The fallout of the pandemic has prompted many commercial landlord and tenants to explore the suitability of a lease surrender; perhaps because the tenant's need for space has diminished or the landlord, in the face of accruing rent arrears accompanied by recovery challenges, has been motivated to cut a deal with its tenant which includes the return of its premises.
The basis of a surrender is that it will bring a lease to an end, releasing both the landlord and tenant from their covenants and liabilities from that date onwards. In the absence of express drafting, the parties will remain liable for any past breaches.
This expected preservation of liability for existing breaches and the frequent commercial pressures of completing the deal often force parties to rush through a surrender without due consideration of its terms. This article considers some of the pitfalls which parties can encounter on a surrender.
Parties negotiating terms should pause to check that the landlord is actually able to grant the surrender sought. In Co-operative Bank plc v Hayes Freehold limited (in liquidation) and others [2017] EWHC 1820 (Ch), the head lease was charged to the bank, and the terms of that charge required its prior consent for any surrender. The tenant failed to obtain such consent, and the attempted surrender of the head lease was ineffective.
Unfortunately for the tenant, a simultaneous surrender of its undertenant's lease was effective. The failure of the tenant's advisers to identify the bank charge left the tenant itself in the undesirable position of remaining liable under the head lease of a premises it did not require, and with the loss of the surrendered underlease's income.
'Parties negotiating terms should pause to check that the landlord is actually able to grant the surrender sought'
In Baroque Investments Ltd v Heis & Ors [2012] EWHC 2886 (Ch), leases were surrendered on standard terms. The surrender released both landlord and tenant from the leases' liabilities for any breaches arising on or after, but not before, the date of the surrender.
The tenant had covenanted under a licence for alterations of the leased premises to 'dismantle and remove the works and reinstate the premises', 'before the end of the lease'. The court considered that the licence meant the tenant had the whole of the lease term to carry out the requisite reinstatement works. As the potential reinstatement liability therefore occurred after, and not before, the date of surrender, this covenant was released on surrender.
Turning to the tenant's repair liability, the parties agreed that its obligation 'to yield up the same at the expiration or sooner determination of the term' did not, on the terms of the leases, survive the surrender. Instead the landlord relied on the tenant company's breach of its covenant 'to keep the premises … in good and substantial repair and condition'.
While the liquidator accepted that the company was liable for its breach of this repair covenant, the liquidator argued that the landlord had failed to properly calculate its claim. The court agreed with the liquidator.
The landlord's surveyor had failed to carry out a proper assessment of the difference in value between the landlord's reversion in repair and its actual state, pursuant to section 18(1) of the Landlord and Tenant Act 1927. Instead the surveyor had considered that this value was equal to the loss suffered by the landlord for the rent-free period, and for the reduced rent it had given to a new tenant that took a lease of the premises shortly after the surrender. However, this was not the proper process for calculating the damages so no provable debt was established.
If a proper section 18 valuation had been undertaken, the court considered that the damage would have been assessed on the day before the date that the leases were surrendered. The landlord argued that the court should consider events after this date, but the court was unwilling to do so. As a result, a valuation of the landlord's reversion would have been a valuation of its freehold, subject to the leases. This was despite the fact that the leases were surrendered the next day, meaning that the landlord may have struggled to evidence any diminution in value to its reversion.
In Dreams Ltd v Pavilion Property Trustees Ltd & Anor [2020] EWHC 1169, the terms of the agreement for surrender provided that, on completion, the tenant would pay all money due to the landlord and the parties would be granted a full release of all liabilities.
Although a schedule of dilapidations had been served, the claim had not been settled before the surrender completion date. Because no sum had fallen due by this day, the tenant could not be required to pay the dilapidations liability to satisfy the terms of the surrender. The tenant would also be able to rely on the full release to be granted by the surrender and escape its dilapidations liabilities completely.
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If you are due to undergo a rent review on a commercial property but you cannot agree the new rent with your landlord or tenant, there is often a rent review clause in the lease which stipulates a procedure for third party dispute resolution.
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If the review date has passed before the date of the surrender and the landlord is not required to take any action to initiate that review – or it has taken whatever action is necessary to do so – the accrued right to review the rent will be preserved.
The tenant will remain liable to pay the balance of any uplifted rent, notwithstanding the surrender of its lease, as per Torminster Properties v Green [1983] 1 WLR 676.
Unless the terms of the surrender expressly preserve the landlord's ability to recover a service charge balancing payment that will fall due after the date of the surrender, the tenant will be released from this liability. The landlord will then be unable to recover the payment from its former tenant.
Practical measures to try to avoid pitfalls
Establish that the landlord is able to grant the surrender offered. Secure any necessary consents before granting any releases to subtenants.
Review the lease and any licences for alterations to establish when the tenant's reinstatement liability occurs. If the liability will be released on a surrender, consider whether the landlord will require a payment to cover the cost of the reinstatement works as a condition of that surrender.
Consider precisely what claims are to be released as part of the surrender, and be wary of sweeping releases – as demonstrated by Dreams.
Attempt to resolve any claims, including dilapidations, before completing the surrender, and collect the monies on completion.
Consider what other payments are to be collected on the surrender. This may include outstanding sums such as rents owed to the landlord, any service charge balancing payment, and any uplifted rent sum that may arise once an outstanding rent review is completed. If acting for the tenant, consider if there are any apportioned rents – including insurance rent – beyond the surrender date to be repaid to the tenant, and to which it might otherwise not be entitled.
Rachel FitzGerald is property litigation associate at Wedlake Bell
Contact Rachel: Email
Related competencies include: Conflict avoidance, management and dispute resolution procedures, Leasing and letting
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