Long-term leasehold developments typically involve multiple stakeholders, including the principal lessee (original lessee) as well as a further transferee to whom the right to use the property may be subleased or further assigned (sublessee/assignee). The original lessee may assign its leasehold interest, create subleases over individual portions of the property, or construct and transfer interests in residential or commercial units.
As a fundamental rule, all interests or rights of assignees originate from the underlying lease. As such, a person deriving title through the lessee cannot ordinarily obtain a greater subsisting interest in the land than that held by the lessee. As an illustration, where the underlying lease is for a fixed term and determines by efflux of time, an assignment or sublease granted out of that interest cannot, merely by its own terms, convert the underlying tenure into a perpetual one. In such situations, frequent questions may arise regarding the nature of the downstream transfer, survival of interests upon different modes of termination, post-expiry occupation, structures erected on the land, third-party financing and, in the case of Government land, the application of special statutory or policy regimes.
Some of the important factors that require consideration are the following:
- Downstream transfer mechanism: The legal relationship between parties in the context of leases can be through an assignment and a sublease, which are distinct concepts. A sublease carves a lesser interest out of the lessee's own estate, leaving the original lessee with a reversionary interest and preserving the head lease between the lessor and the original lessee. On the other hand, in an assignment, the lessee ordinarily transfers its entire remaining leasehold interest to the assignee. An assignment therefore bestows more contractual rights than a sublease, which has two important consequences:
- While privity may arise between the principal lessor and the assignee in respect of covenants running with the land, the original lessee remains liable for the contractual obligations it undertook under the lease as per Section 108(j) of the Transfer of Property Act, 1882. Accordingly, an assignment does not, by itself, release the original lessee from its contractual liabilities.
- If the lessee had a contractual right to extend or renew the principal lease beyond its original period, the same may be exercised by the assignee.
- Determination of lease: The manner in which the underlying lease comes to an end is equally important, because expiry, surrender, and forfeiture do not necessarily produce identical consequences for downstream interests:
- Efflux of time: Where a fixed term simply expires by efflux of time, the estate out of which the derivative interest was created has itself run its course.
- Voluntary surrender: A sublease stands on a different footing in case of a voluntary surrender by the original lessee before expiry of the principal lease term. Once the lessee has already created a sublease, it cannot necessarily extinguish that interest merely by agreeing with the principal lessor to surrender the principal lease, as the surrender of a lease does not prejudice an underlease previously granted under Section 115 of the Act. In such a case, the sublease becomes the principal lease and the sublessee steps into the shoes of the original lessee.
- Forfeiture: Forfeiture brings the lease to an end before its agreed term because of a specified default or conduct of the lessee, such as breach of a lease condition, or asserting a contradictory title to the property under Section 111(g) of the Act. Forfeiture of the principal lease ordinarily annuls the underlease as well, unless it has been procured by the lessor in fraud of the sublessee, or where the Court grants relief under Section 114, based on the lessee paying the arrears or furnishing security.
- Holding over v. renewal: If upon expiry of the original fixed term, the lessee or sublessee remains in possession, and the lessor accepts rent or otherwise assents to the continued possession, a fresh periodic tenancy may arise. This is the doctrine of holding over recognised under Section 116 of the Act. The period of tenancy would be month-to-month or, in the case of an agricultural or manufacturing lease, year-to-year. Notably, this is conceptually different from renewal, which involves the continuation of the lease for a further fixed term pursuant to a contractual or statutory right to renew.
The distinction can be especially relevant in layered developments where, following expiry of the principal lease, the principal lessor begins dealing directly with an existing downstream assignee/occupant. However, a tenant paying monthly rent after expiry of the lease would not renew the lease for the complete duration.
- Structures constructed by the lessee/assignee: In many commercial developments, the land is leased, but the entire superstructure has been constructed at the cost of the lessee or downstream purchasers. While these elements may be treated as one asset commercially, it raises several legal questions on the expiry of the underlease: Whether the lease requires construction/improvements to vest in the lessor, whether removal is permitted, whether removal must occur before possession is surrendered, and whether the nature of the structure makes removal commercially or practically possible.
Section 108(h) of the Act recognises, subject to a contract to the contrary, a lessee's right to remove things attached to the earth by it while it remains in possession, even after determination of the lease. In Jamnadas Dharmadas v. Dr J Joseph Ferreira, the Supreme Court held that the tenant, having failed to remove the substantial superstructure, lost its rights in it and the landlord became entitled to possession of the land together with the structure.
- Leasehold rights as project security: In addition to the risk of the borrower defaulting, the lender’s risk also depends on the leasehold rights remaining valid. A lease with a long remaining term provides stronger security than one with a short remaining term or one at risk of forfeiture. If the leasehold property that secures the loan is lost, the lender’s security may be significantly weakened, even though the borrower remains personally liable for the loan.
Contractual protections such as notice to the lender before forfeiture, an opportunity for the lender to cure specified defaults, restrictions on voluntary surrender of the principal lease, recognition of enforcement transfers, and direct arrangements with the principal lessor are therefore extremely relevant to determine whether the security package protects the lender against events capable of destroying or materially reducing the underlying leasehold estate.
The principle that a downstream holder cannot ordinarily enjoy a greater subsisting estate than the person from whom it derives title therefore remains the starting point, but it should not be treated as the conclusion. The aforementioned factors have direct drafting and due-diligence consequences. These are not merely protective drafting points; each determines which legal relationship will govern if the underlying lease approaches expiry or is terminated prematurely. These considerations become heightened in the case of the original lessor being a Government entity, in which case the post-expiry rights of the assignee are determined by the policies applicable to long-term leasehold land. Importantly, a right to apply under such a policy is not necessarily equivalent to an automatic extension of the existing lease, and may entail additional/revised obligations, including an enhanced premium or other charges. Further, if the downstream transaction is represented as conferring permanent ownership, an assured renewal, or a tenure longer than the balance of the principal lease, the assignee/purchaser, who may have no right to compel the principal lessor, may nevertheless have a contractual or regulatory claim against the lessee for damages.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
