeing such requests becoming less common.

i) The lease negotiation

Whilst the basic provisions in any retail lease, as outlined above, may be pretty much the same, leases will vary greatly in relation to the level of detail and how onerous those provisions may be for a tenant.

It is vitally important that a tenant is properly advised on those provisions, and that the lease is fully negotiated, so as to water down or delete any onerous provisions, so that the lease is as fair as possible to the tenant:

• To ensure that there is nothing in the lease which might result in the tenant having to pay an increased cost
• To ensure that there is nothing in the lease which might have a practical impact on the way the tenant runs its business
• To ensure that there is nothing in the lease which might affect the value of the lease if the tenant wished to assign it

5. The Rent Deposit Deed

If the company taking the lease or giving the guarantee is a foreign company (i.e. not incorporated in England or Wales) then the landlord will require an “Opinion Letter” from a lawyer qualified in that jurisdiction to confirm that the company is properly formed, is not subject to any liquidation or insolvency proceedings and has capacity to enter into the documents etc. The reason this is required is to ensure that if the landlord ever has to enforce the provisions of the lease (e.g. to recover rent) then it knows that the foreign company is bound by the terms of the lease.

Other advisers

As well as lawyers (who will negotiate the legal documents referred to above), there will be a number of different professionals involved in the process. These include:

• Property agent – to learn as much as possible about the retailer’s business and target customer base, to advise on possible property options, and once a site is selected to negotiate the rent/terms and HOT
• Accountant – to prepare a business plan/cash flow projections/accounts/VAT returns and advise on tax
• Designer – to prepare fit out plans
• Technical adviser – to advise on the precise technical requirements – for example a restaurant operator will have detailed requirements on water/gas/drainage/power/venting/mechanical and electrical systems. The adviser will need to ensure that these can be provided by the Landlord to the required capacity
• Fit out contractor – to carry out the fit out
• Project Manager – to supervise the fit out, and apply to the local authority for buildings regulations consent for the fit out and any planning consent required for any signage.

We hope you find the above a useful and practical summary of the basic retail lease structure. If you require any further information please contact Nigel Griffiths.