Heads of terms in commercial property leases: a guide for landlords and tenants

Heads of terms are a crucial element in negotiating commercial leases.  

While not legally binding, heads of terms provide a roadmap for the lease agreement, ensuring that both landlord and tenant understand the core terms of the deal before proceeding to the formal drafting stage. This process is vital for reducing misunderstandings, saving time, and smoothing the path to completion.

Often, a property surveyor or agent will be appointed by one or both of the parties to assist with the negotiation and framing of a commercial property transaction.  For more complex transactions, property lawyers are often involved too, to advise parties on the terms before they are finally signed off.

This guide will explain the purpose of heads of terms, the key components that should be included, common pitfalls to avoid, and the benefits they bring to both landlords and tenants.  

Whether you are a first-time commercial landlord or a seasoned tenant, understanding heads of terms is essential for successful lease negotiations.

What are heads of terms, and why are they important?

Heads of terms set out the fundamental details of a lease agreement before the full lease is drafted.  They act as a record of agreement between the landlord and tenant.  Although heads of terms are typically not legally binding (unless specifically stated otherwise), they help to:

• Clarify expectations: Heads of terms ensure both parties are aligned on key points, such as rent, lease duration, repair and property use.
• Save time and costs: By identifying and addressing major issues early, heads of terms can prevent lengthy disputes during the formal drafting stage.
• Enhance negotiations: They provide a basis for discussions, allowing both parties to focus on the most critical aspects of the lease.
• Provide a framework for property lawyers: The more detailed the heads of terms, the more efficient commercial property lawyers will be at drafting the lease, reducing the room for negotiation, as well as reducing the risk of misunderstandings or the need to come back to you for instructions.

Understanding heads of terms is particularly important in the context of complex commercial property leases, where various provisions (such as service charges, repair obligations, and break clauses) may significantly impact the interests of both parties.

As heads of terms are not binding unless specifically agreed, they can be varied during the course of a transaction if needs be.  However, if the parties have invested a decent amount of time in negotiating heads of terms at the outset, such changes should be minimal.

Key components of heads of terms in property leases

While heads of terms can be adapted to suit specific transactions, there are certain key elements that should always be included.  These are outlined below:

Details of the parties: Include the names and contact information for the landlord, tenant, and any guarantors involved.  Also include contact details for the professional team – i.e. lawyers and agents. 

Property description: Provide a clear description of the premises, including the address, size, and boundaries. It may also be useful to include information on shared facilities or parking spaces, if applicable.

Rent: State the agreed rent, payment frequency (e.g., monthly or quarterly), and any rent review provisions. If a rent-free period is included as part of the negotiation, ensure this is clearly outlined.  Also confirm whether or not VAT is payable.

Contractual term: Specify the length of the lease, including start and end dates. Include information on any options to renew or extend the lease, as well as any break clauses allowing either party to terminate the lease early.  If a break clause is agreed, also detail any conditions to exercising that break.

Repair obligations: Outline responsibilities for property maintenance and repair. Common arrangements include:

• Full Repairing and Insuring (FRI): The tenant takes full responsibility for repairs and insurance.
• Landlord’s responsibilities: The landlord retains responsibility for structural repairs or shared facilities, for example where the demise forms part of a wider estate or is only of the internal parts of a building.

Permitted use: Specify the intended use of the property and any restrictions on activities or alterations.  For example, in retail leases, the permitted use might be limited to operating as a specific type of shop.

Service charge: Include details of any service charges, such as contributions towards maintenance of shared areas or facilities.  Clarify how these charges will be calculated and reviewed.

Alterations: Define the tenant’s rights to make alterations to the property. Restrictions on these activities should be clearly stated.

Dealings: Define the tenant’s rights to assign or sublet the lease to another party. Restrictions on these activities should be clearly stated.

Timetable: Provide a proposed timeline for completing the lease agreement and moving into the premises. This helps both parties stay on track and plan accordingly.

Third party consents or conditions: Set out whether the transaction is conditional on anything (e.g. the parties’ board approval, or superior landlord or lender consent). 

Common mistakes to avoid

Drafting heads of terms requires careful attention to detail.  To avoid potential disputes or delays, watch out for these common mistakes:

• Ambiguity in terms: Ensure all terms are clear and unambiguous.  Vague language can lead to misunderstandings and may complicate lease negotiations.  If you are unsure, take advice.
• Missing key components: Failing to address critical aspects of the lease (such as rent reviews or responsibility for repair) can result in disputes during the drafting stage.  It’s better to resolve these issues up front.
• Ignoring legal advice: While heads of terms are not always legally binding, it’s essential to seek legal advice to ensure the terms are fair and comprehensive.  Property lawyers can help identify potential risks and suggest improvements.
• Failing to address future changes: Consider how future changes (such as property market conditions or changing tenant needs) might affect the lease. Include provisions that allow for flexibility wherever possible.

Benefits of heads of terms

Both landlords and tenants can benefit from well-drafted heads of terms in several ways:

For landlords

• Reduced risk: Heads of terms minimize the chances of disputes by ensuring the tenant understands their obligations.
• Efficiency: A clear set of terms allows property lawyers to draft the lease quickly and accurately, saving time and costs.
• Transparency: By agreeing key terms upfront, landlords can build trust with tenants and avoid misunderstandings and delay.

For tenants

• Clarity: Heads of terms provide tenants with a clear understanding of what they can expect from the lease.
• Flexibility: Including provisions such as break clauses or options to renew can help tenants adapt to changing circumstances.
• Protection: Tenants can negotiate terms that protect their interests, such as caps on service charges or limitations on repair obligations.

Conclusion

Heads of terms are a vital tool in the negotiation of commercial leases. By addressing the key aspects of the lease up front, both landlords and tenants can save time, reduce costs, and minimise the likelihood of a dispute.   Whether you are leasing office space, retail premises, or industrial property, investing the time in drafting and agreeing comprehensive heads of terms will go a long way towards achieving a positive result.