When a tenant decides that they no longer wish to occupy their leased premises, they can make the decision to assign or underlet their interest to a third party.
When is it appropriate to assign a lease?
In assigning the lease, the tenant will be transferring the benefit of the lease from themselves to the new tenant (“the assignee”). The assignee will be obliged to comply with all covenants within the lease and (provided the lease was granted after 1995) the tenant will automatically be released from any liability under the lease. Many tenants favour an assignment because of the automatic release from the tenant’s liabilities.
However, it is common for a Landlord to require the outgoing tenant to enter into an authorised guarantee agreement (AGA). Under the terms of an AGA, the outgoing tenant guarantees the obligations of the assignee until the assignee is released from its covenants (either by the lease term coming to an end or on a further assignment).
Another drawback of assigning a lease is that it will be necessary to obtain the landlord’s consent to such an assignment. Any landlord considering an application for consent to assign will carefully scrutinise the incoming tenant and where the proposed assignee has a weaker covenant strength than the existing tenant, they may either refuse to grant consent or require the assignee to provide additional security (such as rent deposits and personal guarantees). Clearly this can make the assignment of a lease much more difficult and means a underlease may be preferential in some cases.
When is the grant of an underlease the preferred option?
If the tenant decides to grant an underlease, they will directly grant the third party (“the undertenant”) a lease of the premises. This would not cancel the tenant’s obligations to the landlord and they would remain liable to observe and perform all of the covenants in the head lease. However, the underlease to the undertenant would contain similar covenants to the headlease. Accordingly, if the undertenant failed to comply with their obligations, then the tenant would be able to enforce the obligations under the underlease directly against the undertenant.
A benefit of dealing with the premises in this way is that it creates flexibility for the tenant. The tenant may anticipate that they may want to regain possession of the premises in the future. Granting an underlease to the undertenant for a shorter period of time, will allow the tenant to retake occupation of the premises following expiry of the underlease.
Similarly, a tenant may decide that the premises are too large for them and rather than relocating, the tenant decided (subject to landlord’s consent) to let part of the premises to a third party.
Tenants may also decide to grant an underlease where the landlord has refused to grant consent to an assignment. As the original tenant is still liable under the headlease, landlords are often more comfortable for an underlease to be granted to a third party who has a weaker covenant strength.
The main drawback of this approach is that the tenant remains directly liable to the head landlord. If the undertenant breaches the terms of the underlease (leaving the tenant in breach of its own lease), the tenant can look to enforce the covenants and restrictions in the underlease. However, this clearly will involve cost and the success of such an action would depend on the financial viability of the undertenant. Accordingly, there is a risk of greater costs in the event of breach.
Advice on leases and deciding to assign or underlet
For advice on leases and whether to assign or underlet please contact Kate Pritchard or email her at kate.pritchard@dtmlegal.com. Kate is a member of our Commercial Property team which provide a comprehensive range of services to clients across the UK as well as at a local level from our offices in Chester and Liverpool.
