Undertenants' relief from forfeiture: Must the branch always fall with the tree?

A brief look at the factors for owners and undertenants to consider when a landlord seeks to forfeit a lease with subordinate interests, such as underleases, beneath them. This blog post considers the options available to both landlords and undertenants when the undertenant affected seeks to remain in possession.

In an economic climate turned upside down by the coronavirus pandemic, reduced covenant strength of previously sure-fire tenants has become a very real worry for commercial landlords. As the courts await an avalanche of forfeiture proceedings against defaulting tenants once the current coronavirus moratorium on forfeiture ends, landlords should not overlook existing undertenants when considering options for the future.

The general rule

Where a lease is forfeited, any underlease will also come to an end. There is no direct contractual relationship between a landlord and an undertenant in respect of the undertenant's occupation and therefore any future relationship requires further steps. This is often seen by landlords as an opportunity to release space and re-let premises on the open market, though in a time of such uncertainty having an 'oven-ready' tenant already in occupation often provides a commercially prudent solution.  Options for landlords include:

1. Direct engagement with undertenants

Where a headlease is forfeited, the opportunity to negotiate a new lease directly with any remaining undertenants is often overlooked. Landlords should always consider whether undertenants could be approached to replace an outgoing head tenant in poor financial health.

By working proactively with undertenants in these situations, landlords can minimise any void periods whilst also sealing a deal with a known (and hopefully trusted) occupier. There are a number of ways in which this can be done, including the use of conditional agreements to let the property that become effective upon forfeiture of the headlease.

2. Relief from forfeiture

Whilst forfeiture of the headlease will mean any underlease falls away, undertenants can apply to the court for relief from forfeiture – a statutory remedy to protect their occupation. This is predominantly done by an application under section 146(4) of the Landlord and Tenant Act 1925 which permits undertenants to apply for relief regardless of the grounds on which the landlord has relied in order to forfeit the headlease, including non-payment of rent. If an application under section 146(4) is successful, the court can make an order vesting the property comprised in the headlease in the undertenant. The new lease created will be on terms determined by the court, though this will usually be on similar commercial terms to the forfeited headlease (save that it cannot be for a term greater than the original underlease). 

The court can impose other conditions (such as making good breaches of covenant in the headlease) and so the undertenant, having considered the terms, is not obliged to take up the new lease if it feels they are too onerous. These conditions will often deter undertenants from pursuing relief proceedings, but landlords should remain wary that such applications can be made.

The costs of such an application are borne by the undertenant, so in some circumstances it may be tactically and cost effective for a landlord not to oppose the undertenant's application, should it be keen to allow the undertenant to remain.  Whilst this can provide a positive outcome for landlords, it should also act as a warning that when a headlease is forfeited it is not certain that an undertenant will be required to vacate.