In the UK, market norms on letting have for many years been dictated by the notion of the “institutional” lease. Institutional lease requirements are themselves underpinned by lender’s obsession for leases with rental streams undiluted by residual landlord risk and a valuation system that emphasises current occupier covenant strength. These norms have become so prevalent that legislative efforts to interfere have met with severe opposition. None of this was an issue historically but modern occupiers’ business imperatives for low risk, flexible space with fixed costs and controlled residual liability does not always sit easily with traditional letting norms.
None of these pressures exist in the Kingdom of Saudi Arabia (KSA). When presented with the opportunity to create the legal basis for a leasing system unconstrained by a narrow concept of what is “institutional”, KSA has chosen outcomes more balanced between interests of landlord and tenant. These are part of a drive to present a business positive environment designed to facilitate investment in KSA. This article is intended to highlight just a few which will be familiar issues to companies established in England.
Original tenant liability
Although qualified by a change in the law in 1996, the English concept of “original tenant liability” (the original tenant being liable for the whole lease term even post assignment) has held particular sway with real estate investors and funders. Preserving the liability of a tenant with good covenant strength beyond assignment is still one of the key points in lease negotiation.
In KSA where lease terms are shorter and valuation concentrate more on quality of the underlying asset, the Civil Transactions Law (CTL) has chosen a very different and fairer route. If a landlord consents to an assignment, completing that assignment releases the assigning tenant from future liability; if it does not consent, either because assignment without consent is permitted or because assignment is in breach, the assigning tenant remains liable.
If the landlord is concerned about the incoming tenant’s covenant strength then it can refuse consent or require guarantors/additional security, but the outgoing tenant does not retain post assignment liability.
There is an inherent logic to this position. If the landlord would have transacted the original deal with the assignee and/or has acceptable security such that it gives consent to assignment, why should it retain the assignor as an effective guarantor. Tenants have the certainty of knowing that if they dispose of a lease, they also dispose of the liability under it.
Fixed cost/all-inclusive leases
The market in KSA has truly embraced the notion of fixed cost occupational arrangements. Standard leases will ordinarily:
- fix the rents with defined rent escalators rather than include expensive to operate and uncertain open market reviews;
- fix service charges, often with annual percentage increases; and
- not recharge insurance costs but include them in the overall rent.
Open market reviews and variable service charges, although permitted under the CTL, are the exception rather than the rule as landlords understand the tenant imperative to have cost certainty to enable effective operation of its business.
Although, as is the case with all-inclusive rental arrangements elsewhere, there may be a tendency for a landlord to dumb down service provision to align expenditure with service charge income, there are legal and commercial reasons not to do so in KSA. Poor quality service provision leads to a poor quality product, lower rents and an immediate impact on value given the lesser significance of current tenant covenant strength in the valuation process.
In addition, the CTL comes to the rescue in obliging the landlord to effect all repairs required for full use and enjoyment by the tenant and both a potential tenant termination right and a tenant self-help remedy for landlord failure to do so. These legal rights for the tenant act as a strong commercial imperative on the landlord to maintain quality, even in a fixed occupation costs environment.
Reinstatement of alterations
Although in England we argue about reinstatement, in most instances the issue is more about how much leverage the reinstatement obligations create for a favourable terminal dilapidations settlement. The “institutional” position of an absolute obligation to reinstate, even alterations that enhance value, gives an artificially beneficial bargaining position to the landlord.
In KSA the position adopted by the CTL is more balanced between landlord and tenant:
- If the tenant makes alterations that enhance the property and are not just for its own benefit, it can claim compensation for them from the landlord.
- Tenant specific alterations must, however, be removed unless the landlord opts to retain them in which case it must pay compensation as, by retaining them, the landlord is effectively agreeing that they enhance value for it.
- The tenant always has the option to remove any alterations rather than take the compensation as long as doing so does not damage the property.
