Analysis of Millstream Plc and Blue Horizons Merger

Millstream plc has its offices in the major city which is a prime location for business due to closeness to customers as well as access to a wider market. However, the company has recently merged with another company known as “Blue Horizons” which is in the same industry and deals with the same product line. However, the other company has its offices in the same country but it’s in a different location which is not as conducive to business. The location is 200 miles away from the city which translates to fewer business interactions. Millstream plc at the moment has approximately 1,400m2 of Grade A accommodation which is run on a single floor in Bream Building which is a very convenient location in the city and is held on the basis of a 10 year lease period.

The contract still has four years covered on the basis of an annual rent of £750,000, whereas the current value for rent of this property is on the annual rent of £850,000. The basis is that if the two companies are to combine, then definitely more space would be required to accommodate the increased number of employees, and infrastructure. The estimate is that the enlarged firm would require at least 2,300m² which would have to be in Breams Building. The Blue Horizons reports that they have approached their current landlord to terminate the existing lease which still has an active year based on a five-year term. The contract can be terminated if the rent of £175,000 is paid for the remaining year.

Dynamic market features

The office space sector is growing rapidly in London, meaning that new entrants are plenty. Therefore, this will be a major issue while assessing how the dynamic will affect the merger initiative. The other regard is that the manner in which customers utilize the office space, as well as how providers use this space is changing on a daily basis (Crosby, Devaney, and Law 2012). Therefore, there is the essence of limited office space, the other result is that irrespective of new office space models, yet the serviced office is still the best. However, Millstream plc evaluates the new models in order to factor in aspects of competition such as the co-working initiative.

Real estate for the legal framework in the UK

There is two major ownership status of real estate in the UK which includes the freehold and leasehold. The freehold status provides for indefinite ownership which is not limited by a specific period of time. On the other hand, the leasehold refers to the rights conferred to a party which allows them to use possession for the property for a limited period after which the lessee loses their rights and they revert back to the lease. In simple terms, the freehold interests would be better off for the merger because the company would not be able to have their rights terminated if they do not adhere to the set restrictions (Crosby, Devaney, and Law 2012). The amalgamation between Millstream plc and Blue Horizons would be better served by the freehold for the office space.

Another consideration is that in London, there has been strong occupier demand which has increased the market rent and there has been a recent trend of rent reviews which is quite unfavorable for the amalgamation as it may result to higher costs. The lease terms have increased to almost 7 years. A large proportion of the demand is associated with the rise in technology and the media industries which have pushed the demand for office space. Another development is that there has been a further increase in the serviced office providers which have been dedicated to the startup firms. There is also the need for the flexible space which controls much of the market, which means that the developers have to adapt quickly to the changing demands.

Real estate ownership

The planning administration in the UK is dependent upon the local planning authorities (LPAs) which is done in close collaboration with the local governments. The mayor in charge of London is able to govern the planning projects at the regional level. There are multiple statutes which govern the working of the planners such as the country planning Act of the year 1990 (David 2015). The implication is that the third parties such as individual companies can be able to make submissions with regard to the planning designs which are then determined by the LPA (Lizieri 2018).

Leases of business premise

Under the law governing the UK, the lessor, as well as the lessee, are supposed to enter the commercial lease on a voluntary basis. The law does not offer specific contents to be covered by a lease. Thus, there are only a few statutory provisions which affect the interaction of the two parties. The Code for leasing seems to focus on fair and flexible terms which mean that the two parties should negotiate and reach an agreement over aspects that seem favorable to all of them. There have been recommendations for more regulations to govern the industry, however, the industry is largely operated on a voluntary basis. In the past, the UK used multiple legislations and rules which made things move a bit slow and added to the complexity. There have been major reforms as the property owners have been focused to satisfy the demand and needs of the office holders. Therefore, the commercial leases are very different from the residential leases which are largely governed by multiple statutes (Lizieri 2018).

Term

Leases can be offered under various terms. The leasehold has a higher advantage as they can be held for between 99 and 150 years. The current form represents a change from the previous relationship where the terms were provided for a period of about 25 years, with there being shorter terms of about 15 years or even shorter (Lizieri 2018). A lessee is however given the right to terminate the lease provided the duration of 5 years has been completed.

