AML: HMRC flexes enforcement muscle to the tune of £7.8 million
Imagine this scenario. You own a site which is ripe for development in a few years. There are a number of tenants who still have leases which don’t expire for between two to three years, which fits in with your development timetable. There was one vacant floor last year but you agreed to let that to a new small business tenant on a one year lease and since that tenant said they may want to stay longer, you agreed that they could have a right in their lease to renew for another year. You agreed a low rent as it was such a short term and saved you the business rates. You didn’t want to bother with solicitors so your agent just issued your standard short term lease and after a couple of amendments from the tenant, this was completed in a couple of days.
Now imagine finding out that the lease you had thought would be for only one year, or two at most if the tenant asked to renew, actually lasted for 2000 years. That can’t be right, can it?
Unfortunately, it can. If not properly drafted, an option to renew can result in the creation of a perpetually renewable lease and whether this has been created intentionally or unintentionally, the Law of Property Act 1922 (section 145 of, and schedule 15 to) converts a perpetually renewable lease into a lease which has been granted for a term of 2000 years from the original contractual term commencement date.
There are some important things to check before the heart-in-mouth moment is confirmed as a grim reality:
The 2000 year term applies to a perpetually renewable lease which has been granted from the freehold.
If it has been granted from a leasehold interest then the perpetually renewable lease term is deemed to be equivalent to the term of the lease out of which it is derived, less one day.
This will depend on the precise wording of the relevant clause.
The courts generally do not favour perpetual renewals. For example, if an option to renew states that the renewal lease will be on the "same terms and conditions as this lease," then this will be deemed to exclude any further right to renew. If, however, the wording goes on to say “including the option for renewal” then this will create a perpetual renewal option. This may seem simple but carelessness in drafting can occur and lead to unintended consequences.
In the recent case of Palo Alto Ltd v Alnor Estates Ltd the Upper Tribunal agreed to correct a lease where one party had taken advantage of the other's mistake to create a perpetually renewable lease.
In this case, the tenant of an office unit with a yearly rent of £3,120 secured a perpetually renewable lease. It was the landlord's practice to grant short leases in a simple form. The final lease, which was completed without legal advice, ran to only two pages in total. The tenant was initially offered a one year term and told that if it wanted a lease for three years (which it did) then this would require solicitors to draft the lease. The tenant did not want to get solicitors involved so the parties agreed that the tenant would take a lease for a term of one year but would have the option to renew it.
The draft lease was issued by the landlord’s agent and included an option to renew. The tenant sent back its amendments and the option to renew clause in the completed lease read as follows, creating a perpetually renewable lease:
The tenancy is granted for a period of one year with an option to renew at the end of the term/or a further one year on the same provisos and agreements as are herein contained including the option to renew such tenancy for a term of one year at the end thereof.”
Following completion of the lease, the tenant applied to Land Registry to register the lease as a lease for a term of 2000 years. The landlord objected to this application and applied for rectification on the basis that their intention was that the lease should only be able to be renewed up to a maximum of twice (to bring it up to the three year term initially requested by the tenant).
The First Tier Tribunal held that there had been a unilateral mistake by the landlord. The judge found that the tenant had known that its amendments would create a perpetually renewable lease and had taken advantage of the landlord's agents. The judge ordered the lease to be rectified so it would only be renewable twice.
The tenant appealed, arguing that in order to find there had been a unilateral mistake, this required dishonesty on the part of the tenant which there wasn’t.
The Upper Tribunal concluded that where the defendant was found to have actual knowledge of the mistake made by the other party, this was sufficient for unilateral mistake and dishonesty was not required. In any event, in this case, the Upper Tribunal said that they were sure that the tenant had both actual knowledge and dishonesty. Not only did the tenant know about the consequences of the landlord’s agent accepting their amendments but their failure to explain the effects of their amendments to the agent amounted to dishonesty.
The landlord was lucky in that case. It could so easily have been a very different and awkward result. It can be very tempting to try and circumvent solicitors, particularly where a transaction involves smaller properties with low rents and/or short terms. Is it really worth saving costs in the short term if you’re running the risk of creating a 2000 year mistake?
Should you require any further information on this issue please contact our real estate team.
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