The first thing that should be resolved when setting the terms of a new lease is “will the lease be a retail lease?”. If so the terms of the lease will be governed by the retailing leasing law of that state in which the premises are located. Defining “what is a retail lease?” and the exclusions from the law differs from state to state and advice should be obtained as to the application of the law to the lease of the premises.
Disclosure Statements must be given to tenants with respect to all retail leases. They must provide the tenant with accurate information as to the nature of the premises and of the obligations such as the outgoings and expenses with respect to the premises likely to be payable by the tenant.
Failure to provide a Disclosure Statement carries serious consequences.
- The tenant can resist payment of rent until a Disclosure Statement is provided.
- The tenant can terminate the lease within 3 months of having commenced occupation.
In New South Wales:
- The tenant can terminate the lease within 6 months of the lease being entered into, unless the landlord acted “honestly and reasonably” and the tenant is “in substantially as good a position” had the failure not occurred.
These are extremely ugly consequences for the landlord!
There are also many restrictions upon the provisions a landlord can include in a lease. If the lease is inconsistent with these provisions, then the retail leasing law will prevail.
Among the prohibited provisions are restrictions upon the outgoings and expenses with respect to the premises which the landlord can recover from the tenant. The landlord will need to make sure that the base rent is enough to cover paying these expenses and still leave the landlord with sufficient moneys to properly represent the appropriate “leasing value” of the premises. If the landlord ignores the retail leasing law and provides in the lease that the tenant is to pay prohibited outgoings and expenses and the tenant later properly resists, this may mean that the landlord falls well short of obtaining the appropriate “leasing value” of the premises.
Works to be undertaken before a Tenancy commences
Often premises have to be altered before the tenant can move in and commence business.
Before the work begins a detailed specification should be approved by the landlord. Often the landlord will need to undertake some preparatory work and/or changes to the services to the premises.
Arguments can arise as to the quality of the work and who is going to pay for it. The landlord will be keen to make sure that the tenant has not engaged Basil Fawlty’s “O’Reilly the Irish builder”.
The parties should also agree whether the alterations need to be “made good” at the end of the tenant’s occupancy, or whether they will become the property of the landlord. Usually the latter is the best option for the tenant.
Repair and Maintenance
Generally speaking the tenant is obliged to undertake all “non-structural” or “non-capital” maintenance of and repairs to the premises.
It is very difficult to establish where the line falls between “non-structural/non-capital” and “structural/capital”. A good practice is to set up in tabular form an extensive list of repair and maintenance items indicating whether they are a landlord or tenant responsibility.
Essential safety measures
Landlords usually want most obligations with respect to the premises met by the tenant.
Obligations such as many of those imposed by essential safety laws are not capable of being delegated.
If these obligations are cast upon a tenant by the lease then they are unlikely to be enforceable.
A better practice is to build the cost of complying with these obligations into the base rent – with the added benefit that the landlord knows that the obligations have been met and properly met.
The tenant is usually focussed upon getting into the premises and running the business – not upon what will happen when the occupancy ends. There can be a high cost to not thinking about the issues to be addressed by the parties at the end of occupancy.
The first thing the parties should do is determine the condition to which the premises are to be returned upon the tenant’s occupancy ending.
The usual proposition is that the premises must be returned to their condition as at the commencement of the tenant’s occupation, subject to “fair wear and tear”. However if the premises have been “refreshed” it may be that a later date is chosen.
The parties should jointly prepare a condition report, recording the “base condition” to which the premises should be returned. This is now a much simpler process than formerly. Telephone cameras can create a digital record which can be stored and used as a comparison point for assessing the condition to which the tenant must return the premises.
The Lease should also be clear as to which fixtures and other improvements to the premises the tenant may or must remove. For instance if the tenant has installed carpet there is little value to the tenant in removing it after their occupancy ends –it is highly unlikely to be usable or saleable and it will cost them money to remove it and take it to the tip. The tenant’s best case would be for the landlord to accept that the carpet need not be removed.
Tenant’s Contribution to operating expenses
The landlord can receive payments by a tenant on the basis of either:
- A “gross rent” – the landlord does not require that the tenant contribute to the cost of the outgoings or expenses with respect to the premises; or
- A “net rent” – in addition to the rent the tenant must pay defined outgoings or expenses with respect to the premises.