Rent Increases

In the past, the contractual relationship for leases required at least five years before a rent review could be taken on the basis of the current rental value for the held property. There has been immense pressure requiring that there be better terms in the industry to make sure that the leases are flexible, however, it is still rare for the UK market to witness fluctuations in the rent on the basis of the market prices. The other rent review form which is experienced in the region is the price index, the problem is that this is only applied when the property rent is being reviewed upwards. Fixed uplifts can be accorded to the contracts, but this can only be done on the basis of several caps. In some cases, the VAT is charged from the property rent.

Lessee liability and security for rent payment

The Act of the year 1995 (LT(C) A) provided that the new leases should be exempt from liability once new leases are assigned. The move was contrary to the previous action where the guarantor would be held reliable for the duration of the lease as guided by the privity of contract even after the assignment date of the lease. Therefore, the set doctrine still applies to the lease contracts which were already complete before 1st January of the year 1996 (David 2015). The law further provided the AGAs where the lessor was covered by a guarantee for the outgoing lessee. The decision arrived at during the KIS Victoria Street v. House of Fraser Ltd and others clearly proved that even though the lessee’s guarantor may not be obligated to guarantee liability provided by the assignee, yet the lessee’s obligations are covered by the AGA provided by the lessee with regards to the assignee (David 2015). A lessor should also be on the lookout for other forms of security such as the rent deposit which ensures that regardless of the occurrences that their rights are safeguarded.

Repair and Insurance

The lessee for a business office space would be responsible for the liabilities which affect a given property this includes the maintenance charges as well as all the repair costs which are due. In the event that the property is let out to multiple parties, then these costs would normally be covered by a service charge. The lessor, therefore, provides insurance coverage for the property and pays the premiums, but the amount is deducted directly from the lessee. Therefore, the leases for contracts are always full repairing and insuring (FRI) provided under leasing. The FRI is crucial for real estate investors in the UK real estate as it provides a clear and consistent income stream (David 2015).

Termination

In the event that Lessee fails to remit the rent or goes against a certain obligation, the lessor is legally permitted to end a lease by forfeiture. However, the UK law allows a court ruling on the matter where the lessee would provide proof of why the breach was unavoidable. The other provision is that the right for forfeit applies when the lease becomes insolvent after the term is over.

Security of Tenure

The LTA ACT established in the year 1954, provides coverage for the lessees who occupy commercial buildings in England and Wales. In the event that a given property is occupied for business-related reasons, the lessee would be permitted to occupy the property until the term of the lease expires and can be granted a new lease on the basis of similar terms (David 2015). On the other hand, the law permits the lessor to decline the establishment of a new lease on one of few grounds as spelled out by the LTA. One of the grounds is where the lessor wishes to develop the property.

The security of tenure is very crucial as a right provided to the lessees and also affects the lessor’s future plans such as carrying further modifications on the property. During some leases, the parties involved agree to establish their contracts out of the provisions of the security of tenure, however, for this to be done, the notice should be provided to the lessee informing them that the details would be excluded. Thus the lessees would be required to provide a concise declaration where they agree to the set terms. However, it is the short leases which are normally contracted out of the security tenure because parties generally need to safeguard their wants (David 2015).

Tenants and insolvency

One of the cases which can be used to explain the occurrence of the insolvency is the lessors responsible for retail stores which had been leased by Game companies. Game-retail had gone into administration on 26th March in the year 2012 after the March quarter day, however, no rent was remitted. The High court in the Goldcare Limited v. Nortel Networks UK made a confirmation that the rent which is paid in advance cannot be recovered because it is not treated as an expense for the administration (David 2015). However, this was overturned by the Pillar Denton Limited and others v. Jervis and others where the court of appeal used the salvage principle theory and as such overruled the earlier decisions. Therefore, their determination was that rent would be treated as an expense during the time when the building was being used for the administrative purposes (Crosby, Devaney, and Law 2012). When evaluating the case of the stores belonging to Game, they ceased to hold the premises for the next quarter day, again the rent would be payable. Therefore, the lessors got back a total of £3 million which was for the March 2012 quarter (David 2015).

