Understanding restrictive covenants in commercial leases

Restrictive covenants play an important role in commercial property agreements as they govern the actions that landlords and tenants can and cannot take during a tenancy.

Unlike freehold restrictive covenants that run with the land, commercial lease covenants create contractual obligations between the parties that shape how business premises can be operated and managed.

Why do commercial leases include restrictive covenants?

The reason commercial property leases include restrictive covenants is to protect the interests of both the landlord and tenant and maintain the property's value, character and surrounding estate.

For landlords, covenants provide control over how their property asset is used and maintained, ensuring activities by the tenant don't diminish property value or create conflicts with other tenancies. For tenants, certain covenants can secure competitive advantages, such as preventing the landlord from letting neighbouring units to direct competitors.

Typical restrictive covenants in commercial tenancies

Commercial lease covenants commonly address the following areas:

User restrictions – These clauses define the permitted business activities on the premises. For example, a landlord may stipulate that the premises is only to be used as a cafe, or conversely, it may prohibit food service businesses entirely. In multi-let properties, this approach protects the landlord's ability to manage the mix of tenants.

Alterations and modifications – Most commercial leases require tenants to obtain landlord consent before making any structural changes, alterations to the shopfront, or even non-structural modifications. This ensures the landlord maintains control over their asset and can prevent unsuitable changes.

Nuisance and conduct – Covenants typically prohibit activities that cause nuisance to neighbouring occupiers, including excessive noise, vibrations, or offensive odours. These provisions help maintain harmonious multi-tenancy environments.

Vehicle and parking restrictions – Commercial leases often regulate what types of vehicles can be parked on or near the premises. Heavy goods vehicles, for instance, might be prohibited from overnight parking if this would impact neighbouring businesses or residential properties.

Signage and external appearance – Restrictions on external signage, advertising hoardings, and the building's external appearance ensure the property maintains a professional standard and doesn't adversely affect the landlord's other holdings.

Exclusive use and competitor restrictions – In shopping centres or business parks, tenants may negotiate exclusive use covenants that prevent the landlord from leasing other units to competing businesses, thereby protecting their market position within that location.

What happens when commercial lease covenants are breached?

The consequences of breaching restrictive covenants in commercial leases differ significantly from those of breaching freehold covenants, as they're governed by contract law and the specific terms of the lease.

Tenant breaches

When a tenant violates a lease covenant – perhaps by operating outside their permitted use class or making unauthorised alterations – the landlord has several potential remedies:

Forfeiture proceedings – For serious breaches, the landlord may be entitled to forfeit the lease and terminate the tenancy early. However, this remedy is subject to strict legal requirements. Before forfeiting, the landlord must serve a Section 146 notice under the Law of Property Act 1925, formally notifying the tenant of the breach and providing a reasonable opportunity for the tenant to remedy it. Only if the tenant fails to comply with this notice can the landlord proceed to forfeit the lease, typically by physically re-entering the premises and changing the locks.

Forfeiture is a drastic remedy and should only be pursued after taking legal advice, as procedural errors can render the forfeiture unlawful and expose the landlord to significant liability.

Damages claims – The landlord can pursue financial compensation for losses suffered due to the covenant breach. This might include lost rental value if the breach makes the property less attractive to future tenants, or costs incurred in rectifying unauthorised alterations.

Injunctive relief – In appropriate cases, the landlord can seek a Court injunction compelling the tenant to cease the breach or perform specific obligations, such as removing unauthorised signage or ceasing prohibited business activities.

Landlord breaches

When a landlord breaches restrictive covenants owed to the tenant, the remedies available differ from those available to landlords:

Specific performance – Tenants cannot typically forfeit their lease due to landlord breaches; however, they can apply to the Court for an order of specific performance, compelling the landlord to comply with their obligations.

Injunctions – If a landlord threatens to breach a covenant, such as by planning to let adjoining premises to a competitor in violation of an exclusivity clause, the tenant can seek an injunction to prevent this breach.

Damages – Tenants can claim financial compensation for losses suffered due to landlord breaches, such as lost profits resulting from the landlord permitting a competing business in violation of an exclusive use covenant.

Mitigating disputes over commercial lease covenants

Prevention is invariably better than cure when it comes to covenant disputes. Clear, unambiguous lease drafting at the outset helps avoid future disagreements about what is and isn't permitted.

Both parties should:

1. Ensure they fully understand all covenant obligations before entering the lease
2. Maintain open communication about intended activities or changes
3. Seek landlord consent in writing before undertaking any action that might breach a covenant
4. Document all agreements and variations formally through deeds of variation
5. Take legal advice promptly when uncertainty arises about covenant compliance

Negotiating covenant releases and variations

During a tenancy, circumstances may change such that existing covenants become problematic or obsolete. A tenant's business may evolve beyond the original permitted use, or market conditions might make certain restrictions commercially unviable.

In such situations, it's often possible to negotiate a variation or partial release of the covenant with the landlord. This negotiation should be approached professionally:

1. Clearly explain why the variation is needed and how it benefits both parties
2. Demonstrate that the proposed change won't adversely affect the landlord's interests or other tenants
3. Be prepared to offer consideration for the variation, particularly if it materially benefits the tenant
4. Document any agreed changes through a formal deed of variation executed by both parties

The distinction between lease covenants and freehold restrictive covenants

It's important to understand that restrictive covenants in commercial leases operate differently from restrictive covenants affecting freehold land:

1. Lease covenants are contractual obligations between the landlord and the tenant
2. They bind the parties for the duration of the lease term
3. They don't "run with the land" in the same way as freehold covenants
4. Different legal principles govern their enforceability and remedies for breach
5. The Upper Tribunal has no jurisdiction over commercial lease covenants (unlike freehold restrictive covenants)

When to seek legal advice

Commercial lease covenant disputes can quickly escalate and result in significant financial consequences, including the loss of business premises. Legal advice should be sought promptly if:

1. You're uncertain whether a proposed activity would breach your lease covenants
2. You've received a Section 146 notice or other formal breach notification
3. You believe your landlord or tenant is breaching covenant obligations
4. You're considering forfeiture proceedings
5. You need to negotiate a covenant variation or release
6. You're facing potential litigation over covenant breaches

Early legal intervention can resolve disputes through negotiation, avoiding costly and time-consuming Court proceedings.