Getting Your Head Around Heads Of Terms
What are heads of terms?
Before drafting a lease, and often before engaging solicitors, heads of terms will be drawn up. This is a document which reflects the commercial deal agreed between the two parties, outlining all of the fundamental terms before the transaction proceeds any further. Typically, the party whose solicitor will produce the first draft of the legal documentation will draw up these heads of terms, and this will either be done by or on behalf of the seller or landlord.
Whilst the intention is that they will reflect what has been agreed, they are not intended to be legally binding nor completely exhaustive. They will outline the general agreement reached, but neither party is obliged to conclude the deal on those terms or even at all. However, it is worth bearing in mind that in the course of negotiating the lease at a later date it may be hard to alter the arrangement in any way that contradicts the heads of terms; therefore it is important to get the terms right from the outset.
Often, the heads of terms form the preliminary basis of legally binding clauses that are to be inserted into the lease. Consequently, it is vital that all parties understand the terms that may feature in heads of terms.
Typical heads of terms
You will always want to ensure that the document either refers to the heads of terms as either being “not intended to be legally binding” or “subject to contract”, ideally both for the avoidance of doubt. This makes it clear that the document has no legal effect and merely outlines the agreement reached.
All heads of terms will outline a number of preliminary matters, namely the parties involved, the property and the term of the proposed lease.
Landlord
Details of the landlord, including their name, country of incorporation/registration, company number and registered office address.
Tenant
Details of the tenant, including their name (and any trading name), country of incorporation/registration, company number and registered office address.
Guarantor
A person who agrees to pay the rent should the tenant fail to do so. They may be included as a party to the rent deposit deed (discussed below).
Solicitors
The details of both landlord and tenant’s legal representation.
Property
The extent of the property should be described, ideally by reference to a plan, along with any additional rights that will be granted to the tenant (i.e. the right to park vehicles and the number of allocated spaces).
Term
The duration of the lease which has been agreed, typically this will be between 5 and 20 years for a commercial lease but can of course be shorter or longer.
There are also other clauses that may be agreed depending on the intention of the parties, as follows:
Alterations / Signage
Any alterations the tenant may make to the building and what signage can be displayed. The clause will outline any approvals that must be sought (e.g. landlords written approval, not to be unreasonably withheld).
Assignments and under leases / alienation
Whether the tenant is able to transfer the lease to another (assignment) or allow someone else to use the property whilst they maintain responsibility for it (under lease). In any event, there will be conditions attached.
Break clause
A clause allowing either party to terminate the lease early. Such clauses may make provision for who is able to terminate the lease (landlord, tenant or both), the date for doing so (at any time, before or after a specific date), any conditions that must be complied with (e.g. that all rent is paid up-to-date), or even how the notice must be sent to the other party.
Conditions
Any conditions for the grant of the lease (e.g. agreement subject to planning permission approval).
Costs
Responsibility for legal costs; this will either be each party paying their own costs, tenant paying landlord’s reasonable costs or landlord paying tenant’s reasonable costs.
Enabling works
Any work that the landlord may need to undertake to make the property fit for use or to enable the tenant to undertake fitting out works.
Fitting out works
Any work that the tenant may need to undertake to make the property fit for use.
Insurance
Who has responsibility for insuring the property and subsequently who will pay the premiums for such insurance.
Rent
The amount of rent to be paid to the landlord. This often refers to the method and frequency of payment (e.g. quarterly in advance).
Rent review
The date(s) on which the rent is to be reviewed and the basis for doing so (e.g. in line with the open market rent price or Retail Price Index).
Rent deposit
A sum of money to be paid to the landlord as security for payment of the rent and performance of the tenant’s covenants in the lease. It will provide for the circumstances in which the landlord may deduct from this money and the conditions on which the deposit will be returned to the tenant.
Rent free
A period of time at the start of a tenancy during which no rent is payable. This may be included as recognition that until the property is fitted out the tenant cannot use it for the purposes of its business.
Repair
It is assumed responsibility for repairs will fall on the tenant, however the heads of terms may limit their liability (e.g. not obliged to repair damage caused by an uninsurable risk).
Schedule of condition
Where a property is not in full repair, it is sometimes agreed that the tenant’s repairing obligation is limited to keeping the property in no worse state of repair than its current state. If that is the case, it is recommended that a schedule of condition (a factual record of the condition of the property which can include photos and statements) is prepared so that it is clear what the required state of repair is when the lease comes to an end.
Security of tenure
Whether the lease will be within the protection of the Landlord and Tenant Act 1954. There is an automatic statutory right to renew at the end of the term, though this can be excluded. If the right is excluded then there is no automatic right to renew and unless renewal is negotiated then the Tenant must vacate at the end of the term.
Services and service charge
If the property is part of a larger building or estate then the landlord may incur service charges the tenant will need to meet.
Use
The permitted use of the building, which is often tied in with planning permission. This may determine that the tenant can only change the use of the property with the landlord’s prior written consent.
What happens next?
Once heads of terms are drawn up the landlord’s solicitors will draft the required legal documentation. It is important therefore that the party who did not draw up the heads of terms (usually the tenant) reviews the document and ensures that it accords with what they understand was agreed. From this point onwards it will be the responsibility of the tenant’s solicitor to ensure that any documentation produced matches the agreed heads of terms and to report to the tenant on any changes.