26.01.06
Clients who are retailers may be familiar with turnover leases. They are used in some of the best shopping centres in the UK.
The headline feature of a turnover lease is the requirement for the tenant to pay a rent which will be the higher of a fixed sum or a fixed percentage of turnover.
This diverts attention from features of a turnover lease which are not always appreciated.
A move to turnover rent leases does not imply flexibility-in fact the opposite. It certainly does not suggest any form of partnership or sharing of risk.
Consider the following imaginary telephone exchange between a retailer who has just secured a deal in one of the best turnover schemes and his solicitor.
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Darren, the big cheese from up and coming retailer, Just Do the Deal (Shops) Ltd telephones his solicitor with news that he has just agreed terms to take a unit in the SuperExcel shopping centre. Darren's solicitor, Earnest, knows the centre. It is one of the best performing schemes in the country and its a turnover rent centre using an industry standard turnover lease.
Darren
Yo, Earnest, I'll get straight to the point. Have you looked at the heads of terms from my shop agent, Rupert. Good, it's a great centre, the rent is scary but I'm lucky to get in because we are still a fairly small operator and I just want you to do the deal and if you've got anything legal to tell me, just give it to me straight over the phone cos you know I am not going to read the stuff you send to me.
Earnest
Thanks Darren and yes I've received the Heads of Terms. It states that the rent is £120,000 a year and its supposed to represent 80% of the market rent.
Darren cutting in
Yeah, don't worry about that- Rupert explained that its a turnover thing, its not true and its really 100% of the market rent but its something we have to go along with if we want to get into the centre- he says all the leases say the same thing about it being 80% but its rubbish, its really 100%. Now just do the deal.
Earnest
Before you go Darren I would ask you to read the lease report I send to you on this transaction because this lease will be a lot different from the other ones you have signed.
Darren
Look Earnest I'm a busy man and I don't have time to read all this legal stuff you send to me. If there's anything I need to know tell me now.
Earnest
Well first of all the Heads of Terms state that you will pay a turnover rent which will be 12% of your yearly turnover minus the base rent of £120,000 and there are some very detailed clauses about turnover rent.
Darren
Earnest, it ain't going to happen. To pay turnover rent, we will have to do more than £1 million a year. We reckon to do two thirds of that if we are lucky and if we do more than a million I'll happily pay turnover rent and you and I can dance around the centre half naked. Now just do the deal.
Earnest
I understand but just think about the position if contrary to your expectations, the shop does not perform. Now I know that if its really bad you'll just close the shop, but if that happens, the Landlord will force you to pay an increase in rent of 25%, which means that you will be obliged to pay rent at £150,000-00 a year while the shop is closed.
Darren
I'm not standing for that, its day light robbery. You cross that clause out and remind them who they are dealing with here. I have 10 shops and one day Just Do the Deal (Shops) Limited will be the biggest name on the High Street. Have you got that Earnest. Unbelievable- you pay more rent for a non performing shop than if it performs. You tell them I will write to the O D P M (the office of the Deputy Prime Minister) if they don't take that one out. I am not standing for that.
Earnest (suppressing surprise at the mention of the O D P M)
Well, I certainly will and I know that one day you will be the biggest name on the High Street, but my experience in this centre is that you are unlikely to get that clause removed. The Landlord is very keen to see its shops in the centre open and trading and will give this as the reason for the need for a penalty rent. We could have a lease meeting with the landlord if you would like to discuss points like these.
Darren (who attended a lease meeting for his first shop)
Look, just do your best on that one, and come to think of it, if the shop does not perform I'll just get rid of it. In fact its not a problem. Don't worry about it. Just do the deal.
Earnest
Sorry but I have to mention that the rules for this turnover centre governing an exit from the shop are significantly more restrictive than for your other leases. You may think that all you have to do is find a retailer whose references and accounts stack up. Its different at the SuperExcel Centre. Remember that you have agreed that your rent of £120,000 is 80% of the market rent. The lease will state that for the first year after an assignment the rent will be increased to what is notionally the market rent of £150,000.
Darren
Get outa of here. The rent goes up by 25% to £150,000 just because I want to assign without there being any rent review. The rent should be the same for the new tenant as it is for me, especially as the only reason I'll want to leave is because the shop is not performing at the existing rent level. That's outrageous. How does the landlord justify that?
