On 1 June 2004, the Office of the Deputy Prime Minister (ODPM) introduced new procedures for contracting business leases out of the security of tenure provisions of the Landlord and Tenant Act 1954. Out went the requirement to obtain a �rubber stamp� court order prior to completion of the lease. Although the court order procedure was tedious, it gave certainty to all involved, was easy to obtain and left a clear evidential trail, as the court order would be placed with the deeds. If the order was lost, a duplicate could be obtained from the court.

The court order procedure has now been replaced by a requirement for the landlord to serve a �health warning� notice on the tenant before the tenant is contractually bound to take the lease (this could be months, if not years, before the actual lease is ever granted). The tenant then has to sign a declaration saying that they have received the landlord�s notice and that they know what rights they are giving up. If the tenant is to be �contractually bound� less than 14 days after service of the landlord�s notice, then the declaration has to be taken to an independent solicitor so it can be sworn as a statutory declaration, rather than just being signed as a simple declaration.

Cause for concern

When the new law was finalised last year, a group of property support lawyers from major commercial firms sat down to try to work out how the new law would work with the type of transaction we typically encounter day by day. We found that the drafting of the Regulatory Reform Order (RRO) (which brought in the new contracting-out provisions) left many of our questions unanswered. We therefore wrote to the ODPM to highlight the issues, and subsequently met them to try to explain our concerns, but this all fell on deaf ears.

We were told that the new law would be reviewed after it had been in operation for a few months, to see how things were settling down. Denton Wilde Sapte, Linklaters, Eversheds and Dechert have therefore just written to the ODPM to highlight the problems we are still encountering with the new law and to suggest a further change in the law that would make life much easier for tenants who are legally represented.

Problems with the new contracting-out procedure

Because of the way the RRO is drafted, it is far from clear how the new contracting-out procedure is meant to work. Examples of the doubts raised include:

• Uncertainty as to whether the warning notice has to be served personally on the tenant or may be served on the tenant�s solicitor.
• Uncertainty as to whether the warning notice can be served at the outset of the transaction or whether the terms of the lease have to be in final form.
• The near-universal use of the statutory declaration procedure (instead of the simple declaration procedure) as a result of the uncertainties mentioned above.
• The requirement for a separate notice to be served on each tenant. Tenants find this confusing. Under the old procedure, all the tenants joined into one court application.
• The complications arising out of the statutory declaration procedure, and in particular the need for the tenant to see an independent solicitor (who does not advise the tenant in any way, and so provides no extra level of security).
• Where the form of lease changes slightly before it is completed, for the reasons set out above, landlords have to serve a new warning notice and tenants must return a new statutory declaration, in case the original contracting-out procedure is invalidated by the change.
• Where there is a change of tenant between exchange of the warning notice/declaration/statutory declaration prior to the agreement for lease, and the grant of the lease (eg where an agreement for lease is assigned), the new tenant has to receive a fresh notice from the landlord and sign another declaration before it takes the assignment. As there is no reliable way to achieve this, currently landlords simply prohibit the assignment.
• The failure of the RRO to specify procedures for options to grant or take contracted-out leases, including options requiring guarantors to take new leases in certain circumstances.
• Complications caused by the need for the new procedure to be undergone before the tenant enters into an agreement for lease, rather than the lease itself.
• The need to serve separate notices on all tenants and guarantors (where they may have to take up a new lease if the tenant defaults) and on new tenants who wish to take an assignment of an agreement for lease, creates a myriad of notices and responses� This causes extra expense and the possibility of confusion between them. This is particularly acute where there are many contracted-out leases in the same building;
• An investment purchaser of the reversion of a let property (such as a pension fund) or a developer will want to check that any occupational leases that are contracted out have been contracted out properly, particularly where future plans for the building are dependent on regaining vacant possession reliably and cost-effectively on a given date. However, the RRO procedure can make this due diligence exercise difficult, time-consuming and expensive.
• To minimise the potentially serious consequences of getting the contracting-out procedure wrong, landlords and purchasers are having to take a very cautious approach. This is resulting in greater delay and expense, without providing tenants with any additional safeguards. Serving potentially numerous notices may greatly increase costs, but (given the continuing uncertainties with the legislation) without any assurance that the procedures have been fully and properly complied with, or can be relied upon.
• Uncertainty as to when, and by whom, multiple notices should be served and declarations made in relation to various possible leases and �potential� leases (eg a covenant to take a lease on default in a guarantor covenant).

All these points are issues which we, our professional colleagues and our clients have encountered regularly in practice since 1 June 2004. They are not just theoretical.

What needs to be changed?

We considered carefully how best to solve these drawbacks without exposing tenants to the risk of unwittingly losing the protection of the security of tenure regime.

Before turning to the detail, it is important to bear in mind that:

• 1954 Act exclusions are not adversarial as between the parties � both have a common aim, namely to finalise the transaction in the shortest possible time, so that the tenant can take occupation and the landlord starts to receive the rent.
• In the commercial property market there are many kinds of landlord and tenant, both large and small, some being large Plcs, while others are small companies, partnerships or private individuals. Some are well-versed in the law and advised by solicitors, while others are not. Where a tenant is legally represented, there is no danger of them being �bulldozed� into signing away their security of tenure rights without realising what they are doing. Therefore, no special protection is required for tenants who instruct solicitors. Such protection is certainly required for unrepresented tenants.
• In many cases, the lease is only a small part of a large and valuable commercial transaction. For example, a large catering contract may be awarded, with the catering company being granted leases of several kitchens on various sites. If the catering contract is ended (by either party), then it is vital that the kitchen leases terminate, in order to allow the new caterer to use the facilities. Similarly, in a potential redevelopment situation, regaining vacant possession reliably, cost-effectively and on a certain date is vital. Landlords of such contracted-out leases are willing to charge lower rents in order to ensure such certainty. These landlords now have to err on the side of caution when complying with the procedures for validly contracting out, even if such caution seems over the top to all concerned. If they do not do so, the investment value of their asset could be seriously compromised.
• Landlords are not necessarily large organisations experienced in property transactions. Many landlords are themselves tenants with spare space in their buildings who wish to let it out on a temporary basis, but need to be certain that they will be able to recover possession at the end of the term. In such circumstances, the tenant�s commercial experience and bargaining power may well be greater than the landlord�s.

