Underlettings: pitfalls and problems – what to watch out for

With lockdown restrictions easing, more and more businesses are looking at their office requirements and procedures, including how many days a week they will expect their staff go into the office.

Many businesses are likely to find that they have more office space now than is actually required. One of the options tenants will be considering is whether they can underlet all or part of their property to another person or business.

If you are looking for office space right now, this could be a good time to strike a deal with a tenant to take an underlease of their surplus office space.  However, it is easy to forget that you are negotiating with someone who only has a limited interest in the property themselves.  So, how secure can an underlease really be and what are the risks for you as an undertenant?

When considering whether an underlease is for you, there are a few scenarios you should think about including:

1. Your landlord exercises a break clause in their lease

Break clauses are an easy way to create flexibility for both landlords and tenants in leases but what does it mean for an undertenant if the landlord or superior landlord decides to exercise their break option? The answer is that any underlease will also determine on the break date.

This could cause huge disruption to your business if you need to relocate. All may not be lost as the superior landlord may be willing to grant a new lease to you directly. This, however, requires a completely new lease which means you are likely to incur further legal fees. At the very least, you should look to address the issue of the possible exercise of the break right in the superior lease when taking your underlease.

2. Your landlord has its lease forfeited

If your landlord has its own lease forfeited by the superior landlord due to e.g. non-payment of rent then all underleases granted out of that lease will also determine on the date that the superior lease is forfeited.

If the worst happens and the lease is forfeited, an undertenant can apply to Court for relief from forfeiture (which essentially restores the lease) or for a vesting order (which grants a new lease on terms decided by the Court at its discretion).  However, pursuing either of these options will be expensive and take time – can your business afford this?  Further, you will need to be aware that if you apply for relief from forfeiture, you may be required to take a lease of the whole of your landlord’s premises and at the same rent as they pay and assuming their obligations such as for repairs if you wish to stay in occupation.

However, the above is subject to the current moratorium in place (currently slated to be in place until 30 June 2021) preventing the forfeiture of commercial leases due to the non-payment of any sums due under the lease.  There has been no confirmation yet from the Government as to whether this deadline shall be extended again as it has been in the past.

3. Your landlord surrenders its lease to their landlord

There is a possibility that your immediate landlord no longer wishes to be bound by the terms of its lease and agrees to surrender its interest in the property back to the superior landlord.

In this situation, you (as the undertenant) will become the direct tenant of the superior landlord and will continue to occupy the property on the same terms as your underlease.

4. Your landlord goes into liquidation and their lease is disclaimed

Perhaps the trickiest point is where your landlord goes into liquidation and a liquidator disclaims your landlord’s interest in the superior lease. Disclaimer operates to determine the insolvent party’s interest and rights, as well as liability, under the lease. It does not determine the underlease or affect the rights and liabilities of any other person.  This means that the disclaimer extinguishes the superior landlord’s rights against their insolvent tenant, and the undertenant’s rights against their insolvent landlord.

However, the undertenant’s interest continues on the same terms as if its superior landlord’s interest had not been determined. This is a tricky situation for the superior landlord who cannot directly enforce the covenants in the disclaimed lease against the undertenant unless there are any direct covenants, but it does have other options for enforcement including forfeiting. You could remain in possession of the property for the remainder of the term of the underlease provided that you comply with the covenants in the superior lease, including the direct payment of the rent under the superior lease to the superior landlord but this has largely been curtailed over the last year due to Covid-19 legislation.

Conclusion

Finding the right space for your business can be a challenge, but it is important to make sure that the intended documentation of the occupation, whether by way of licence, lease, assignment or underletting, is on the right terms for you.  In this pandemic era “flexibility” is the buzz word but this must of course be balanced against having full control of the space you occupy and a secure interest to give suitable continuity for your business.

Legal advice should be sought if any of the circumstances outlined above occur which we would be more than happy to assist with.  Please contact Eleanor Stark, or any members of the Property team or Property Litigation team.

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