Think carefully if you want to share the details of your turnover with your landlord before taking advantage, advises Tristan Wark
Your landlord has offered you a turnover-based lease to replace your fixed-rent lease. Before you take up the offer you need to be fully informed: how will your new lease work? Which terms do you need to review? And are there any potential bear traps?
The law and the current market
Turnover-based leases have become increasing widespread in recent times, and bring the UK more in line with the US and Italy, where rents linked to turnover and visitor traffic are more common. Since the beginning of lockdown there has been growing demand from retailers and hospitality businesses for turnover- based rents. There are two types of lease:
- A ‘pure turnover' lease, where the only rent the tenant pays is based on turnover;
- A ‘turnover top-up' lease, where the tenant pays a reduced fixed base rent at a certain percentage of the open market value, with a turnover top-up paid in addition where turnover exceeds the base rent.
A number of issues need to be considered when entering into a turnover lease. The most critical of which is what constitutes turnover. For example, tips and gratuities paid by customers that are passed on directly or via a tronc to your employees should not form part of the turnover for the purposes of calculating turnover rent. Perhaps you have an offsite kitchen for deliveries – how should that be treated?
Payment mechanics also need careful thought, and the following are important:
- Turnover leases typically involve paying an on account turnover rent estimate, which is then reconciled against actual turnover.
- Consider the effect of seasonal turnover variations – most restaurants prefer to pay a more even turnover rent throughout the year rather than receive one large turnover rent bill in the Christmas quarter.
- Consider tying the annual turnover reconciliation date with your financial year-end, so that certificates of turnover can be more easily produced.
A turnover lease will almost certainly mean a more proactive landlord and tenant relationship than you have been used to. Your landlord will become interested in your trading success, seeking to maximise their rent with a high-turnover occupier. This may result in very restrictive provisions to prevent you underletting or assigning the lease. The closer relationship also means your landlord will have more information about your business, so you will need to ensure there are suitable confidentiality obligations in place.
Your landlord will become interested in your trading success, seeking to maximise their rent with a high-turnover occupier
Turnover leases often include a keep open covenant, where if the restaurant doesn't open a turnover is assumed. Check how this works and that an artificial turnover won't be assumed where it would be unreasonable to do so – for example, if it would be unlawful to open or if you close the restaurant to undertake refurbishment and decorating works.
Stamp Duty Land Tax (SDLT) in respect of the grant of the lease is also more complex for turnover leases and involves estimating what the turnover rent will be during the term of the lease and potentially making multiple SDLT returns.
- Appoint a specialist solicitor and surveyor to support and advise you on negotiating and agreeing the terms of the turnover lease.
- Examine the definition of what the lease treats as turnover line by line.
- It is likely you will be asked to provide turnover certificates and detailed records. Ask yourself if you are happy with your new obligations, and be honest about the time that will be needed.
- Timing is crucial. When must you pay the rent and any top-ups? Do the new terms work with your typical cashflow?
Turnover rents can be beneficial, but they are not without their difficulties, both in terms of drafting and management. Failing to consider the detail of your new turnover lease could result in you paying more than you would other- wise have, or struggling under the administrative burden of calculating and auditing turn- over rent levels too frequently.
Tristan Wark is a senior associate in the commercial real estate team at London law firm Goodman Derrick LLP
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