Lease Negotiations for Private Practices – Tips and Traps
If you have a private practice, you will know that the location, quality and cost of your premises are of fundamental importance to the ongoing success of the business. Your practice may even be synonymous with its location and maintaining that presence could be crucial to the goodwill of the business and its sale value.
If you do not own your practice premises, the chances are that you have or are looking to take a lease which will typically be for a fixed term at a market rent. Either your practice may be starting out and looking to enter its first lease or the end of your lease term may be approaching and you are looking to renew or perhaps relocate. In either case, what are the key issues you should be considering when starting lease negotiations?
The truth is that agreeing lease terms is highly complex and professional assistance should always be sought – but we will consider below some of the common tips and traps to look out for when negotiating with your Landlord and planning for the future of your practice.
- Length of term – It goes without saying that the duration of the lease should be carefully aligned with the current and anticipated future requirements of your practice. Clearly the longer the lease, the more security you will have and the easier it is to justify initial fit out costs and improvements. However, this should also be balanced against the increased commitment and liability under a lengthier term e.g. in terms of rent and repair costs which will inevitably mount up over time.
Your surveyor should explain to you how the length of the lease impacts on rental and other commercial terms but it is important to appreciate that the term length always has valuation consequences. For instance, a Landlord holding the premises as an investment is more likely to agree a lower rent in return for a longer term, particularly if your financial covenant is strong.
If you are a smaller private practice, it may be tempting to seek a lease expiry date which ties in with the retirement plans of the key principal(s). However, the lease being close to expiry at the time of the retirement(s) may damage the prospects of selling the practice as a going concern. In a worst-case scenario, this could leave the retired principal(s) not only with the cost of winding up the business but perhaps of greater significance, with a reduced or even zero value of the goodwill of the business.
- Security of tenure – Tenants who occupy premises in England and Wales for business purposes benefit from security of tenure under the Landlord and Tenant Act 1954, unless they have agreed otherwise with the landlord. This protection means that when the lease expires, the tenant will have statutory rights to renew unless the landlord is able to obtain possession under certain statutory grounds (e.g. if the landlord wishes to redevelop the premises or to occupy them for its own purposes). If the landlord can recover possession under any of the grounds listed it may have to pay statutory compensation to the tenant – although this is not likely to provide very much as it is based upon the rateable value of the premises.
You should check whether the lease you are being offered either has or alternatively excludes this protection. A landlord may wish to exclude the 1954 Act to make it easier obtain possession when the lease ends or (even if it is willing to renew the lease) to place it in a stronger negotiating position. In other cases, the landlord may have no alternative other than to exclude the lease from the Act e.g. where this is a requirement of its own lease (in circumstances where you are taking a sublease). Either way you should consider this point carefully, particularly in a case where the location of the premises is crucial to the establishment and ongoing success of your business for the long term.
- Options and pre-emption rights – If the premises are key to your long-term vision for the practice, it may be worth considering whether you can negotiate within the lease an option and/or pre-emption agreement with the landlord. An option can give you the right to call on the landlord to sell its interest in the premises to you, usually at market value. A right of pre-emption would require the landlord to offer to sell the premises to you before it can sell it to a third party.
- Means of exiting the lease – Of course there may be circumstances in which the practice or its principals would want to exit liability from the lease before the term expires. The extent to which this is possible will depend on the terms of the lease.
In particular, it is important to ensure that the alienation provisions allow for the assignment and subletting of the premises subject to acceptable conditions.
On an assignment, an outgoing tenant may be required to guarantee the performance of the lease by the new tenant although it is possible exceptions may be agreed e.g. where the lease is being assigned to other partners in your practice on a retirement and the tenant covenant remains strong.
Under a subletting, you can pass on some of the liability under the lease to your sub-tenant. This may for instance be helpful if you have spare rooms in the premises which you could rent out to offset your own rent. However, so far as your relationship with your landlord is concerned, you would remain liable for all of the tenant obligations under your own lease.
It may also be possible to agree break options allowing you to end your lease before the expiry of the term. It is important to check that any proposed tenant break option is not subject to onerous conditions which could prevent it from being freely exercised. You should also be aware that the inclusion of a tenant break option is likely to lead to the landlord seeking a higher rent. It should be kept in mind that exercising a break option is very much the nuclear option which not only would require the practice to vacate but would also likely bring forward any terminal dilapidations’ costs arising under the repair obligations in the lease.
- Repairs and service charges – When considering lease repairing obligations, the first question to ask is whether the terms are FRI (Full Repairing and Insuring) or IRI (Internal Repairing and Insuring).
An FRI lease will make the tenant fully responsible for the costs of repairs to the premises. If the FRI lease is of the whole of a building, then the tenant will often be responsible for undertaking the maintenance itself – and this is likely to include everything from the internal plasterwork to the exterior and structural parts, including the roof and the foundations.
A common mistake is for a tenant to believe it has no FRI liability if the lease makes it personally responsible for carrying out internal maintenance only. However, a lease which imposes a service charge on the tenant which includes the repair costs of the structure and exterior (notwithstanding the works are the responsibility of the landlord), is also an FRI lease. This may well be relevant in the case of a lease of only part of a building.
A tenant under an IRI lease is likely to pay a higher market rent to its landlord than under a FRI lease of the same premises, as the landlord is effectively carrying the risk of the premises’ maintenance.
Whether the lease is FRI or IRI, you should consider whether your repairing obligations should be limited by reference to a “schedule of condition” documenting any existing wants of repair for which you do not want to be responsible. Depending on bargaining positions, it may also be possible to agree a service charge cap to limit your exposure to higher than anticipated service charges.
- Succession planning for partnerships – If you operate your business through a partnership, careful succession planning is always an essential requirement and even more so where there are lease liabilities. If done well and tied in with well negotiated lease alienation provisions, then there is no reason why arrangements should not work for both retiring and new partners.
As part of good succession planning, best practice advice is always to ensure that when entering a new lease, the practice puts in place an updated form of Partnership Deed and Declaration of Trust to ensure that:
(a) all partners in the practice legally enjoy the benefit of, but share the burden of, the lease (and as a maximum of four partners can be named on a lease, this is particularly important for larger practices);
(b) all decisions relating to the lease are subject to the usual partnership decision making protocols;
(c) contractual arrangements are in place to deal with the retirement or death of a partner (typically the continuing partners may agree to accept an assignment of the lease and to indemnify the outgoing partner against future lease liability); and
(d) a reserve fund is built up over the life of the lease against the costs of future repair, decorating and any reinstatement costs.
This should provide for a sensible balance between the interests of the senior and junior partners in a practice. A senior partner will want to ensure he or she can retire without having to worry about future liability under the lease. On the other hand, a junior partner should be aware of the “last man standing” risk and would be advised to ensure a reserve fund is in place to fund future liabilities.
- Stamp Duty Land Tax – The adage that the only things certain in life are death and taxes is unfortunately largely true in the context of the SDLT tax payable by a tenant taking or renewing a lease. The amount of SDLT increases in proportion to both the length of the lease and the level of rent and should be checked early in any lease negotiations. It may also be worth considering whether the terms could be more tax efficient – e.g. in some cases it may be beneficial to opt for a shorter initial term with a tenant right to renew rather than opting for a longer term coupled with a tenant break option.
- Professional team – Every lease negotiation carries with it legal, valuation, building condition and taxation considerations and risks. It is therefore not only important to seek professional input from experts in these fields, but also to ensure your advisors understand the significance of the healthcare environment in which you operate your business and the issues which are specific to it.