Using heads of terms in commercial leases and commercial property transactions

When you’re looking to enter a commercial property deal or transaction, especially a commercial lease, heads of terms can be used to set out basic future intentions and expectations ahead of the lease being prepared, without being (usually) legally binding.

Here we’ll be covering:

1. What are heads of terms in commercial leases and property transactions?
2. Who produces Heads of Terms in commercial property?
3. What do heads of terms cover in commercial leases and property transactions?
4. Do terms change?
5. Checking the documentation against heads of terms
6. Signing the heads of terms
7. How do you know if you need a surveyor or legal advice for your commercial lease heads of terms?

What are heads of terms in commercial leases and property transactions?

The basic premise of heads of terms is to set out the key terms agreed by the parties in a commercial transaction, without being legally binding. That’s why it’s important to ensure that the document is clearly marked ‘subject to contract’. In exceptional cases, heads of terms have been held by the courts to be legally binding, so if you are in any doubt as to the legal status of a document you should seek legal advice from our commercial property solicitors.

Full and clear heads of terms help to:

• identify issues that may prevent the transaction from taking place
• determine how to structure the transaction
• speed up the drafting of the legal documentation.

Who produces Heads of Terms in commercial property?

Typically, heads of terms will be produced by or on behalf of a seller or landlord of a commercial premises. A surveyor will normally produce the first draft for approval by all parties, but increasingly sellers and landlords and their solicitors are involved in negotiating heads of terms.

What do heads of terms cover in commercial leases and property transactions?

Below is a list of the details covered in heads of terms:

• The parties (including contact details), which may include a guarantor for a lease
• A description of the land (including a plan)
• Price or rent (including the method and frequency of rent payments)
• Property specific issues to be considered (such as rights to be granted over any retained land)
• Costs (whether each party is responsible for its own costs, or if one party is to meet both parties’ costs)
• Timing
• Conveyancer and other advisers’ details
• Conditions which the transaction is subject to, such as board approval, planning consent

For commercial leases, additional points covered include:

• Term - the length of the lease term.
• Security of tenure - whether the lease will be within the protection of the Landlord and Tenant Act 1954 providing statutory rights of renewal at the end of the term.
• Break clause - detailing if the lease will have a break in it and, if so, whether there are any conditions which must be satisfied before the break is effective.
• Rent review - if the rent is to be reviewed, when and on what basis, such as market rent or increased in line with the Retail Price Index.
• Rent-free period - the landlord might grant a rent-free period to enable the tenant to fit the property out before formally occupying for the purposes of its business.
• Rent deposit - if a deposit is payable, how much and when it will be returned to the tenant.
• Services and service charge - if the property is part of a larger building and/or estate then the landlord may be required to provide services to ensure that the remainder of the building/estate enables the tenant to operate from the property. There will be a cost incurred in providing these services which will be met by the tenant.
• Insurance - who is to insure the property.
• Use - what the property can be used for; and if the tenant can change the use.
• Alienation - whether the tenant can transfer its lease to a third party; and whether the tenant can sublet.
• Repair - the standard of repair which the tenant is required to put and keep the property in, which may include reference to a schedule of condition. (Read our advice post on Is a tenant responsible for repairs and maintenance in a commercial lease? For more information on this).
• Alterations and signage - what alterations and signage the tenant can make and whether the landlord’s consent will be required.
• Fitting out - if a tenant needs to carry out alterations to the property to make it fit for use, then the extent of the alterations may be agreed at this stage.
• Enabling works - it might be necessary for a landlord to carry out enabling works to put the property into a state where the tenant is able to fit it out or occupy for trade.
• Other documentation - it might be necessary to enter into a rent deposit; a licence for alterations; and/or an agreement for lease. An agreement for lease binds the parties to enter into the lease and other documentation once a critical condition has been discharged, such as the landlord completing enabling works, or the tenant obtaining planning permission for its intended use.

Do terms change?

They can. Although not usually legally binding, the heads of terms should be accurate as they will have a certain moral force. A party that seeks to change its position during negotiation of the legal documentation may find itself in a weak negotiating position. It is not unusual for terms to change as a transaction develops due to circumstances, or for the parties and/or their advisers to have a difference of opinion when interpreting heads of terms. It is important to continue to track the heads of terms to ensure that any changes are picked up in the documentation.

Checking the documentation against heads of terms

It is always important to check the ‘agreed’ documentation against heads of terms to ensure that the terms are accurately reflected. Legal documentation is complex and often overwhelming for a person to read. You should consider asking for a report which picks out the main terms and which should act as a useful aid in checking that the documentation reflects the heads of terms.

Signing the heads of terms

Heads of terms should be signed by a person with suitable authority but, as they are not intended to be legally binding, this need not be a director of a company. In some cases, heads of terms will be signed on behalf of the parties by their surveyors.

How do you know if you need a surveyor or legal advice for your commercial lease heads of terms?

Producing detailed and effective heads of terms can be complicated. Whenever possible and depending upon the size of the transaction we would recommend instructing a surveyor to act on your behalf. Not only do they deal with heads of terms on a daily basis, but they will be able to add value by advising whether the terms are commercially acceptable. We also recommend a legal review of heads of terms to ensure that expectations are managed and to safeguard against issues of interpretation once the transaction moves into the legally binding stages. Break clauses are a particular area that often becomes contentious if not agreed in sufficient detail at heads of terms.

About our expert

Parmjit Gill

Parmjit is a Partner and the Head of Commercial Property at Harper James. Pam qualified in 2004 and has over 20 years’ experience within private practice and industry. Pam is an expert in landlord and tenant law and has considerable experience in a wide range of commercial property work from portfolio management through to investment and development work.