The difference between a licence agreement and a lease – and why it pays to make sure

If you occupy a commercial property or rent one out to a tenant then it’s vital that you understand the principles underpinning the agreement between the two parties, and in particular whether this agreement takes the form of a lease or a licence.

The two forms of commercial rental agreement have many similarities but differ, in the protection afforded to tenant and/or landlord. Understanding the key differences between the two is essential as  some cases have seen agreements that were intended by landlords to be licences actually interpreted by the court as being leases, with all that this implies for the future relationship between tenant and landlord. Landlords will often think that by granting a tenant a licence they are circumventing the security of tenure provisions of the Landlord and Tenant Act 1954, but often they are just building up problems for later.

Why agreements are important

The main similarity between a licence and a lease is the fact that both are written agreements setting out the details of the arrangement between tenant and landlord.

Both grant permission for the tenant to use all or part of a commercial property, and establish the parameters of that permission, however, there are substantial differences between leases and licences around the rights and obligations of each party.

In some cases, the fact that the commercial property is small, its rental period is relatively short, or that the rent is only a small amount, can lead to the misguided belief that the arrangement between tenant and landlord can be relatively casual in manner.

This often happens when someone rents out a commercial space on a short-term sis , with the thought that they are not going to be there for very long so I do not need a full blown lease. This is a mistake, since an occupier only needs 6 months occupancy on an exclusive basis of a space to gain security of tenure which is often not what is intended by the landlord.

6 months can go very quickly, and if the occupation is extended by the grant of another licence the landlord could easily end up with a tenant who has security of tenure in respect of the space which is not at all what the landlord wants.

The issue of rent increases is one which can quickly become fraught without an agreement in place. An agreement of any kind, if drafted properly, will set out the terms upon which a renewal of the lease can take place after the initial term, and how any change in the rent charged will be calculated. Often if a licence is granted enough consideration will not be given to future terms, as the original intention is very often short term.

In the majority of cases, this process will take the form of a rent review, based on a calculation of what the property would fetch if leased there and then on the open market, or an index-linked shift, which sees the rent increasing in line with inflation rates (the latter arrangement will have a ‘collar and cap’ provision written into it, stopping the increase rising or falling above or below agreed percentages).

Without provisions of this kind being set out in a written agreement, the tenant will be entitled, under the Landlord and Tenant Act 1954 (‘LTA 1954’), to have the tenancy renewed as it stands, with the landlord having little or no legal room for manoeuvre as far as altering any terms of that tenancy is concerned.

Similarly, taking possession of premises back following non-payment of rent is a much more legally complicated matter if an agreement of some kind is not in place, and even if a landlord is successful in persuading the courts that the lease should be forfeited and the property handed back, the tenant may be able to apply for relief which sets the tenant/landlord relationship back to what it was, simply by paying the rent they owe in the 6 months following possession of the property by the landlord.

These are just two examples of what a written agreement should always be agreed upon and drafted by legal experts.  The type of agreement very much depends on the specific circumstances or commercial requirements, but it is crucial to understand the differences between a lease and a licence agreement to be sure the most apt route is followed.

Leases

A lease is a contract agreed between tenant and landlord. It is a legally binding agreement which gives the tenant the right to use the property for commercial or business activities over a specified term. In return for this right, as set out in the lease, the tenant pays an agreed rental to the landlord.

As well as these basic principles, a lease will also set out the rights and responsibilities of the tenant and landlord. This includes who is responsible for repairs and maintenance of specific parts of the property, i.e. the interior and exterior, and usually an obligation for the landlord to ensure that the tenant has exclusive access to and use of the property without interruption during the course of the tenancy.

Some agreements may state, for example, that the tenant can refuse to admit the landlord to the property. Under the aforementioned Landlord and Tenant Act 1954 (‘LTA 1954’), the tenant will enjoy security of tenure and the right to remain in occupation at the end of the contractual term.

This is not the case if the parties agree to exclude the provisions of the 1954 Act when negotiating the terms of the lease, meaning that any renewal after the contractual expiry of the lease will be subject to new negotiations.

An arrangement of this kind is referred to as ‘contracting out’ and needs to be fully understood and agreed to by both parties. Once a lease is in place the tenant can remain in the premises for the agreed period of the contract even if the landlord sells the building to another party. The tenant can also sell the lease on to another party, but only with the consent of the landlord.

