Key considerations when a landlord assigns a lease
|Services:||Real Estate & Construction|
|Industry Focus:||Real Estate & Construction|
|Date:||16 March 2018|
|Author:||Bill Burrough, Partner|
What you need to know
- In most circumstances, a tenant will not be given an opportunity to object to a landlord assigning its interest in a lease, because most landlords will not want to limit their ability to do so.
- Whether or not a new landlord will be bound by specific obligations of the original landlord will depend on whether those obligations ‘run with the land’.
- Some tenants may seek certain safeguards to protect their position in the event of a future assignment of the lease by their landlord, particularly where they have the benefit of incentives or rights that have been negotiated outside of the lease itself.
In our most recent publication on leasing, we focused on the consent that a tenant might need to obtain from its landlord if the tenant wishes to assign its interest in a lease.
In this article, we explore some key considerations that arise when it is the landlord assigning its interest in a lease. This might occur by the landlord selling the freehold or otherwise transferring its reversionary interest, or by granting a concurrent lease to a third party. Usually, the tenant’s consent to an assignment by the landlord will not be required. This is because it would be unusual for the landlord to agree in any lease to fetter its ability to deal with the reversionary interest.
However, a landlord’s assignment may become particularly relevant to a tenant where there are:
- previously negotiated incentives or rights under a confidential separate side deed or licence agreement, or
- onerous positive covenants to be performed by the landlord during the term of the lease.
Tenants will want to be sure that a new landlord will honour the old landlord’s obligations, but this may become a problem if the obligations in question do not run with the land.
Here we explore the landlord / tenant relationship and, more specifically, the type of landlord’s covenants that are more likely than others to run with the land. We also highlight some of the safeguards that tenants might seek when initially negotiating their lease.
The landlord / tenant relationship
A lease creates a contractual relationship between a landlord and a tenant. Lease covenants are enforceable by a tenant against a landlord on this basis. However, difficulty arises when a landlord assigns its interest in a lease. This is because there is no direct contractual relationship between the new landlord and the existing tenant. On what basis, if any, are lease covenants enforceable by the existing tenant against the new landlord?
Historically, under the common law, the new landlord could neither sue nor be sued except in relation to obligations inherent in the relationship between a landlord and a tenant, such as the covenant to pay rent.
The common law has since been altered by legislation so that the new landlord now has the benefit and burden of covenants having reference to the subject matter of the lease. Therefore, although there is no direct contractual relationship, there is a proprietary relationship between a new landlord and the existing tenant.
What obligations run with the land?
Despite legislative change to clarify that there is a proprietary relationship between a new landlord and an existing tenant, a number of court decisions have held that the legislation only applies to lease covenants which ‘touch and concern’ the land. Courts have found it difficult to agree upon a formulation of the test for determining whether a covenant ‘touches and concerns’ the land in general terms and any test which has been applied cannot be taken to be an exhaustive statement.
Nevertheless, some guidance can be taken from previous cases which suggest that in general, a lease covenant will ‘touch and concern’ the land if it affects the nature, quality, mode of user or value of the land and is not expressed to be personal. The fact that a covenant is to pay a sum of money will not necessarily prevent it from touching and concerning the land so long as the covenant is connected with something to be done on, to or in relation to, the land.
The following covenants by the landlord have been held to ‘touch and concern’ the land:
- to renew the lease
- to supply the leased premises with good water
- not to build on adjoining land
- to erect a new building in place of an old building
- to consent to the assignment of the lease.
The following covenants by the landlord have been held to not ‘touch and concern’ the land:
- to sell its interest in the property
- to permit the tenant to display an advertising sign
- not to open a beer or spirit house within half a mile of the leased premises
- to purchase buildings erected by the tenant on the land
- to keep in repair a large number of houses in the district
- to repay a tenant a security deposit
- an option enabling the landlord to require the tenant to purchase the leased premises.
However, each case needs to be considered carefully with regard to its particular facts and the legislation applying in the relevant State.
Separate side deeds and licence agreements
Landlords will often grant incentives to tenants under separate confidential side deeds. The reason for keeping such incentives confidential is purely commercial. The grant of the incentives enables the landlord to attain a higher rent which then appears on the face of the lease, thereby giving rise to the expression 'face rent'. The true rental value of the premises, or 'effective rent' after taking account of the incentive, may be substantially less than the 'face rent. However, where such side agreements are not referred to in the lease document and may be expressed to be personal to the landlord and tenant, they are unlikely to run with the land.
Unlike leases, licences do not confer exclusive possession of premises on the licensee. Rather, a licence grants a non-exclusive contractual use right which is often personal to the licensee. Again, where such rights are granted under a separate document not referred to in the lease, they may not be binding upon a new landlord.
Of course, a tenant who is granted an incentive under a separate side deed, or rights under a separate licence agreement, will still have rights arising from its direct contractual relationship with the original landlord. A landlord selling its freehold will therefore generally:
- disclose all such arrangements to the incoming purchaser
- obtain an undertaking from the purchaser that it will perform and observe the landlord’s obligations under these arrangements
- keep the original landlord indemnified against any claim by the tenant.
A prudent purchaser in its due diligence will also generally carry out a thorough investigation as to any arrangements not otherwise discoverable through its title searches, to ensure that appropriate allowances are made in relation to the purchase price.
In addition to these factors which help to give a tenant some comfort, a tenant may feel that there is little risk where the original landlord is, for example, a long standing Real Estate Investment Trust (REIT) with billions of dollars of property under management. There may however be other situations where a tenant might be concerned to seek certain safeguards when initially negotiating its lease. While a major REIT is not going to want to restrict its ability to sell an office tower building worth hundreds of millions of dollars, a tenant who leases the whole of a building from a private investor may be able to negotiate various restrictions upon the landlord’s ability to deal with the reversion.
What safeguards might tenants seek?
In the following circumstances, it is particularly important for a tenant to consider seeking safeguards to protect its position if its landlord at some stage in the future seeks to assign its interest:
- where there are onerous positive obligations of a personal nature to be fulfilled by the landlord
- where there are incentives to be allowed to the tenant under a separate confidential side deed
- where there are important rights granted to the tenant under a separate licence.
A tenant will want to be sure that a new landlord will honour such obligations to the extent that they remain outstanding when the new landlord acquires its interest. Depending upon the particular circumstances, tenants may seek to negotiate terms into the lease whereby the landlord is prevented from assigning its interest without first ensuring that the new landlord executes a deed in favour of the tenant, agreeing to be bound by the terms of the lease and any ancillary documents.
While most leases are unlikely to provide that the tenant must consent to the landlord’s assignment of the lease, this does not mean that tenants should dismiss from their minds the prospect (and consequences) of a future assignment. Prudent tenants will consider what steps they may be able to take, including safeguards that may be negotiated into their lease, to protect their position down the track.
Thanks to Abdullah Ahmed and Stephanie Fiteni for their assistance in preparing this article.
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