Turning over a new leaf?
Turnover related rents appear to be finding favour in the current market. Retailers like Next are offering landlords terms based on a turnover rent. Administrators seeking rental concessions are sometimes asking landlords to accept a turnover rent for a couple of years (as in the administration of Stylo Barratt) so the tenant has a better chance of continuing to trade.
When are they used and what is involved?
Turnover rents are most common in the retail sector. They might also be appropriate in the case of premises which are in some way unique, where it would be difficult to find comparables for the purpose of carrying out an open market rent review.
Landlords will rarely be willing to accept all of the rent in arrears so there will often be a fixed minimum base rent collected periodically in advance. The base rent may be subject to regular review if the lease has a term of more than five years, and that review is commonly by reference to increases in an index such as the Retail Prices Index. The turnover rent will be payable in addition to any base rent and is calculated as a percentage of the tenant's turnover.
The items to be included and excluded from the calculation of turnover must be clearly defined in the lease to avoid any uncertainty. For example, the tenant should make sure that VAT is an excluded item and that the calculation is based on sums received rather than receivable. The lease is likely to include obligations for the tenant to maximise trade.
Problems with administering this arrangement
Unless the landlord is operating a shopping centre where all the tills are linked to a central reporting system there are inevitably problems arising from the need to obtain accurate information about turnover. If you wait until audited accounts are available before calculating the rent there is likely to be a significant delay in collecting that rent. The usual solution is to require the tenant to provide quarterly or monthly management accounts and to certify their accuracy. The turnover rent can be based on these accounts and a reconciliation can take place at the end of each year with a balancing payment being collected if appropriate. The parties should make sure that the obligations in the lease to produce accounts are achievable in the context of the tenant's usual administrative practices.
The landlord will need to reserve rights to police this arrangement. These are likely to include the right to enter the premises to inspect receipts and accounts.
Not all tenants will be willing to allow the necessary level of scrutiny and not all landlords will have the resources properly to review the evidence of the tenant's turnover. Agreeing a turnover rent will usually involve an element of trust between the parties.
Is a turnover rent appropriate during the whole term of the lease?
The landlord will need to consider what happens when the lease is assigned or underlet or if there is a change of use. The turnover rent will have been agreed with a specific use and a particular tenant in mind. The lease will therefore often prohibit underletting and change of use, while imposing tight controls on assignment. Alternatively, the lease may provide for the rent to be calculated by a different method (open market rent, indexation etc.) following these events.
Conclusion
Turnover rents can be a useful option where a tenant is willing to disclose its financial records to the landlord and is capable of producing accounts with sufficient regularity. However, the landlord should only consider this option where it has the resources to administer the arrangement and to check the accuracy of the information produced.
Abigail Mitchell, Solicitor
Commercial Property Practice
email a.mitchell@pglaw.co.uk
tel 020 7591 3360