Is the FRI lease manifestly unfair?

I sat in a very interesting meeting the other day which was a general discussion on various points in negotiating an agreement for lease and lease when acting for landlords and tenants. Much of the discussion focused on the inter-relationship between warranties, repairing obligations and service charges and then moved on to insurance and uninsured risks. However, what was most interesting was that the discussion touched on a more general issue about the English institutional fully repairing and insuring (FRI) lease - is the whole proposition of an FRI lease not manifestly unfair and unbalanced.

For the uninitiated, in England and Wales the starting point with a lease which will be acceptable to institutional investors is one in which the investor receives all the rent and the tenant is financially liable for every cost associated with the property (apart from "income" tax on the rent). This works by imposing full repairing obligations on the tenant, requiring the tenant to fully re-imburse the landlord for the cost of insuring the building and requiring the tenant to pay, through the service charge, for the cost of repairing parts of the building outside the tenant's demise.

Now let us examine the relative positions and aims of the parties.

The landlord owns the property for the purposes of investment. It receives income in the form of rent and the potential for capital increases resulting from rent increases and/or yield compression. It is very much interested in the long term existence of the property.

The tenant is renting the property as a place from which to conduct its business. It does not care about the building per se. Its income is generated out of the property but not from the property and it does not, in general terms, specifically have to be located within a specific property. It does not benefit from changes in yields and only sufferes from rent increases.

Now let us consider where the risk in relation to the property should lie. The tenant requires occupation to run his business but has no interest in the long term existence of the property and sees no benefit from any increase in value. The Landlord benefits not only from the existence of the property but also from the continuing ability of the property to meet the tenant's needs. As the tenant's business flourishes so does the value of the property as it is likely to be let to a tenant with greater covenant strength. Therefore you would expect that the landlord would bear the risk of need to repair the property or it being destroyed; he is the owner afterall.

However, the FRI lease is such that the only risk the landlord is taking is that the tenant goes bust. All other risks are placed firmly at the tenant's door. Repairs within the demise the tenant will be required to carry out itself. Repairs outside the demise the landlord will carry out but recover the cost from the tenant. If the building is destroyed by an insured risk there is likely to be a rent cesser but this will only be for the period for which the loss of rent insurance is available and after that the rent restarts even if the building is still unbuilt. Uninsured risks, all things being equal, can fall completely on the tenant with the landlord being able to recover the cost of rebuilding through the service charge. So a tenant who decided against being an owner/occupier could actually find itself in a worse position as a result with higher annual costs and the potential for huge liability when something goes wrong.

Of course, the above is a worst case scenario but it is one which is likely to represent the legal position on a significant number of leases in the market today. The UK is unusual in its total lack of legislation in seeking to prevent landlords from placing the full burden and risk on the tenant. In Germany, for example, it is against the law for landlords to seek to recover the cost of structural repairs through the service charge; this is a risk the landlord took when he bought/developed the building.

Matters have in the last 20 years moved somewhat from the position highlighted above. Tenants have seen much success in toning down liability for things such as uninsured risks and liability to repair latent defects but the the risk is still most firmly with the tenant. So all you tenants out there, a little less criticism of the tenant lawyer who seeks to negotiate a lease and is reprimanded by his client for delaying the deal; the detail could very well matter.

Is this fair? As always it depends on who you ask. In reality it is market forces and perhaps as a result of the current downturn tenants and their lawyers will use the opportunity to further push the pendulum back towards the landlord in terms of carrying the risk. However, I doubt very much that it will swing too far. The fact is that tenants don't appear to care that much - maybe that is because occupiers are businesses who are used to taking larger risks than the institutional property owner funds who tend to be risk averse. Fair it might not be but so what.

