Bell & Scott's Property Update, December 2009

Welcome to the December 2009 issue of Bell & Scott’s Property Update.

In this month's issue, we provide a briefing on tenant incentives in lease contracts and a review of a case highlighting the importance of getting the detail right in planning suspensive conditions.

We also update you on a number of other relevant news items.

Briefing

Tenant incentives
It’s icy cold out there!

A cold snap might well have arrived, but landlords have being feeling the biting winds of recession for some time now. The challenging market conditions and chilly economic climate of the past 12 to 18 months have put landlords under enormous pressure to secure and preserve rental income, resulting in an unprecedented level of incentives being offered to tenants to entice them to sign up to new deals.

In a bid to fill empty units, landlords of high street and in-town shopping centres have been offering attractive tenant incentive packages. We’ve seen shorter leases, lower rental levels and capping or easing of service charges. Despite these alluring efforts, tenants don’t seem to have taken the bait. That may be because the real deal clinchers are those which minimise the tenant’s risk and put cash in its hands at the earliest possible moment - capital contributions, rent free periods and tenant only lease breaks are the taste of the season. Whilst this menu may well tantalize the taste buds of a hungry tenant, the ill-advised one can experience considerable discomfort down the line, if it does not proceed with caution. Incentives can turn out to be short-lived and the tenant’s benefit may even disappear altogether if the correct measures are not taken at the right time to protect it.

Rent-free periods

Generous rent-free periods, extending well beyond the usual stretch of three months, to compensate the tenant for its fitting-out expenses, are commonplace. The equivalent rental value can be considerable. Securing an extended rent free period is not only beneficial to a tenant from a tax and Stamp Duty Land Tax perspective, but from a cash flow perspective, it is vital. It can make a business venture viable. It is, therefore, crucial that the arrangement is not downplayed and is recorded properly.

A rent free period can be recorded in the lease itself. The lease will be publicly registered in Scotland. Anyone will be able to find out the rent free deal agreed. So, to manage the risk of a rent free deal becoming common knowledge to other occupiers (and almost certainly being used as evidence at rent review), some parties prefer to plump for keeping a private arrangement between the landlord and tenant, just that - private. Devices used include documenting the rent free period in a side (back) letter, or in the agreement or offer to lease which precedes the formal lease.

In Scotland, the danger in expressing rent free concessions in a side letter or agreement or offer to lease is that the concession is purely personal to the landlord who agrees to it. Landlords who buy the property subject to the lease down the line will not be bound to honour the concession granted by the original landlord. The safest route here is to ensure that the rent free period is documented in a formal minute of variation of the lease. This need not be publicly registered and can be backed up by an agreement between the parties to keep the agreement confidential. Sometimes, to give the landlord comfort, agreement can be reached to destroy the document at the end of the rent free period.

A minute of variation of the lease is something that the parties may want to think about at heads of terms stage.

Capital contributions

Here, a landlord agrees to pay a tenant a substantial capital contribution at the outset of the lease. The contribution is often paid in two tranches. The first is paid when the tenant takes access to start its fit-out of the premises - the second, when it actually opens for trade.

There is fertile ground for confusion when capital contributions are on offer. What is the contribution actually for? Who actually pays it? At what point does it become payable? What are the tax implications?

Parties need to be clear, at the outset, what the contribution covers. Is it purely an incentive payment or is the tenant to apply the funds to its fitting-out or other works?

If it is purely an incentive payment, it’s unlikely that a landlord would receive tax relief on its expenditure until the property is sold. That is because the payment is treated as a fixed capital asset designed to enhance the value of the property by securing an income stream. Here, a tenant would have to treat the cash as taxable income, albeit spread over a number of years depending on the accounting basis it uses.

On the other hand, where the tenant is to apply the money towards its fit-out, or other costs, both the landlord and the tenant can seek tax advantages by way of capital allowances on qualifying expenditure.

If a contribution is to be paid “on access”, what does this mean? Does it mean that payment falls due when the fit-out works actually start or when the unit becomes available for access? A tenant will be relying on the funds to be able to fit-out and open on time and to start paying rent. So, it is in both parties' interest to be crystal clear about these points at the heads of terms stage.

If payment is not made on time, what happens? If late payment is the case, then the tenant should insist on the landlord paying penalty interest on the amount due. But what if that doesn’t work? To cover that eventuality, a tenant should get the landlord to agree to an alternative to payment, such as allowing for the tenant to convert the right to the contribution into a rent-free period. Otherwise, in the case of insolvency of the landlord, the tenant is effectively left without a remedy.

Lastly, careful consideration should be given to the VAT status of the contribution. The view of HM Revenue & Customs is that mere inducements fall out with the scope of VAT altogether. A contribution to the cost of works which the tenant would ordinarily be expected to carry out, in the course of taking a lease are considered to be just that, but the line between the two can be a thin one. Clearly, a tenant does not want to find itself in the position where VAT on the contribution must be paid to HMRC without it having been paid by the landlord or, even worse, without the tenant having any right of recovery at all.

