Leasing issues to consider when negotiating a lease of new premises

by DC Strategy 4th of April, 2019

1. Leasing issues to consider

A major consideration of many new businesses starting out is to secure premises from which to operate the business.
A large number of businesses in Australia operate from leased premises, whether they are commercial, industrial or retail. Leasing of business premises is far more common, particularly commercial offices and retail
shops.

The advantages of leasing of premises, include:

less capital required to lease a premises;
more flexible arrangement where a business owner is able to exit the premises after a set period of time without having money tied up in the premises;
rent is deductible.

In basic terms, a lease is a right granted by the owner (landlord/lessor) to the occupant (the tenant/lessee) to use the land or building in return for regular payment (rent).

A lease constitutes an interest in land, which can be registered on the title of the land in
Australia. When signing a lease, it is important that you make the effort to negotiate a fair lease before
taking occupation of the leased premises.

Too often tenants concentrate on the most obvious lease terms – such as the commencing rent;

rental increases and option terms – but disputes often arise between landlords and tenants regarding provisions in the lease which are generally not focused on during negotiations.

Here are some examples:

2. Permitted Use – make sure the permitted use under the lease is compatible with the zoning of the land. The misconception is that ";permitted use" means ";use permitted by both the landlord and the local authority";.

The tenant is responsible for obtaining its own approval from all competent authorities for the conduct of the business.
If that business may not be legally conducted in the premises, the tenant may still be required to pay rent under the lease (subject of course to any claims under misleading and deceptive conduct under s.18 of the Australian Consumer Law (Sch 2, Competition and Consumer Act 2010 (Cth)).

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3. Market Rent Review – many landlords will offer incentives to tenants to enter into a lease.

When negotiating it is important to understand the difference between the terms

"face rent" - the rent figure written in the lease document and the term

"effective rent" - the rent figure arrived at after reducing the face rent to take account of the value of any incentive provided to the tenant.

Disputes often arise at the time of exercise of an option to renew where the rent is to be reviewed to market and an incentive was granted for the initial term of the lease to induce the tenant to enter into the original lease.
A market review mechanism in a lease usually includes a provision that protects the landlord's recoupment of the incentive via a "face rent" determination for mid-term market rent review (i.e the quoted rental rate before taking into account incentives or increases).
A tenant should therefore ensure that the lease terms provide for the market rent review mechanism to clearly reflect that there is to be an "effective rent" determination at the commencement of the option term (ie giving consideration to rent free periods or up-front incentives).
If this is not done, the tenant will find itself paying an artificially inflated commencing rent in the option term in circumstances where no incentive has been received for the option term.

4. Make Good/Reinstatement Obligations – often at the end of the lease term, disputes arise in relation to the extent of the tenant's reinstatement obligations.

The lease should allow the tenant to make an election to pay a "make good amount" to the landlord instead of undertaking a physical make good of the premises, which will allow the tenant to continue to trade in the premises until the end of the term rather than vacating well ahead of the end of the term (whilst continuing to pay rent) in order to undertake a physical make good.

5. Directors Guarantees - where directors guarantees are given for the obligations ofthe tenant under a lease, the landlord will usually require the guarantors to "stay onthe hook" on the assignment of the lease so that a guarantor is liable for the assignee's obligations under the lease.

Tenant's should consider the risk when asked to provide a directors guarantee; and
Should negotiate to provide a bank guarantee or security deposit as the only form of security required under the lease.

6. Encumbering the Lease – often a tenant agrees to enter into a lease which prohibits the tenant from encumbering the lease.

In circumstances where the tenant has granted charge over all its assets in favour of a financier, the tenant is placed in immediate default of the lease.
It is important for the tenant to negotiate an amendment to such a restrictive provision prior to the lease being entered into so that the grant of security to its financiers is not prohibited.

7. Relocation and Demolition Clause – If your lease is in a shopping centre, your lease may contain what are commonly known as relocation and demolition clauses. These clauses give the landlord the right to either relocate you to another premise within the centre (relocation), or terminate your lease if they are going to redevelop the centre (demolition). These types of clause may have a significant impact on your business and the fitout installed in the premises. It is best to negotiate with the landlord to have such clauses removed from the lease. However, in essentially all shopping centre leases, landlords will resist such requests, and in such circumstances, you should then try to water down the operation of the clause so that the risk to your business is minimised. Sections 34 and 35 of the Retail Lease Act 1994 (NSW) provide some protection to the tenant (ie the business owners operating from those premises) from
the consequences of relocation and demolition, whereby a landlord must comply with strict notice requirements and responsibility for compensation.

Conclusion

In addition to the above, tenants should consider the possibility of seeking rent free incentives and landlord contribution towards fitout. It is important that tenants/business owners negotiating a new lease obtain professional advice and speak to their lawyer before agreeing to and/or signing any lease offer with the landlord.