The ruling by the Supreme Court thus favors the lessors and comes as a warning towards the administrators from timing their appointments or using other dubious means in an attempt to avoid paying rent (David 2015). Therefore, companies should also be very keen to ensure that they effectively vacate the properties that are no longer being used, which means that Lessors can be left with vacant properties even prior to the completion of the lease term as will be the case in the Blue Horizons which will have to leave the offices with a year still remaining. The other observation is that the Supreme Court clearly spelled that no appeal would be allowed for Game Retail which meant that the court was certain that the decision made was actually the right one.

Counterfactual

Millstream plc assesses the merger in terms of the relative situation that would have occurred say if the merger was nonexistent. The pre-merger condition provides a better way of evaluating competition on a counterfactual basis as opposed to doing the same on the impact brought about by the merger. Therefore, the company will assess the pre-merger conditions to be the relevant counterfactual basis.

Solution

As the representative of Millstream plc, the first case is for the Blue Horizons. The company still has a year left on their contract. The agreement was for four years, and currently, only 4 have elapsed. Therefore, based on the tenants and insolvency guidelines in the UK and light of the several cases such as the Supreme Court ruling on the Game retail it would be appropriate to ensure that the rent of £175,000 is duly paid. The other aspect is that the company needs to vacate the premise much earlier to ensure that no extra charges accrue. The amount would be a loss to the amalgamation because there would be a payment for a whole year which would not be used. However, due to the existing business circumstances, the value would have to be regarded as collateral damage. Thus, much focus would be on getting a new office for the amalgamation needs as well as ensuring that the new business works smoothly.

Millstream plc had initially entered a 10-year lease at a yearly rent of £750,000 in a prime building in London. The site would be the best for the amalgamation since it is in the city and thus provides a more conducive office space. The main concern is that the existing space would be too little for the new company. The new company would require an additional 900m2 in terms of office space. The current term is safeguarded under the security of tenure, which implies that the company can still hold on to the existing property for the remaining 4 years unperturbed. The current lease is held on the basis of the full repairing and insuring which means that the additional space needed by the company can be acquired (Duffy, Cave and Worthington 2016).

The main focus would be to negotiate on the additional office space to be part of the existing lease. The security of tenure provides a provision for such a negotiation. The consideration is that the current 10-year lease has not yet matured, therefore, the new office space ought to be covered under it. The new company would want to avoid the current market valuation of the rent which currently stands at £850,000. A lease entered on the basis of the new valuation would be too expensive and would disadvantage the amalgamation. The current annual rent is for £750,000 for the 1400m2, therefore, the current rate features a charge of approximately £535.71 for every m2 of office space. Thus, the new lease should be entered for a total of £1,232,133 for the office space which would apply for the remaining period of 4 years. Therefore, after the term expires, then probably a rent review could be considered and negotiated between the two companies (Duffy, Cave and Worthington 2016).

The calculations show that the amalgamation would surely result in higher costs for office space noting that Blue Horizons was paying a comparatively low rent amount. However, the consideration of office space should not solely rely on the cost, there are other important factors such as business growth and the attraction of a wider market for the business. After the 4 years are complete, it would be advisable for the company to consider another contract such as a leasehold, which would guarantee the amalgamation the premise for a number of years, and would also result in fairer rent charges basically attracting some form of discounts (Duffy, Cave and Worthington 2016). The contract would also be entered in terms of the FRI which would mean that the lessor is attracted to the contract because there is some guarantee in form of the rent revenue received every year. The amalgamation should adhere to the contract rules established during the negotiation period to ensure that they do not attract unnecessary fines or possibly even termination.

References

Crosby, N., Devaney, S. and Law, V., 2012. Rental depreciation and capital expenditure in the UK commercial real estate market, 1993–2009. Journal of Property Research, 29(3), pp.227-246.

David Waterfield. , 2015. The Real Estate Law Review. https://www.slaughterandmay.com/media/2082938/the-real-estate-law-review-England-and-Wales.pdf

Duffy, F., Cave, C. and Worthington, J. eds., 2016. Planning office space. Elsevier.

Lizieri, C., 2018. Property ownership, leasehold forms, and industrial change. In Industrial Property (pp. 181-194). Routledge.