Sub-let to accumulate

In today’s economic climate, tenants may find themselves with surplus floor space in their property following a restructuring programme or downsizing of operations. It may be possible to sub-let either the whole or a part of their property. Before any decision can be made, facilities managers should be aware of the legal and practical issues.

17 June 2010 

1. Check the lease
Generally, commercial leases allow a tenant to sub-let the whole of the property with the landlord’s consent. In some cases, tenants may also be able to sub-let part of the property, again with landlord’s consent, although the ‘permitted part’ will usually be restricted to a distinct part of the property, eg, one floor where the lease is of the whole building. There is often an express obligation that the landlord’s consent will not be unreasonably withheld, although in any case this is implied under statute. There is also a statutory obligation on landlords to respond to any application for consent to subletting within a reasonable time.

2. Pre-conditions to sub-letting and the sub-lease
Landlords may require certain information from a proposed sub-tenant before granting consent, eg, its accounts and details of its proposed use of the property. It may therefore be advisable to create a ‘package’ for the landlord’s approval, consisting of three years’ accounts and landlord and bank references. Consent may also be conditional upon the proposed sub-tenant entering into a direct covenant with the landlord to pay the rent and comply with the covenants in the sub-lease. Additionally, the landlord may require a guarantor to secure the sub-tenant’s obligations.
Typically, commercial leases require sub-leases to be on similar terms to the lease (in particular the sub-lease should contain the same tenant’s covenants and alienation provisions). There is also often a requirement for the sub-lease to be contracted out of the Landlord and Tenant Act 1954. Perhaps most importantly, the lease may provide that the rent reserved in any sub-lease should be no less than the open market rent. In some cases, leases go even further and require that the rent under the sub-lease must be the higher of the open market rent and the passing rent under the lease. Although such a provision is rare nowadays, if present it may effectively prevent any sub-letting, particularly in today’s climate of falling rents. 

3. Practical considerations
On a practical level, facilities managers may need to consider various factors before entering into negotiations with a proposed sub-tenant. For example, the proposed term of any sub-lease cannot extend beyond the term of the tenant’s lease. Therefore if a tenant’s lease only has three years to run, a sub-lease can only be granted for a term of three years.
Another issue is whether the proposed sub-tenant’s intended use is permitted under the lease. Commercial leases will normally restrict the use of the property, eg, as offices or as a retail store. There may also be an absolute prohibition in the lease not to use the property for certain purposes, such as not using the property as a betting shop or for the sale of alcohol, etc.
Any sub-lease will need to be consistent with these provisions. A proposed sub-tenant could change the use the property, eg, from offices to retail, only upon the grant of planning permission.
This would naturally require the landlord’s consent and if obtained, would permanently change the use of the property. Consequently, upon the expiry of the sub-lease (where the sub-lease is not for the residue of the term under the lease) the tenant would either need to continue with the ‘new’ use or obtain a second planning permission to revert back to the property’s original use. This could be both costly and time consuming.
A further point to consider is rent review. As the sub-lease would usually be on the same terms as the lease, any rent review under the sub-lease would usually need to be on the same dates (and on the same terms) as the lease. It may therefore be difficult to market a property for sub-letting if a rent review is due under the lease within the next six to 12 months.
If only part of the property is sub-let, it may also be necessary to establish a service charge for the use and maintenance of any common parts of the building, eg, reception areas, lifts, etc. This service charge could be costly to administer.
Finally, the landlord will incur legal and surveyors’ costs in considering an application to sub-let and granting consent. These costs will need to be met by the tenant, so it is important that sufficient funds are set aside before any application is made.

Anish Raja is an associate in the real estate department at law firm Allen and Overy