Commercial Lease Code - let's be radical

The news that the 2007 Commercial Lease Code has not proved any more well known than its predecessors has been met with dismay by the Government. Larger, institutional landlords did embrace to some degree the Code and did their best to publicise it. However the fact remains that much of the country's commercial estate is owned by small landlords and managed by small agents who have no interest in publicising the code as all it would do is damage their negotiating position and, in the case of agents, raison d'etre. So the prospect of legislation looms closer.
What I am about to say may shock you but . . . bring on the legislation. But not in half measures. Let's not tinker around the edges. Let's be radical.
I propose that for all leases of an area less than a certain minimum and/or a rent below a certain level (eg. £50k per annum) there should be a statutory prescribed form of lease. It could have the following:

• a minimum 2 year and maximum 10 year term
• Index-linked upwards only rent
• Security of tenure
• Repair to standard at date of first lease
• Assignment with consent not to be unreasonably withheld ("ntbuw")
• Underletting of whole with consent ntbuw
• Specific user with change permitted within same use class ntbuw subject to estate management considerations
• No alterations apart from internal non-structural with consent ntbuw
• Service charge drafting would be fixed by reference to the RICS Code

These are just suggestions but you get the idea. It may be that a few variations of the leases would be needed for different types of property and rental structures but all of this is achievable.
Why do this? Well the amount of time and money that is spent in the negotiation of heads of terms and subsequent documentation of those heads is one good reason. All landlords and tenants would need to agree would be the rent and term.
But the benefits go further. When an investor is reviewing a portfolio of properties low value leases would not need to be reviewed for consistency as the terms would be dictated by law. Certificates of Title could be reduced in size. Lawyer review time would be cut leaving more time to do the deal. Disputes would be dealt with more easily since the wording could quickly be interpreted by the courts and the number of disputes would fall. Everyone would benefit to some degree at some point.
The downside? Mainly in reduced flexibility although quite how much flexibility would be lost is questionable. Agents might need to reduce fees to reflect the lack of terms to negotiate but they would still be needed to find the tenants and get them signed up. Lawyers would lose out on fees as our services would not be required for straightforward leases but we would still be needed to negotiate agreements for lease, licences for alterations, etc.
So I say let's legislate, let's be radical, let's create the standard lease.

Planning for flexibility

It appears that the Government wants to listen to the British Chambers of Commerce's wish to improve the planning system (see my blog of 19 June 2009) but it would appear that they are not quite on the same page when it comes to what is required.
On 18 June 2009 the Department for Communities and Local Government issued a consultation paper called:

Greater flexibility for planning permissions - consultation

The consultation considers two issues:

1. Extension of time limits for existing planning permissions; and
2. Minor material amendments to existing planning permissions.

Interestingly the issue regarding time limits has arisen because the recent legislation cut the time limit for implementation from 5 to 3 years. Now faced with an uncertain economic climate developers are not rushing to implement permissions and the 3 year limit means that applying for permission without any certainty that a development could be let/sold in the short term is unappealing. This means that planning authorities are likely to be deluged with planning applications.

Bearing in mind Gordon Brown's favourite phrase during his tenure as Chancellor: "Goodbye to Boom and Bust", it is not surprising that the implementation was lowered. Why allow five years for implementation time as surely once permission is given a developer will jump at the chance to develop.

So, yet another climb-down for the Labour Government from its previous policies is proposed. Although it does not propose a complete climbdown (or really a climbdown at all). The measure proposed would be temporary and only apply to major developments. Further an extension application would be considered a new application in terms of the need to obtain an Environmental Impact Assessment and result in supplemental planning agreements (at least in the form of a confirmatory deed). Whether or not the local planning authority decides to consult on the application is intended to be discretionary.

I can't see these proposals being greeted that warmly by the developer community.

As for the proposal for minor material amendments, well, the legal community are likely to be rubbing their hands together with glee - I can feel the warmth generated by BLP's planning department already. The interim proposals are that LPAs could approve a minor material amendment "if its scale and nature results in a development which is not substantially different from the one that has been approved". If that is not a proposal for dispute and litigation then I do not know what is.

One question I have is once you have made a minor material amendment can you then make another one? If so, is the reference point the unamended permission or the amended permission? If the amended permission then it is possible to envisage a situation whereby a permission, through minor material amendments, results in a development which is substantally different from the one that has been approved - I am assuming the legislation would not be that carelessly drafted!