The recent judgment in TFS Stores Limited v BMG (Ashford) Limited et al  EWHC 1363 (Ch) reminds us all that there are important details which must be complied with for effective Contracting Out for both landlords and tenants of commercial premises. “Contracting Out” is shorthand for the procedure to exclude a tenant’s security of tenure i.e. it’s right to renew its commercial lease at the end of the term and is set out in Section 38A of the Landlord and Tenant Act 1954 (1954 Act).
The Section 38A mechanism was introduced in 2003 (amending the process set out in 1954 ) and it allows parties to agree that a lease excludes tenant security of tenure. The effect of excluding these provisions is that a landlord can regain possession of its property without having to justify its actions by reference to specific tenant default or other non-fault grounds. Without s.38A exclusion, a landlord is more likely to have to go to Court to recover possession. Exclusion also removed the obligation on the landlord to pay compensation if possession is recovered under no-fault grounds. For these reasons it can be seen that s.38A exclusion is potentially a very useful tool for a landlord and it will be important for it to be done correctly.
Unless a commercial lease is contracted out by the Section 38A mechanism, the 1954 Act will automatically give a tenant security of tenure, which protects the tenant’s right to remain in occupation of the premises and its right to the grant of a new lease following the expiry of the existing lease.
The parties can agree that this protection is waived provided the lease grants a fixed term and these three steps are taken before the lease is granted:
1. The landlord serves a warning notice on the tenant, with specified content, explaining that the tenant’s rights are being waived.
2. The tenant makes either a simple or statutory declaration to acknowledge that it understands the consequences of contracting out. A simple declaration can only be made if the tenant has received the warning notice at least 14 days before the grant of the lease.
3. The lease includes an endorsement referring to the landlord’s notice and the tenant’s declaration and the parties’ agreement that the relevant provisions of the 1954 Act are to be excluded from the lease.
The Fragrance Shop, a large national perfume retail operator entered into leases at six designer retail outlets and in each case the contracting out procedure was followed.
When these leases expired, the landlord decided not to grant renewals but to let the stores to a rival perfume retailer. The Fragrance Shop sought to establish that the six leases were protected by the 1954 Act.
Concerns raised by the Fragrance Shop in TFS Stores Limited v BMG (Ashford) Limited et al
The High Court firstly considered arguments concerning the alleged absence of authority of the tenant’s solicitor and the tenant’s retail director, as agents, to receive the warning notices and/or to make the declarations.
The judge held that the tenant’s solicitors did have actual authority to accept service of the warning notices on the basis that this formed part of their instructions to complete the transaction in accordance with the terms agreed between the parties and which included the leases being contracted out.
The High Court also held that the tenant was bound by the acts of professional and employee agents as having actual authority to act as they did, meaning the tenant was unable to challenge the validity of the authority by the person making the declarations.
The High Court secondly considered alleged defective wording in the statutory declarations due to a failure to include a fixed date for the grant of the lease.
As the term commencement date was not known at the time of drafting the notices, wording was used to circumvent using an exact date, such as “for a term commencing on the date on which the tenancy is granted”
The judge held that an exact term commencement date was not essential because the purpose of the wording was to identify the tenancy to be granted and therefore the wording used was sufficient for those purposes.
The High Court also confirmed that statutory declarations must be made “in the form, or substantially in the form” set out in Schedule 2 of the Regulatory Reform (Business Tenancies) Order (the Order). The declarations were rescued by virtue of them being in “substantially” the form contained within the Order.
Implications for landlords and tenants of commercial premises
Whilst a very useful device for landlords, the s.38A procedure must be carried out with care and attention, both as to the notice and declaration but also as to the form of lease. As exclusion has a significant impact on a tenant, there is potential for action to dispute the validity of the procedure carried out. In this case, ultimately, the High Court found that the leases were validly contracted out and this approach confirms current market practice.