Break options

Tenant only break options are increasingly common and now they are featuring earlier in the period of the lease - often at years three and six in a ten year lease.

It is critical that the break option is served on the correct party, in the correct form and on time. Parties should know when, and in what circumstances, the break can be exercised. They must keep a diary note of the requirements. The usual expectation is that a break exercisable on, say, the fifth anniversary of the date of entry, will require service of at least six months' prior written notice. In such a situation, a tenant ought to be aware that it will not be possible to wait for agreement or determination of a rent review at year five before deciding whether to exercise the break. The decision will need to have been made by then.

Care should also be taken to avoid requirements in heads of terms which state that the break can only be exercised where the tenant is not in breach of its obligations under the lease. Such requirements potentially allow a landlord to look for and rely on a very minor breach of, say, the repairing or decorating obligations as an excuse to render the break option void and unenforceable.

Our case comment "Enterprise conquers Ben", in the February 2008 edition of Property Update, considers the legal issues surrounding break notices.

“Every cloud has a silver lining…”

There is a silver lining. There are exceptional opportunities out there for the prospective tenant. Greater flexibility and a willingness and capacity to innovate are leading to opportunities within the retail property market. Change is happening on an almost daily basis. As we say, it is crucial to consider all of the consequences of change and to secure the best deal for you.

Our specialist Retail and Leisure Team has helped a wide range of landlords and tenants to exploit the opportunities in the current climate. We are uniquely well placed to advise on the incentives available and all other aspects involved in leasing retail premises.

For more information please contact Dawn Henderson, Partner.

Recent case

Drafting bowls out Tenpin

Gregory Projects (G), a developer, and Tenpin (T) the bowling alley operator, entered into a conditional agreement for lease for a new premises in the centre of Halifax. There were several conditions which needed to be cleared before the developer’s building obligation kicked in and T was bound to take the lease. One of the conditions to be satisfied was receipt of planning permission for G’s development. The planning condition was set out in the usual way – G was to obtain a permission free from “unacceptable conditions” and confirm that position to T. When all of the various conditions in the agreement were satisfied, the agreement for lease would become unconditional. A further, separate condition provided that, if the conditions were not satisfied by a defined date (“the end date”), either party could pull out of the contract.

G obtained its planning permission free from unacceptable conditions and informed T by letter. No copy of the permission itself was given at that time, but a copy was provided after the end date. In the meantime, T pulled out of the contract on the basis that the condition had not been properly satisfied by the end date. T had not been given a copy of the planning permission issued to G by the end date in the contract.

The court had to look at all of the detailed provisions in the contract covering items that had to be obtained before the obligation to build the premises and take the lease became live. Each of those conditions had its own peculiar timescale and method for clearance or challenge. The planning condition required G to get a satisfactory planning permission and to send a copy of the permission which it had received to T by the end date in the contract. G had technically not done that. However, the court interpreted “obtaining planning permission” to mean just that and no more. The mere grant of the permission, free from unacceptable conditions, was sufficient to satisfy the terms of the planning condition. G could in terms of the contract provide a copy to T of the permission it obtained at any time before the end date in the contract. T knew the permission had been granted and could have asked that a copy be delivered to it but chose not to do so or to visit the planning authority’s office to inspect the decision. The fact that G was supposed to provide T with a copy by the end date meant simply that and this did not interfere with the part of the contract which said that the planning condition was cleared on the receipt of the planning permission. The content of the clause containing the methodology for determining the end date was immaterial to the interpretation of the terms of the clause containing the planning condition.

The Court conceded that the party drafting the clauses had been alive to the possibility that there may be some uncertainty in calculating the end date and had provided machinery to deal with that in other clauses of the agreement. Crucially, however, the machinery provided could not apply to the condition governing the grant of the planning permission and thus mere grant of the permission was enough to stop T’s right to walk away from the contract. There was no need for any further argument or interpretation of any other clause of the agreement.

Dawn Anderson, Senior Associate, comments:-

On the face of it, this seems a peculiar decision – the terms of the condition had not been properly satisfied by G because it had not sent a copy of the planning permission it received to T. However, the court in this case simply applied the rules of drafting as they have been honed over the centuries. If satisfaction of a conditional clause in a contract is to be linked to several specific actions, say so. If other clauses in the agreement are to impinge on the interpretation of that condition, say so. If you don’t the Court will not help you to rectify the error. Meticulous care must always be taken with suspensive conditions and the hows and whens of clearing them – they are so central to the contract for the development and letting or purchase of land.

 Case referred to Gregory Projects ( Halifax) Ltd v Tenpin ( Halifax) Limited and Tenpin Ltd [2009] EWHC 2639 (Ch)

A full text of the decision is available on the British and Irish legal Institute website accessible here

News updates

Consultation: Zero carbon for new non-domestic buildings

The Department for Communities and Local Government (DCLG) has launched its consultation, “Zero Carbon for New Non-Domestic Buildings: Consultation on Policy Options”, which sets out DCLG's proposals for a regulatory route map to zero carbon non-domestic buildings in England from 2019, with the public sector leading the way from 2018.