If the outgoings or expenses which the tenant is either to meet or reimburse are understated in the Disclosure Statement then the tenant may be in a position to say that the landlord misled the tenant into entering the lease by understating the occupancy costs – if successful in this claim this may result in the landlord having to pay damages to the tenant or to a reduction in the payments received under the lease.
Some outgoings and expenses will not be legally recoverable with respect to retail leases e.g. land tax in Victoria. The landlord must build these costs into the rent, rather than seeking to recover them from the tenant.
“Ratchet clauses” are not permitted under retail leases law i.e. a provision to the effect that the rent cannot fall upon rent review.
Landlords should be careful in applying “current market” rent reviews. Not complying with the process set out in the lease may have the consequence that the rent remains unadjusted.
A prudent landlord should seek that the tenant secures it obligations under the lease.
The most common forms of “security” are:
- Directors Guarantee’s for corporate tenants;
- Cash bonds; and
- Bank Guarantees.
A landlord should have the directors or principal shareholders of any corporate tenant provide personal guarantees. At that time the landlord should also request that the guarantors submit a verified statement of their personal financial positions, so that the landlord has a better idea of their capacity to meet any claim upon them and also to know how they might best direct recovery action if the need arises.
The problem with obtaining directors guarantees is that if the tenant is struggling to pay the rent or meet its obligations under the lease, then its directors are also likely to be struggling financially! Furthermore, it is a rare guarantor who immediately writers a cheque when the landlord calls upon them to meet the tenant’s default. As a landlord, having to recover your losses through litigation means more pain.
Better security strategies are to obtain from the tenant either a cash bond or a bank guarantee.
If a cash bond is obtained, the landlord’s interest in the cash bond should be registered on the Personal Property Security Register – otherwise upon insolvency an external controller of the corporate tenant may claim these monies.
If a bank guarantee is obtained it is essential that the landlord ensure that the bank guarantee:
- Either does not have an expiry date, or an expiry date well after the end of the expected occupancy period; and
- Is addressed to the correct landlord entity.
Options to renew
An option to renew is a benefit to the tenant only – the tenant may choose to take a further term of lease, but is not obliged to do so. The landlord is ordinarily bound.
Mostly the landlord will want the tenant to continue, but there will be instances where the landlord wants the premises free of the tenant – for example where they have development plans for the property.
There are traps for both landlords and tenants.
The tenant must ensure that the option for renewal is exercised strictly in accordance with the terms of the lease. Close enough is not good enough. If the option requires exercise by a certain date, then it must be exercised by that date. One day later will not do. The landlord can decline to accept the exercise of the option if it is late. Tenants should diarise the opening and closing dates for exercise of these options.
If the option says that it must be in writing, then it must be in writing. It is not enough for the tenant to telephone the landlord and tell them that they are exercising their right to renew.
It must be notified to the correct person – if it requires notification to the landlord, then notification to the landlord’s solicitor or agent will not be good enough.
The trap for the landlord is that if the tenant has not been a good tenant, the landlord may not wish to have the tenant renew the lease. If the landlord wants to rely upon poor past performance by the tenant then it must have issued written notices requiring the tenant to comply with the terms of the lease, which generally must still be outstanding at that time.
Assignment of Lease
Generally the landlord’s consent to an assignment of the lease from the current tenant to a proposed new tenant must be obtained.
It will be up to the current tenant to satisfy the landlord that the proposed new tenant can replace them.
If the tenant wants to avoid delay in the landlord considering the new tenant, then it should be proactive and obtain detailed information from the proposed tenant as to their financial position and prior appropriate experience relating to the use of the premises.
The landlord must ensure that the “assignment clause” gives them sufficient grounds to reject a proposed tenant “reasonably” and to request and receive adequate information about the proposed tenant.
The landlord cannot recover any of its costs of preparing a new lease from a tenant with respect to a retail lease. This is open for negotiation with respect to non-retail leases.
Generally the landlord’s costs incurred by considering an application for consent by the tenant (such as an assignment of lease) will be paid by the tenant. The parties should be clear as to the basis and extent of this cost recovery.
What to do to avoid disputes
Address all issues thoroughly at the time the lease is prepared and before the tenant occupies the premises.
Take the time necessary to get it right.
Do the background work.
Get it in writing.
Use a good commercial property agent or lawyer to assist you if the issues may be complex or unusual.