Turnover Leases: a flexible alternative to open market rents

The Covid-19 pandemic has caused huge disruption in the retail and hospitality sectors and with businesses often unable to trade at previous levels and cover their costs, landlords and tenants are increasingly looking at ways of restructuring existing lease arrangements to deal with the unprecedented market conditions which now exist.

One solution which is being advocated by tenants is the introduction of turnover based rents. Opting for a turnover rent arrangement is one method of spreading the risk between landlord and tenant and tying the rent payable to the tenant’s trading performance is, in the current market, being seen as fairer than a traditional open market rent.

There are various types of turnover leases. Up to now, however, these have generally only been used in factory outlet centres and retail units at airports and railway stations, with the relevant mechanism being one of the following:

• rent based solely on an agreed percentage of the tenant’s turnover;
• tenant pays a minimum base rent OR turnover rent based on an agreed percentage of gross turnover. In this case, the rent payable is the greater of the base rent and the relevant percentage of gross turnover;
• tenant pays a minimum base rent with a top-up based on a percentage of gross turnover above an agreed amount eg 10% of gross turnover in excess of £700,000.

There are a number of important factors for the parties to consider enabling turnover leases to work effectively. Below are some examples:

Keep open provisions

From a landlord’s perspective it is essential that the tenant is obliged to keep the premises open for trade during agreed hours and days of the week. There will be exceptions where the premises cannot be open due to damage or destruction or where the tenant is carrying out permitted alterations or repairs. There should also be exceptions for force majeure events and where it would be unlawful to open the premises due to government restrictions resulting from pandemics or epidemics.

Notional turnover

Where the tenant does not open for trade in breach of the keep open provisions there should be a notional turnover to be applied to the tenant. This will be based on historical trading figures.

Calculation of turnover

In addition to physical sales made at the premises landlords often want to include online orders placed in store and click and collect orders placed remotely but collected from the premises. This can be problematical for certain retailers who wish to keep the definition of turnover as narrow as possible. Account does however have to be taken of the way goods are now sold through various channels and what part the physical premises play in creation and/or the fulfilment of such sales. Consideration also has to be given to the treatment of gift vouchers, staff discounts and returns.

Alienation

From a landlord’s perspective strict control over assignations and the prohibition of subletting is critical. Whilst a landlord might be prepared to accept a turnover arrangement with its original tenant it should not be forced to accept such an arrangement with a new tenant and in the event of an assignation the landlord should have the right to insist on the rent reverting to an open market rent.

Break rights

If turnover is too low or a tenant is not properly reporting its turnover provisions then a landlord might wish the option to break the lease.

Audit

The landlord should have the ability to audit the tenant’s accounting records to determine whether the turnover is being properly reported. If there is a shortfall discovered the tenant should have to pay for the audit.

Confidentiality

This is critical from the tenant’s perspective especially as the landlord will be entitled to have access to a very wide range of sales information to support the turnover certificate provided by the tenant.

Turnover rent leases are not always straightforward in terms of drafting and administration but they do go some way to striking an important balance between risk and reward for both landlords and tenants in today’s climate. These types of leases are likely to play an increasingly important part in the survival of our struggling High Streets and shopping centres.

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