DCLG's proposals mirror those made for zero carbon homes, whilst recognising the differences between domestic and non-domestic buildings. Therefore, it will apply the same three-stage hierarchy to achieving zero carbon:

• Energy efficiency: a high level of energy efficiency in the fabric and design of the building
• Carbon compliance: a minimum level of on-site renewable energy generation or directly linked heat networks
• Allowable solutions: a range of measures for achieving zero carbon for the balance that cannot be achieved by carbon compliance – in the main this will be through off-site renewable energy

Though the consultation will be of interest to the construction and property sector south of the border, it is hard to imagine that Scottish Building Standards will take a radically different approach when it consults for Scotland.

Details of the consultation are available on DCLG’s website accessible here

Increase in VAT standard rate

On New Year’s Day 2010, the standard rate of VAT will go back to 17.5% following its temporary reduction to 15%. Under anti-avoidance rules, a supplementary charge of 2.5% will be due on 1 January 2010 if, among other things, a supplier issues a VAT invoice before that date in respect of a supply to be made on or after that date and the invoice does not have to be paid for at least six months.

It is not thought that the supplementary charge will impact on normal commercial activities. However, HMRC has become aware that hire purchase and other similar commercial transactions may be caught by the charge. Therefore, regulations have been made under which there will be no supplementary charge if the invoice relates to a hire purchase, conditional sale or credit sale agreement of which it forms part, the invoice is issued in accordance with normal commercial practice, and the goods are intended and expected to be delivered within six months of the invoice date.

Details are available on HMRC’s website accessible here

RICS valuation regulatory framework  

RICS Governing Council has approved the introduction of a mandatory accreditation scheme for members carrying out valuations under the RICS Valuations Standards (the Red Book). For the first time, RICS standards and regulation will be linked to a specific area of practice carried out by chartered and associate members and regulated firms. Previously regulation has been limited primarily to the conduct of business.

The scheme aims to improve the quality of valuation, meet RICS' requirement to self regulate effectively and protect and raise the status of the valuation profession.

The scheme will be self-funding with the cost being borne by those members and firms who fall within the scope of the scheme.

Details are available on RICS website accessible here

End of SDLT holiday

In September 2008, the Chancellor announced that residential property costing less that £175,000 would be exempt from SDLT for all purchases completed between 3 September 2008 and 2 September 2009. The Chancellor subsequently extended this exemption until 31 December 2009. Unfortunately, for purchasers of property in this price bracket, there will be no further extension and the SDLT holiday for properties costing between £125,000 and £175,000 will end at the end of the year.

As of 1 January 2010, SDLT will again be charged at 1% of the purchase price for all residential property costing between £125,000 and £250,000. Any property costing less than £125,000 will continue to be exempt from the tax. The only exception to this rule is if the property you purchase lies in an area designated by the government as a "disadvantaged area", which, in Scotland, is determined by the property's postcode. If the property is in a disadvantaged area, the threshold is raised and SDLT is not payable if the property costs £150,000 or less.

Details of the rates of SDLT payable on purchases of both residential and commercial property are available on HMRC’s website accessible here

Money attachment  

Scottish creditors can now ask Sheriff Officers to seize cash from within a debtor's business premises. The method is known as “money attachment”. It is a remedy open to creditors who have obtained a court decree or "document of debt" - most formal leases of premises will constitute such a document.

Money attachment allows creditors to have Sheriff Officers search business premises (residential property is excluded) to take coins and banknotes in sterling (or any other currency), cheques and banking instruments, in satisfaction of debts which are owed. Money attachment is not allowed on Sundays or local public holidays nor is it allowed outwith the hours of 8am to 8pm without the prior approval of the court.

Clearly, in many commercial premises such as bars and restaurants, money attachment during excepted periods, having obtained the prior approval of the court, could become common place. A creditor will want to secure maximum advantage by attaching money at the close of business which could be late in an evening and, indeed, on a Sunday or public holiday.

For creditors, in particular landlords, money attachment will be a useful collection tool. You can see it being a weapon of choice in retail premises and places of entertainment such as pubs, clubs and restaurants where money, often in very large amounts, may be available. Conversely, people owning and running these types of business, where they may be in financial difficulties, need to be aware of what is proposed, and prepare accordingly.

Our Property Dispute Resolution Team can advise you accordingly.

Report: consultation on the removal of the duty of planning authorities to notify Historic Scotland on certain types of listed building consent application

The Scottish Government has published a summary of the responses received to the consultation on the implementation of the removal of the duty of planning authorities to notify Scottish Ministers on certain types of listed building consent application.

Details are available on the Scottish Government’s website accessible here

Permitted Development Rights: domestic wind turbines and air source heat pumps

The Scottish Government has published a report which considers the feasibility of extending Permitted Development Rights to domestic wind turbine and air source heat pump microgeneration technologies.

Details are available on the Scottish Government’s website accessible here