Business, Property & Finance

Agreements to Lease – Clauses for Consideration

on Wednesday, 08 June 2016. Posted in Business, Property & Finance, Leasing

Agreements to Lease – Clauses for Consideration

This Guide focuses on break or early termination clauses, make good or reinstatement clauses, rent review and ratchet clauses which are commonly negotiated for agreements to lease and the issues to be considered when negotiating these clauses.

Break or Early Termination Clauses

This type of clause allows the landlord and/or the tenant to end the lease in certain circumstances. A landlord may want a break clause to regain control and possession of the premises in order to redevelop the property for greater return or sometimes to provide room for expansion for a major tenant.

A tenant may require a break clause to provide an exit path from a lease if a particular business or business strategy is proving unsuccessful or hopefully is proving so successful that a need for bigger premises has arisen.

If required by a landlord: Where a landlord requires such a clause in a lease the tenant will want to ensure that:

  • There is ample length of notice to be given to the tenant to facilitate relocation.
  • Notice can only be given in specific circumstances, for example if the premises are required for redevelopment. Otherwise, the landlord may use the termination provision to leverage more rent from the existing or a future tenant.
  • Any notice to be given is to be given in writing and properly served on the tenant.

A termination provision is sometimes seen by the tenant as a preferable option to subletting or assignment where the tenant no longer requires the premises. Not only does it overcome the difficulty of having to find a subtenant or assignee who is prepared to pay the same rent and take on the lease obligations but it also terminates any obligation as between landlord and tenant. Under an assignment or sublease the tenant remains responsible for performance of the lease term through to its end.

Where a tenant has a break clause in its lease it should regard the lease as having a term of the length of the notice which the landlord must give. This is because notice could be given by the landlord the day after the term has commenced, unless of course the lease termination provision provides that it cannot be given for a certain time.

Break clauses should be considered when assessing a tenant's reinstatement obligations at the end of the term.

If required by a Tenant: If a tenant seeks a break clause the landlord will want to consider:

  • Higher rent if the tenant is potentially less stable, although the impact of that may diminish if the break clause cannot be implemented for a specified time.
  • Certainty as to reasons for exercising the option to terminate the lease for example, business difficulty, requirement for more space.
  • The right to provide or at least offer alternative premises whether small or larger.
  • A penalty for the early termination and to ensure that the tenant (and guarantor) is not relieved of any of its obligations, for example make good, by exercising the termination option.

MAINTENANCE AND MAKE GOOD OBLIGATIONS

Most leases contain a provision to the effect that the tenant has the obligation to keep the premises in the same clean order repair and condition as they were at the commencement of the lease. Most leases also contain a redecoration obligation for example in the ADLS lease to "paint and decorate those parts of the interior of the premises which have previously been painted and decorated when the same reasonably require repainting and redecoration."

The tenant needs to take care when entering into a lease that it will not be assuming an obligation to ultimately benefit the landlord without having some compensating obligation on the part of the landlord either by way of rent reduction or contribution to redecoration when that is deemed necessary.

If the lease requires the Tenant to replace or make a contribution towards carpet maintenance the tenant needs to make careful assessment of the condition of the carpet and other floor coverings at the commencement date to ensure that it does not face a large bill to replace floor coverings or make a substantial contribution to wear which has occurred before the term.

MAKE GOOD OR REINSTATEMENT

These types of clauses require the Tenant to remove all of its fixtures and fittings and strip down the premises so that they are in the same condition they were on commencement (ie before the tenant's fitout). They can come as a great surprise to tenants particularly when the fitout is in good condition and they think the landlord will simply re-let the premises making use of what they leave behind. Although this may be the case, it does not release the tenant from its obligations.

In order to avoid arguments, not only is clear lease documentation necessary but also a clear record of the state of the premises at the commencement date is essential. The use of videos, photographs, carefully written descriptions and plans agreed to by both parties will often help. The current ADLS lease has provision for a Premises Condition Report to be included in the lease.

Some alternatives which may be negotiated at the commencement or renewal are:

  • transferring the tenant's fitout to the ownership of the landlord;
  • reaching agreement that the parties will make an objective determination at the end of the lease (with the assistance of external experts) as to what part of the tenant's fitout may remain on the premises;
  • by agreeing a programme of works to be carried out by either or both parties over the term of the lease so that, at the lease end, the fitout remains but remains in such condition and configuration as the landlord accepts will enable it to re-let the building or premises readily; and increased rental in conjunction with removal of a make good obligation.

RENT REVIEWS AND RATCHETS

It is common for a landlord to seek to have a ratchet clause in the lease which provides that the rental on review will not fall below rental as at a certain point in time eg commencement.

Neither the landlord nor tenant should consider these options as written in stone and incapable of being negotiated.

Where exposure to unlimited increases in rent are a concern for a tenant, it may be possible to negotiate a "ceiling" on any increase. Where a landlord is concerned about unlimited decreases in rent, it may be possible to negotiate a "floor" with rentals at review moving between those figures but neither above nor below them.

Increases governed by movements in the consumer price index seem, once again, to be finding favour with landlords and tenants. For those of us old enough to remember "stagflation", there is always a nagging uncertainly about such formulae which may bear little reality to current market rent movements in a particular area or building. Often these clauses are expressed in the alternative as being the higher of CPI or market.

All these provisions are aimed at giving some certainty and in many cases the wish for speedy resolution of rental reviews.

There is probably little wrong with the current ADLS form of rent review which in effect does no more than expose both parties to the market place with something of a cushion for the landlord in terms of the ratchet to commencement date (of the then current lease term) rent.

One matter which is rarely addressed in leases is the timing of rent reviews on renewals. There are often lengthy periods of notice required to be given by tenants of their intention to renew and invariably that notice must be given before the rent review is determined. A prudent tenant may take valuation advice as to what the likely rent will be on renewal but valuation being an art and not a science, so they say, the tenant may still be faced with a renewal and a greater rent than anticipated. A tenant could seek to have a provision in its lease where it is not permitted to renew until rental is determined. As a tradeoff would it be reasonable for the tenant to meet the landlord's costs of the review if the tenant did not renew?

For a landlord such a provision could mean going through a lengthy rent-setting process with the tenant who then either does not renew or still maintains that it will not renew at that rent and attempt to force the landlord's hand towards a lower rental rather than face the cost of obtaining a new tenant or run the risk of having premises empty.

Again, this is an area for negotiation and, not one that should be overlooked.

CONCLUSION

Inevitably there will be occasions where landlord and tenant disagree over something. Frequently these disagreements occur over issues relating to who is responsible to do or pay for what.

It is probably not possible to eliminate such disagreements but clearly written documents will certainly give a better basis to work from than a brief document that relies in part on terms implied by the common law or statute. Similarly a report on the condition of the premises included in the lease will be a better aid to determining obligations of maintenance and make good than will unreliable memory or no memory where both landlord and tenant were not the original parties to the lease.

It is better to spend time and effort and yes legal fees up front to get the documentation as good as it can be than to spend three times the amount of time effort and legal fees to find out what a judge or arbitrator determines your obligation to be.

For more information about negotiating and drafting an Agreement to Lease, please contact Ian McCombe, Brookfields Lawyers 0508 Brookfields or .

DISCLAIMER

This information is intended to be general in nature. You are strongly recommended to seek your own legal advice in relation to the matters dealt with here.

© Brookfields Lawyers 2016 – All Rights Reserved

 

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