Whilst we accept that unrepresented tenants need further protection, in most commercial contracted-out leases, both parties are legally represented and know what they are doing. The rent is pitched accordingly. What they need is a method of recording their informed agreement to contract out that is quick, cheap and forms a permanent part of the lease, so that it is easy to demonstrate to third parties in the future.

Our proposed solution

The contracting-out procedure would be greatly improved if it distinguished between the method for contracting out where the tenant is legally represented (for which we suggest a new alternative) and the method for contracting out where the tenant has n� legal representation (where the current RRO procedures should continue, but with some tidying up to make them easier to operate).

Where the tenant is legally represented

We suggest that the �health warning� that currently appears on the landlord�s warning notice should be reproduced instead on the signature page of the agreement for lease/lease. In addition, there should be a compulsory statement on the same page that the tenant is legally represented, setting out the details of the solicitors advising the tenant. There would be no separate warning notice and no declaration/statutory declaration required from the tenant. Where the warning words are included in the agreement for lease, they will also be required to appear on the signature page of the lease as eventually granted (so that, were the agreement for lease to become divorced from the lease at any later stage, as frequently happens, it will still be clear from the lease itself that the proper contracting-out procedures were followed).

This has the advantage of including everything in the document itself (cutting down the risk of lease and notice/declaration becoming physically divorced at a later stage). It ensures that all tenants and guarantors have seen the warning before they sign up to the deal (so removing the need for separate notices and declarations, etc), and it would be the final form of agreement for lease/lease that is before the parties when they decide to sign notwithstanding the warning. There would be no continuing problems of ascertaining whether the warning notice has been properly served, on whom, how long beforehand, nor whether the statutory declaration has been properly executed and witnessed (all of which can, and often do, currently cast into doubt the validity of contracting out).

There is no risk that the issue of contracting out will come as a surprise to the tenant/guarantors by leaving the warning to the final form of lease � they will generally have been negotiating the form of lease (including these words) for some weeks. Their own solicitors can explain the implications of contracting out to them.

Where the tenant is not legally represented

Here the RRO procedures should be retained, but with the following changes:

• The landlord�s notice should be redrafted so that it sets out the basic details of the transaction, ie tenant, premises, rent, whether or not the rent is subject to review, and length of term (the �mandatory terms�).
  
• The RRO should state that:
  
  (a) the warning notice may be given at any time whether or not the lease negotiations have started or been concluded;
  
  (b) no copy of the lease need be attached to the warning notice; and
  
  (c) the exchange of warning notice and declaration/statutory declaration will validly exclude from security of tenure any lease granted (or agreement for lease exchanged) to anyone at any time so long as the equivalent provisions in the lease/agreement f�r lease conform with the mandatory terms (differences in any other terms/additional terms inserted would not invalidate the contracting out).
  
• The RRO should state that only if any of the mandatory terms change in a material fashion will the exchange of warning notice/declaration/statutory declaration be ineffective and require repetition. It should be expressly stated that an increase or decrease of 10% or less in the area of the premises or the amount of the rent should not be material for this purpose.
  
• Some other minor changes are required to clarify the RRO. We have passed details of these to the ODPM.

In both cases, in addition, the RRO would need to be amended to confirm that:

• Valid contracting out (by whichever method) would cover (in the case of a contracted-out agreement for lease) any lease granted in the form permitted by that agreement, no matter to whom it was granted. This would enable the original contracting-out procedure to cover a situation where the benefit of the agreement for lease was assigned on to a new potential tenant, before the lease was actually granted. There is currently doubt as to whether this is permissible.
• Contracting out (by whichever method) would cover (in the case of a contracted-out lease) any lease granted pursuant to it or any document supplemental to the lease (eg under an option to renew/option to extend/option to require the guarantor, or any future guarantor, to take a replacement contracted-out lease where the original tenant became insolvent, or an obligation to take a new lease pursuant to an authorised guarantee agreement). The later documents would contain wording to confirm this.
• Where a stand-alone option is granted for a tenant to call for a new contracted-out lease at some point in the future, that contracting-out procedure will be implemented before the option is granted (and having done so, the contracting out will apply to the agreement for lease that arises when the option is exercised, and to the lease that is granted pursuant to the option). The same would apply to any leases granted pursuant to subsequent options contained or referred to in the original lease, but each lease would contain a clause making it clear on the face of the lease that the lease is contracted out.

Conclusion

Urgent action is needed on the part of the ODPM to put an end to the endless paper trail which has been imposed on us since last June.

As a final thought, it is interesting to note that the notice requirements brought in last June bear a striking resemblance to the old procedure for �notices of assured shorthold tenancy� under the Housing Act 1988. In the case of assured shorthold tenancies, the need for prior notices was abolished by later legislation because so many incorrect notices were being served.  © Property Law Journal