To explore the question of when a tenant is entitled to negotiate a rent-free period, consider the hypothetical case of a commercial tenant that is in talks with its landlord over terms of a new 10-year lease.
Referring to the Landlord and Tenant Act 1954, the tenant’s advisers say it is entitled to a discount to the headline market
rent to account for a rent-free period, as this is market standard. The landlord, referencing the Boots case from 2021 on the issue, disagrees, and says because the tenant is already in occupation, it is not entitled to factor in a rent- free period.
Frustratingly, there is no definitive answer to the question of who is right because of conflicting case law on this point.
Courts have interpreted the 1954 act as requiring them to grant renewal leases based on what a new tenant would seek. Under this approach, a tenant is entitled to any incentives on renewal that would have been offered to an incoming tenant.
However, more recent decisions have muddied the waters. In the 2021 Boots case, the judge held that the terms of a renewal lease had to be based on the ‘principle of reality’. In that case, the existing tenant was staying in the property and would not require a rent-free period to carry out a new fit-out, unlike a new tenant.
In contrast, in the 2022 case of GB Healthcare, the judge affirmed the ‘hypothetical lease’ approach and held that the correct method was to consider market comparables. If a rent-free period or other incentives were ‘market standard’ for similar lettings in the area, then the headline rent should be discounted to factor these in.
Both of these were County Court cases, which means they are not binding on future courts. The starting point is Section 34(1) of the act, requiring the court to determine a renewal lease rent. The act says that with regard to the “terms of the tenancy (other than those relating to rent), the holding might reasonably be expected to be let in the open market by a willing lessor”; but disregarding (a) “the fact that the tenant or… predecessors in title have been in occupation”; (b) “any goodwill attached to the holding” from the tenant’s running of a business there; (c) “any improvement” made by the tenant; or (d) any value attributable to a tenant’s alcohol licence.
This means the court must base its decision on the likely level of rent a hypothetical new open-market letting would achieve – excluding tenant goodwill, improvements or an alcohol licence. For example, a 10-year lease at a headline rent of £100,000 per year with a six-month rent-free period would be calculated as having a net rent of £95,000 per year (being the £950,000 payable across 10 years, divided by 10 to give an annual figure).
Conflicting cases
However, a spanner was thrown into the works by the Boots case, in which the court held that a renewal lease should not contain a rent-free period. The landlord pointed to the principle of reality, arguing the existing tenant of the premises was also in the market for a new letting of the premises. Section 34 required the rent to be what the premises “might reasonably expect to be let for in the open market”, and “a tenant who does not need the fit-out could not reasonably ask for a rent-free period for one”. The court was persuaded by this reasoning and found in favour of the landlord.
Within the year, the County Court came to the opposite conclusion in GB Healthcare. It declined to follow the reasoning from Boots, instead handing down judgment in favour of a rent-free period. It held that the correct approach was to look at the terms of a hypothetical lease, to analyse comparable lettings to assess what rent-free period the tenant would have received on an open-market new letting, and to discount headline rent accordingly.
Ultimately, it will require reform of the act or an appeal to a higher court to decide matters. Landlords and tenants should identify this issue early on and take proactive steps to bolster their position.
Landlords could seek advice in advance of contractual termination of any leases and consider offering a renewal lease with turnover rent provisions. Tenants might leverage their position in the run-up to lease termination/renewal by examining options to carry out renovation and/or fit-out works, which could justify requesting a rent-free period or a rental discount; and/or instructing agents to seek alternative premises early on. This may assist tenants in negotiations with landlords who want to avoid the expense of void periods and re-letting to third parties.
Andrew Ross is head of property disputes and Chris Lee is associate in the property disputes team at Travers Smith
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