Earnest
Well what the Landlord will say is that the rent increase is only effective for the first year after the assignment and that the additional rent is payable in lieu of turnover rent. He will remind you that you have accepted that your £120,000 rent is 80% of the market rent and so for one year the deal is 100% of the market rent and no turnover rent. I can argue that the turnover rent is a fiction (which it is for the vast majority of tenants in the centre) and has never been paid, but I am pessimistic that the Landlord will agree to a concession on this.
Earnest (continuing)
It gets worse. The lease at the SuperExcel Centre also states that after the first year the new tenant, having put up with the 25% rent increase, has to agree to a new turnover percentage. This is done by reference to a formula which is potentially very onerous. It's a formula based on the market rent of the shop after the first year relative to the new Tenant's turnover in its first year. Its works particularly badly in a case where the new Tenant needs time to establish its business and turnover is low. For example if the market rent after one year is £150,000 and turnover is £600,000, then the new Tenant's new turnover rent percentage would be 25%.
Darren
Come on Earnest. That's ridiculous. Where would I find a punter who is going to take an assignment and first accept a 25% hike in the rent and then a turnover rent of 25%. What it means is that as well as all the other normal rules on assignments and changes of use that you have told me about there are these extra rules. Earnest, if I accept terms like this I am signing up for a lease which is virtually non assignable in the real world. I am really worked up about this. I am going to phone Rupert and give him a piece of my mind and I am going to write to John Prescott. I am really steaming. Hey, hang on a minute I can always get out by underletting.
Earnest
Actually no. Leases in the SuperExcel Centre do not permit underletting and by the way even if you find an assignee who is willing to live with the increase in base rent and take a risk on a high turnover percentage, which I agree is unlikely, you will not be able to proceed without first offering to surrender the shop back to the landlord. You have to give the landlord a month to make up its mind and only after this period has expired can you assign to the party who was interested a month earlier. Will he still be wanting to take the unit? Who knows?
Earnest (continuing)
I have mentioned all this because you need to know that a turnover lease is a different animal to a high street shop lease. Its really all about control. A shopping centre is a highly controlled environment and never more so than in the case of the SuperExcel Centre. You will recall that you asked me in relation to one of your other shops whether you need landlord's consent to blow your nose. Well it's a question worth asking here and the answer is thankfully no, but all the rules in the lease are geared to giving the landlord control over everything relative to ownership use and fitting out of the shop. Consent may be required for anything which impacts on such matters. All these turnover provisions are often irrelevant to the amount of rent the landlord receives because in the vast majority of leases, the base rent is so high that turnover rent does not kick in.
Earnest (now in his element)
What these turnover provisions achieve for a landlord is twofold, firstly control with a capital C over the identity of the Tenant. If the landlord does not want the assignment to happen, it will not take place because of the line of hurdles that have to be overcome by the tenant and his proposed assignee. However the Landlord is a commercial person. It is not in his interests to obstruct a non performing tenant who wants to exit, when a new assignee is presented whose use and covenant is acceptable. Frequently the landlord will take a surrender of the lease and grant a new lease to the assignee proposed by the Tenant who wants to leave. Frankly it is often an opportunity for the landlord to increase the rent it receives from the unit. I am sure that if you speak to Rupert, he will be able to advise from experience how this landlord has behaved historically in relation to assignment proposals. ..
Secondly the turnover provisions give the Landlord important information about the trading performances of the respective tenants which it can use to its advantage even if little is generated by way of turnover rent. So the turnover lease has more to do with control and information than turnover rent
You need to be aware of the potential pitfalls in the lease that I have described but I am not saying you should not proceed because the shop might turn out to be your best outlet. We can have a go at changing some of the terms that I have mentioned but frankly I think it unlikely that we will get much change on them. Maybe one day when you have more financial muscle
Now shall I arrange a lease meeting so that we can discuss all these points with the Landlord and others that I have not mentioned?
Darren (totally exhausted)
Earnest, just do the deal. Adios.
John Gillette, Barker Gillette LLP solicitors. 26th January 2006
For more information contact: John Gillette on john@barkergillette.com
Department: Commercial and Residential Property
