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Forfeiture from a lender’s perspective

Gateley Legal

When acting on behalf of a lender, which is taking a legal charge over commercial property, due diligence is undertaken always with the aim of ensuring that good and marketable title will be obtained.

It is not uncommon for lenders to secure a loan against a long leasehold interest, usually with a term of 50 years or more, which has a capital value and for which a premium is payable by the tenant in addition to an annual ground rent. Where this is the case, compared to freehold property, there tends to be greater potential for issues to arise which put the value of the lender’s security at risk.

A classic example is forfeiture provisions which appear in many long leases. Forfeiture, otherwise known as re-entry, is the landlord’s right to terminate the lease in certain circumstances, normally in the event of the tenant’s insolvency as well as non-payment of rent or a breach of any of the tenant’s obligations under the lease.

Forfeiture on Insolvency

Where a long lease allows for forfeiture on insolvency, this will not be acceptable to a lender. This is because, typically, it will be in an insolvency situation that the lender will be seeking to enforce its security and want to retain the leasehold asset in order to ensure that it can recoup its loan through a sale of that asset.

Forfeiture on Other Grounds

Generally, leases will allow a landlord to terminate the lease in the event of a breach of covenant or non-payment of rent by the tenant. At worst, the result is that the lender’s security disappears and the lender is left only with the possibility of making an application to the Court for relief from forfeiture, which is expensive and time consuming.

The rules and commercial considerations in this area are not straightforward. For example, even if a claim for relief from forfeiture by a lender for breach of tenant covenant or non-payment of rent under section 146(4) Law of Property Act 1925 is successful, it is a new lease that would be granted in the lender’s favour. This means that not only would the lender be on the hook for all liabilities under the new lease but also, subject to statutory rights, any occupational leases granted pursuant to the forfeited lease could be brought to an end, leaving the lender without the expected rental income. This can impact detrimentally on the value of the borrower’s leasehold property, especially if the Court grants a new occupational lease on terms less favourable than previously granted. On top of that, there is, of course, no guarantee of success in a claim for relief from forfeiture.

Notwithstanding the complexities of relief from forfeiture, these rights are only potentially helpful if the lender is aware that forfeiture is intended. In cases of forfeiture by the landlord’s peaceable re-entry for non-payment of rent, for example, there is no requirement on the landlord to give the tenant’s lender notice of the forfeiture, leaving the lender with no security and no opportunity to do anything about it until it is too late.

Clearly, such risks are ones which a lender would rather avoid, and a way of doing that is to ensure the lease contains mortgagee protection provisions. These should typically include:

  1. an obligation for the landlord to notify the lender of any breach of covenant and intention to forfeit the lease; and
  2. a right for the lender to remedy the breach within a reasonable period

Although some leases will already contain these, many leases, particularly older ones, do not. In these instances, the lender will often require the tenant, as borrower, to enter into a deed of variation with its landlord to incorporate mortgagee protection provisions into the lease. Some tenants will have already negotiated the inclusion of these upon entering into or taking an assignment of the lease, particularly where the intention is to charge the leasehold interest in the future.  Other tenants will not have done so or may not have found it possible, for example in the event of acquiring a leasehold interest at auction from receivers. In either case, borrowers must be alive to the fact that a lender will require the lack of mortgagee protection provisions to be addressed. This may mean an expensive premium has to be paid to the landlord in consideration for a variation to the lease as well as, ultimately, a delay in completion of the security.

Top Tips for Tenants Negotiating a Long Lease:

  1. Ensure the landlord has no right to forfeit on an insolvency event
  2. Negotiate mortgagee protection wording even if the lease is not being charged at the outset
  3. Ensure the landlord’s notice provisions are clear and unambiguous

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