A licence

A licence is an arrangement which provides contractual permission for a party to occupy all or part of a commercial property. Unlike a lease, however, a licence offers no security of tenure, and can be ended when the party granting the licence wishes to do so.

Rather than tenant and landlord, the parties involved will be known respectively, as licensee and licensor. If the licensor opts to sell the property, then, unlike the situation which applies to a lease, the licensee will have no further right to occupy that property.

For many licensees the lack of security offered by a licence may seem unattractive, but there are still some scenarios – i.e. wanting to trade from a space for a limited seasonal market opportunity, such as selling Christmas trees – in which the speed and flexibility of a licence are appealing. For the landlord the fact that they can monetise a space quickly but still enjoy longer term options if a tenant seeking a lease agreement comes along is clearly desirable.

When is a licence, not a licence?

Landlords opting for a licence rather than a lease should be aware that it doesn’t matter what they call the agreement drawn up between the parties since, in the event of any dispute, the courts will judge examine all of the circumstances of the contents of the agreement and the nature of the arrangement, not any understanding of what it represented.

As a simple rule of thumb, if some or all of the following criteria are met then the licence may well in fact be a lease:

• The occupier enjoys exclusive possession of the premises.
• A regular ‘rent’ will be paid for the period in question.
• That period – a specific length of time – is set out in the licence.
• The licensee has been in occupation of the premises for a period in excess of 6 months.

In most cases if there is genuine doubt regarding whether an agreement is a lease or a licence, the court is likely to view that doubt as sufficient to decide that it is a lease. The principle likely to be applied in any dispute was set out by the Court of Appeal in the case of Addiscombe Garden Estates v Crabbe (1958), when it was stated that:

“(if) the right conclusion appears to be that, whatever label may have been attached to it, it in fact conferred and imposed on the grantee in substance the rights and obligations of a tenant, and on the grantor in substance the rights and obligations of a landlord, then it must be given the appropriate effect, that is to say, it must be treated as a tenancy agreement as distinct from a mere licence.”

Potential consequences of confusion

More recently, the case of London College of Business Limited v Tareem Limited (2018) illustrated just how important it is to ensure that the practical details of the operation of any agreement comply with the definition of a licence rather than a lease if that was what you, as a landlord, intended.

In this case, the owners of the property in question went to great lengths to ensure that the agreement they drew up only granted a licence, rather than a lease. This included making sure that the terms ‘landlord’, ‘tenant’ and ‘rent’ weren’t used, declaring that the right to occupy applied only to the owner of the property, reserving the right of the owner to enter the property at all times, and stating that the licensor remained in occupation of the property and retained possession. As well as being called a licence, the agreement included a clause stating the following:

“It is agreed that this agreement constitutes a personal Licence to occupy by the Licensee and shall not be deemed to constitute a tenancy within the meaning of the Landlord and Tenant Act 1954 (as amended) or otherwise…”

On paper this would seem to be unassailable, but when a dispute arose the court took an alternative view, with the judge stating that:

“…the court will be alert to the possibility that parties have included provisions in their written agreements whose only purpose is to disguise the fact that the reality of the situation is that a tenancy has been granted.”

Looking at the reality of the relationship between the two parties, which dated back several years, the court observed that the property owner would never, realistically, have had a commercial interest in interrupting the business to gain a right of entry. Plus,  over a number of consecutive ‘licence’ agreements, the owner had never once exercised the absolute right of entry which each of the agreements contained.

When the owner finally sought to gain entry to the premises, in fact, they contacted the occupier to arrange access. Having regard to this the court decided that the occupier, in effect, enjoyed exclusive possession of the property and there was therefore no reason for the agreement to be a licence, rather than a lease. It was judged that it was, in fact, a lease.

What this case helps to illustrate is that while the wording of any agreement may be vital – with certain terms and clauses automatically creating a lease rather than a licence – what is equally important is the day-to-day reality of the application of any agreement.

As such, it is imperative that both parties seek experienced legal counsel when entering into any such commercial agreement. Clarity of each party’s intentions should always be predefined to avoid confusion or unnecessary complication in the future, and no documentation should be signed without a thorough understanding of the potential consequences. We have recently seen a situation where the landlord’s redevelopment of the building was halted because the tenant  had been in occupation under a licence for two years. This could have been avoided with the grant of an excluded lease.

The team of dedicated commercial property lawyers at Newmanor Law can support in the creation and negotiation of both lease and licence agreements, as well as acting on behalf of tenants of landlords where there are agreement disputes. Contact us today for an impartial, confidential consultation.