Change to fair

Economic storm clouds gather and leave the commercial property market grounded, as financial graphs increasingly resemble the erratic flight of a plane caught in turbulence. While some clients react to danger by buckling up and holding tight, others see opportunities during these uncertain times.

Similarly, 2009 presents opportunities for property lawyers willing to embrace the changes ahead – not just changes to the law, such as further reforms of the licensing and planning regimes, but also to the advice we provide as market conditions and client expectations require us to rethink basic assumptions.

For property lawyers the key words of 2009 will be flexibility, restructuring and sustainability.

Bending with the economic wind

Will 2009 be the year of the flexible lease?

The end of 2008 saw some of the UK’s biggest retailers, including Arcadia, Boots, Carphone Warehouse and DSGi, successfully campaign for rent payment dates within their existing leases to switch from quarterly to monthly, as trading conditions on the high street deteriorated.

For tenants, monthly rent assists cash flow as they pay one rather than three months’ rent in advance.

For landlords, cash flow is also an issue: they receive one month’s rent rather than three.

It may also mean an increased administration burden (and ultimately cost) as they process 12 payments rather than four.

Yet agreeing monthly payment may help the landlord retain a tenant through these difficult times, while also providing it with the means to monitor the tenant’s financial position more closely, as it will know within a month whether the tenant has cash problems. It may then be in a position to take steps to remedy matters at the first sign of trouble (whether agreeing alternative payments, performing summary diligence or, ultimately, terminating the lease).

But flexibility is not just about responding to today’s conditions – we know that tomorrow the market will change. Should tenants continue to benefit from monthly payments once the market recovers? Further variations or even time limits now should be considered by the landlord.

All of these changes should be discussed not only by the landlord and tenant but also with any funder. A funder may require that any variation has its consent, and without that consent the landlord may be in breach of its banking facilities.

Equally, once agreement is reached it must be validly documented. Failure to do so may leave a landlord exposed as, for example, an unrecorded variation to payment terms could render summary diligence invalid.

Will 2009 therefore see the rise of the flexible lease as terms change to reflect market conditions? Probably not – for new leases, monthly rents are increasingly used, while for existing leases it may be that landlords (and their funders) will adjust to monthly rental incomes. What we will see though, is an increase in flexible landlords, willing to look again at contracts already in place, and even, perhaps, flexible lawyers as well?

Changing tack

Flexibility applies to more than just monthly rents and the landlord/tenant relationship. It also applies to any contract where either (or both) parties seek changes to reflect new commercial realities.

In this context, flexibility, in the form of restructuring, refers not just to the property issues surrounding corporate restructuring of insolvent or near-insolvent companies, but also restructuring of any contract and its terms – a scenario particularly prevalent with conditional missives.

Missives agreed months or even years ago may become irrelevant in the current market as prices drop, values fall and timescales for purification of conditions no longer reflect reality – a purchase conditional on an operator being secured for a retail park may have seemed simple a couple of years ago, but time limits agreed in 2007 may not reflect time limits required today. So, what can we do?

Early action is essential. Clients should review longstop dates and, if they are unable to comply with them (and assuming they wish to continue), one option is to try and agree amendments to missives so that both parties know where they stand. But what if one or both parties can no longer implement its obligations under the contract?

If a purchaser under a purchase contract is no longer able to complete due to unavailability of funding, another party may step in to complete the deal. It is possible for original documentation to be recycled to take advantage of the negotiated position, saving time and money for both parties, while making only those adjustments required to ensure that any deal-specific terms are included.

Sometimes court action is unavoidable, but flexibility and pragmatism can combine to ensure deals are restructured to the advantage of all parties rather than have contracts fall away.

Planet greenhouse

If restructuring is essentially the creation of Plan B when Plan A fails, then the words of Marks & Spencer’s chief executive Stuart Rose on the launch of that company’s environmental programme are pertinent when we examine sustainability: “it’s called ‘Plan A’, because there is no ‘Plan B’”.

With the introduction of energy performance certificates (EPCs) and the publication of the Climate Change (Scotland) Bill, sustainability has moved to the top of the agenda for many clients (whether by choice or circumstances). But why is sustainability such an important issue?

The UK has set itself a legally binding target to reduce carbon dioxide and other greenhouse gas emissions by 80% by 2050. And, as buildings are responsible for 50% of the UK total carbon dioxide emissions, the Government has targeted the property sector as one of the key drivers to achieve this reduction.

Following the implementation of the Energy Performance of Buildings (Scotland) Regulations 2008, EPCs are becoming a standard part of a property transaction in the same way as asbestos surveys and fire risk assessments.

Additionally, we expect to see later this year, the introduction of a mandatory carbon reduction commitment, which aims to reduce energy use through increased accountability. Certain larger businesses will be expected to report publicly on CO2 emissions and invest in energy-efficient initiatives. This will impact property lawyers, as practices will need to be reviewed in relation to the landlord-tenant relationship and the sale and purchase of companies affected by the scheme. For example, landlords may wish to recover the cost of carbon allowances from tenants but will need to have documentation that allows them to do so.

The British Property Federation is involved in a working party to provide guidance on how the allowances should be treated between landlords and tenants, and this looks set to be a further point for negotiation between the parties.

Finally, 2009 will see further discussion about the “green lease”. A green lease is simply a standard lease with a number of additional clauses that provide for energy saving measures and variations of traditional clauses to ensure both landlord and tenant take account of sustainability issues – for example, the alteration clause may require the tenant’s works to meet set energy efficiency standards.

Sustainability may lead to decreased costs, as energy efficiency lowers energy costs but, as tenants struggle to pay rents due, and as deals are restructured to reflect current conditions, it may be some time before we truly see the green landlord and the green tenant embrace the green lease in any meaningful way. Perhaps, instead of the green landlord and tenant, we will see instead the rise of the green funder who sees costs savings as the ultimate goal for pursuing a sustainable agenda?

Further outlook

Today, clients attempt to pilot a safe course through unpredictable market conditions.

Yet, while flexibility and restructuring can help prevent current contracts becoming current liabilities and sustainability can provide a path to reduce costs, the journey towards calmer skies will undoubtedly be one of uncertainty and hope.

Tomorrow, for commercial property lawyers, flexibility, pragmatism and a continued focus on understanding client objectives may yet help clients challenge the adage that it’s an ill wind that brings nobody any good.