Importance of understanding lease renewal obligations
A recent High Court decision highlights the importance of having effective procedures in place for renewing a lease and understanding and complying with renewal obligations.
Stylo Medical Services Limited v Hum Hospitality Limited centred around a commercial lease between Stylo (the landlord) and Hum (the tenant), where the tenant had two rights of renewal to extend the Term of its lease. In order to exercise one of those rights of renewal, the lease required the tenant to give written notice at least 3 months prior to the end of the current term. The tenant overlooked this requirement and did not give the notice within the requisite timeframe. The landlord refused to accept the tenant’s late notice of renewal. The case ended up in Court because the tenant sought relief against cancellation under applicable provisions within the Property Law Act 2007. Ultimately, the Court granted relief to the tenant and ordered that the lease be renewed. However, significant time and costs could have been saved if the tenant had simply understood and complied with its renewal obligations, including the timing of its renewal notice. There would no doubt have been considerable anxiety for the tenant, not knowing if it had continued occupation rights for its business.
The basic premise to a right of renewal is that it is the tenant’s to exercise, and the landlord does not have a choice whether or not to grant it – i.e. if the tenant exercises the right to renew then the landlord must grant the renewal. However, the renewal of the lease is not automatic, and the tenant must actively exercise its right to renew by giving notice. In addition, the lease may state that the exercise of the right to renew is subject to certain conditions.
Common pre-conditions of renewal may be:
- minimum timeframes for giving notice of renewal; and
- that the tenant is not in breach of its covenants under the lease (for example, there may be maintenance and repair covenants to comply with).
In the Stylo v Hum case , the Tenant did not meet the 3 month timeframe requirement for giving the notice of renewal, and the landlord alleged that the tenant was in breach of the covenants to pay rent on time, and only use the premises for the permitted use.
Generally, the Courts have tended to give a degree of ‘latitude’ to tenants when it comes to the timing of serving the renewal notice, but some leases specify that in relation to renewal “time is of the essence”, which makes the renewal date more ‘cast in stone’. Ultimately, it is risky (and unnecessarily costly) for a tenant to have to try and convince a Court to allow it to renew late, and it is much better to be properly organised and ensure notice is given in plenty time. Usually the notice can be given at any time prior to the recorded cut-off date, so if the tenant knows a long time in advance that it wishes to renew, and is confident its plans will not change, the notice can be given as soon as the decision to renew is made.
If a lease Term expires and the lease is not renewed, the lease become “terminable at will”- i.e. either party can cancel the lease on 20 working days’ notice. This is a very vulnerable position for a tenant to be in, as the practicalities of relocating a business in that time-frame is improbable.
Do you know the rent for the renewed Term?
A key factor in renewals is that often a tenant will not know the rent payable during the renewed Term if the renewal date is also a market rent review date. Once the tenant has given notice, the process to determine market rent begins and, once determined, the tenant is bound to pay that rent during the renewed Term. If there has been a material market shift in rent, the tenant may have a significant imbalance in its occupation costs.
Practical Importance of Renewals
Whether or not to exercise a right of renewal is often a decision of critical importance to a tenant, as occupation costs and the dynamics of its business ’home’ can be key elements of its business.
There may be many factors to take into consideration:
- suitability of the premises to innovative working conditions (e.g. feasibility)
- market rent
- the ‘direction’ the business is taking
- availability of alternative premises and costs
- the costs of any reinstatement obligations under the existing lease; and
- fit-out of new premises.
It is also material for a landlord to have these discussions with its tenant well in advance of the key date, so that if the tenant is going to leave, the landlord has as much time as it can to re-let the premises.
For both parties, it is not something that should be left to the last minute, and certainly not a decision that a tenant should want taken out of its hands.
To avoid that being the case, tenants need to have the relevant dates properly diarised so they can begin their internal process several months (if not years) in advance. As part of that process they need to check the lease terms so they are fully aware of, and understand, any renewal conditions imposed by the lease. This will ensure a smooth renewal process and mitigate the risk of the landlord refusing to grant a renewal because of unsatisfied conditions.
If you would like further information about preparing for the exercise of a right of renewal, the Stylo v Hum case, and/or the court’s powers to grant relief against cancellation under the Property Law Act 2007, please contact one of our experts.