Colocation – lease or licence?

What is the difference? A licence is a personal permission to occupy property while a lease constitutes a legal estate and can give the occupier significantly enhanced rights to remain in occupation and/or renew at the end of the contractual term.

This question arises when looking at colocation agreements in relation to data centres.

If one were ever to find oneself in Court faced with the question of whether the property owner and the occupier have created a lease or a licence the Court would look at the substance of the agreement rather than what the agreement calls itself. 

There are certain indicators that a Court will hold as pointing towards the agreement having created a lease, the most important of which is whether the agreement has given the occupier exclusive possession. What that means is whether the agreement provides for the occupier to be able to exclude third parties (including the owner apart from specific rights of entry it has reserved) from the premises it has taken. Other lease indicators include the reservation of a rent and the grant of rights for a fixed period.

In a data centre context, one will typically find two scenarios. Firstly, there is the installation of servers in a shared room controlled by the data centre provider and secondly, there is the grant of rights to use a separate private cage or room.

Where there is a room shared by various entities, an occupier’s colocation agreement is likely to create a licence. The data centre owner will control and operate the room and there will be no question of any of the users having exclusive possession.

However, where the occupier takes its own cage or room the position could well be different. If the occupier is granted rights to exclude third parties from the space it has taken then there is a risk that, whatever the colocation agreement may call itself, it in fact creates a lease.

The potential issue with a lease is that it may then have security of tenure under the Landlord & Tenant Act 1954 and this, in theory at least, will mean that it is more difficult for the owner to terminate the agreement at the end of the agreed term and will give the occupier statutory rights of renewal on the same terms and at a “market” rent.

Frequently people seek to avoid this outcome by including provisions in documentation aimed at avoiding any suggestion that what is being created is a lease. These will typically include provisions stating that the agreement constitutes a licence not a lease, a statement that the owner retains possession and control of the property being licensed, a statement that the licence being granted is personal, and a provision that the owner can move the occupier to alternative space on notice.

It isn’t clear whether this approach will always work in a data centre context.  It is established law that the fact that an agreement calls itself a licence won’t make it a licence (although there has been some judicial comment in more recent years potentially lending more weight to arguments that it does).  As for the owner retaining possession and control, typically a party taking its own room or cage will want to ensure that it has control over that area itself.  As for the agreement being personal, whilst a true occupational licence will be personal, there are many leases that prohibit assignment.  Finally, what is the position when an occupier signs up an agreement providing for relocation in a data centre where relocation is not a practical possibility?

Is any of this a concern in practical terms?  Providers in general appear to take the view that, even where exclusive possession is being granted, it is easier just to have people signing up on standard colocation agreements.  Furthermore, given the particular nature of the data centre market, one rarely hears concerns voiced regarding the potential risk of renewal on the same terms and at a rent potentially determined by the Court. However, providers would be advised to bear the legal possibilities in mind.

For more information, please contact Andrew Stobbart.