UK: Pre-Emption Rights In Leases

Contractual pre-emption rights

This article focuses on contractual rights rather than the statutory rights from which some residential tenants benefit (ie the right of first refusal pursuant to the Landlord and Tenant Act 1987 and collective enfranchisement rights pursuant to the Leasehold Reform, Housing and Urban Development Act 1993). There are two types of contractual pre-emption right which can be incorporated into a lease:

1.1 Right of First Refusal ("ROFR")

This gives the tenant the right to be 'first in the queue' should the landlord decide to sell its interest or grant a lease within the pre-emption period. This right of pre-emption arises only when the landlord decides to dispose of the land during the pre-emption period. The tenant cannot force the landlord to sell or grant a lease, so if the landlord does not want to dispose of its interest during the pre-emption period, the pre-emption right never becomes exercisable.

1.2 Offer-Back

This requires the tenant first to offer its lease to the landlord (by way of surrender) as a pre-condition to the tenant's right to assign and/or underlet its lease. It can also be triggered by a change of control of the tenant entity. The right to assign/underlet/change control only arises if the landlord declines the tenant's offer.

What are the benefits of using a pre-emption right in a lease?

There are several reasons parties may find it useful to incorporate a pre-emption right into a lease:

• A ROFR gives certainty to the tenant that they will be offered the property first. This provides flexibility for the tenant if current circumstances dictate that they are unable or unwilling to enter into a lease at that point (i.e. they may not know whether they want to take multiple floors of a building but would like the option to do so in the future).
• A tenant can request a ROFR to prevent rival occupiers from occupying the land if it is of strategic importance.
• Equally for a landlord, a ROFR could allow for an easy exit.
• An offer-back is often included within shopping centre leases as landlords want to ensure the best tenant mix and are of the view that it, rather than its tenants, should identify prospective new occupiers (particularly from an ESG perspective).
• If the tenant is obliged to offer to surrender for no consideration, the landlord can take advantage of a rise in rents by accepting the surrender and re-letting at the market rent.

Are there any disadvantages in using a pre-emption right?

It is worth pointing out that the inclusion of a pre-emption right is not without its drawbacks:

• Genuine buyers/tenants may be deterred from making an offer if they do not have the certainty that they will secure the property after undertaking due diligence.
• The process can create delay as the parties have to follow the prescribed timeframes to exercise the right, at which point the market may have shifted or the deal may no longer be an option.
• Inclusion of an offer-back may have an adverse impact at rent review. A landlord could counter this by amending the rent review provisions to include a disregard of the offer-back provisions.

Drafting points and practical things to consider

The parties will want to consider the following points when assessing whether a pre-emption right is appropriate:

4.1 Service

The offer and acceptance notices must be served in accordance with the lease otherwise there is a risk they will be deemed invalid. It is therefore necessary to check whether there is a prescribed form and which method of service is correct. If multiple methods of service are available, it is best to consider when service is deemed under the notice provisions to have taken place as this will have an impact on the acceptance period. It is also important when drafting the notice provisions to consider:

• including an obligation for the beneficiary of the pre-emption right to notify the landlord of any change in their address so that the burden is placed on the party who actually has the information; and
• allowing deemed refusal so that the beneficiary is unable to block the other from progressing the transaction.

4.2 Preparing the client

Once the other party has accepted the offer, the parties have effectively "exchanged" an agreement for sale and it is irrevocable. It is worth making sure that those involved in the transaction are aware of this in advance given they may require internal approvals and/or bank consent and there is a prescribed timeframe within which to complete the sale/grant of the lease.

If the landlord has charged its interest, its lender's consent to the surrender may be required under the terms of the charge. A landlord will therefore need to ensure it has obtained lender consent before confirming acceptance of the tenant's offer to surrender.

A tenant's charge will survive a surrender and the landlord could become liable under it. A landlord should check prior to accepting a surrender whether the tenant has charged its leasehold interest and if so, ensure that the charges are discharged on completion. If there are any floating charges, the landlord will want to obtain certificates of non-crystallisation from the tenant's lender (dated at the date of the surrender) as evidence that the floating charge has not crystallised.

4.3 Trigger

Parties will want to consider the definition of a "disposal" within the pre-emption provisions as this will have an impact on what the landlord can do with the property without initiating the obligation to offer the property to the tenant. The landlord needs to be able to manage the property during the pre-emption period without triggering the pre-emption right. This can be achieved by either (i) imposing a blanket prohibition on all dispositions of the property and listing any agreed exceptions or (ii) setting out a list of all the prohibited transactions. The latter theoretically risks the landlord finding a gap through which it can avoid the pre-emption right.

4.4 Security of tenure and the Landlord and Tenant Act 1954

Any lease containing an offer-back clause should ideally be contracted out of the Landlord and Tenant Act 1954 (the "1954 Act"). An agreement to surrender a business lease is void under section 38(1) of the 1954 Act unless the landlord has first served a warning notice on the tenant and the tenant has sworn a statutory or simple declaration. It is unclear at what stage the tenant becomes contractually bound to enter into an agreement to surrender. The point is untested in the courts and may depend on specific drafting of individual offer-back clauses. Taking the view that the tenant is not bound until the landlord accepts its offer, one drafting option for protected leases containing offer-backs is to make the landlord's acceptance of the tenant's offer subject to the statutory notice procedure having been completed by the landlord and tenant within the prescribed time. This is problematic for landlords who find that their ability to accept the offer-back is dependent on the tenant swearing a statutory declaration prior to their acceptance. There are various ways around this such as appointing a third party as the tenant's agent to sign on their behalf or structuring the provision as an assignment rather than a surrender, although it is likely that the courts will have regard to the substance of the provision rather than its technical form in which case this approach would be unsuccessful.

4.5 Land Registry

The benefit of the pre-emption should be registered at the Land Registry so third parties are put on notice. The beneficiary may want to register a restriction to be entered on the leasehold title register rather than just a unilateral notice to ensure the pre-emption terms have to be complied with. If the right is not registered and the landlord sells to a third party who is unaware of the pre-emption right, the new owner will not be bound by it.

Conclusion

In summary, whilst not massively favoured by tenants, pre-emption rights can be a useful tool for landlords to ensure they have control over the identity of their tenants. Parties should however consider the ramifications of including a pre-emption right in a lease as it can cause delays and create unnecessary obstacles before a tenant's transaction can proceed to completion.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.