Common Lease Problems

Leases are complex documents. They often deal with complex situations and/or complex relationships. This article explores some common problems and suggests strategies to overcome them.  At the outset the author acknowledges that this article owes much to Michael Redfern of Russell Kennedy Lawyers.

The permitted use

All leases restrict the tenants use of the premises to a use which may be highly specific (e.g. retail sale of cosmetics) or more general (e.g. retail shop). The restriction on use lasts for the full term of the lease and any renewal unless the landlord otherwise agrees. There is no obligation on the landlord to agree to a change of use.

If a tenant wants to transfer the lease the new tenant will be bound by the permitted use set out in the lease. This could have the effect of making the lease more or less un-transferable.

When the lease is negotiated the permitted use should either be so widely described so as to encompass any other contemplated use or should be specific but allow for “such other uses as the landlord may consent to such consent not to be unreasonably withheld”.

The initial rent

Rent is often based on a figure per square metre. The landlord and the tenant may have quite different views as to what areas are to be taken into account in establishing the rent. If the rent is based on a figure per square metre it makes sense to establish the precise area for which the tenant expects to pay rent and incorporate in the description of the rent the reference to the area and the rate of rental per square metre.

Rent review

A common method for reviewing rent to market is to provide that the landlord may give the tenant notice proposing the rent for the review period. If the tenant does not object within a specified period the proposed rent becomes the new rent. The danger is that the tenant can overlook the landlord’s notice or not realize that the notice requires an objection. It is preferable that the lease should provide that unless the tenant accepts the proposed rent within a specified time then the rent is to be determined by valuation.

If rent is to be determined by valuation the lease should be clear as to what factors the valuer is or is not to take into account. The lease should also provide for the valuer to give reasons for his valuation.

Tenants are frequently concerned when exercising their option for renewal because they do not know what the rent will be until after the option has been exercised. It should be possible at the outset of lease negotiations to have the lease provide that the tenant can give notice requiring the rent for the renewal period to be established by valuation and that the tenant thereafter has 21 days to elect whether or not to exercise the option.

Assignment/Transfer of lease

The Property Law Act (Section 144) provides that a lease which prohibits the transfer or subletting without consent (unless the lease contains an express contrary provision) is deemed to be subject to the proviso that consent is not to be unreasonably withheld. It is common for leases to provide a contrary provision i.e. that Section 144 of the Property Law Act does not apply. Either that provision should be deleted (or, and this is the more likely scenario) the lease will negative Section 144, but allow transfers or subletting with consent provided that certain prerequisites are met.

One common prerequisite is that a prospective transferee have at least as good financial standing and reputation as the transferor. If the tenant is a leader in its field there will be few transferees who would qualify. The test should be simply the transferee has good financial standing and reputation.

The transferability of a lease will most commonly arise on the sale by the tenant of his business. If the lease cannot be transferred the tenant will not be able to sell his business.

Repairs

Unless the lease specifically requires the Landlord to effect structural repairs then under the general law the landlord has no obligations to do so (but the landlord may be liable under the Retail Leases Act).  Leases normally exempt the tenant from carrying out structural works (unless the tenant is the direct cause of the work). The situation can arise when neither the landlord nor the tenant is liable. In that case the reality is likely to be the tenant will do the required work so as to be able to continue to effectively use the leased premises and carry on his business. The answer is to ensure that the lease requires the landlord to maintain the premises in water tight condition and in good structural repair.

Options to renew

Long term security of tenure may be important to a Tenant because:
–    the cost and inconvenience of moving to new premises is substantial;
–    the Tenant’s business may be reliant on being in particular premises or in a particular area
–    the saleability of the Tenant’s business may be dependant on the continuing right to occupy the rented premises.

Options normally give a right of renewal to the tenant only. From a tenant’s point of view it is preferable to have as many options as can be negotiated. After all, there is no obligation to exercise the options.

In the case of retail premises leases the landlord has an obligation to tell the Tenant of the last date for exercising its option. There is no such obligation in non retail leases. The consequences of failure to meet the strict time constraints necessary for the exercise of an option could be disastrous.

An alternative method of providing for options would be to have a lease for a long period with the Tenant having the right to terminate the lease at specific times with not less than a specified period of notice.

Rent guarantee and leases where the starting rent has not been negotiated at arms length

Rent guarantees are designed to provide a specified percentage return to the landlord. The rent guarantee may bear no relationship to the rent which is in fact obtainable for the property. If there is a rent guarantee a prospective purchaser of the premises should be satisfied that the return obtainable when the guarantee expires will not be less than the guaranteed rent.

When premises are initially leased there may be incentives given to the tenant (e.g. fit out contributions, rent free period). The incentives will possibly not be disclosed to any purchaser of the property.  The result may be that that a purchaser will rely on the rent shown in the lease as being a true market rent. Then, if there is a market review and there is no underpinning ratchet provision, the rent will reduce. Once again any prospective purchaser should be satisfied that the rent shown in the lease is a fair market rental.

Variation of a lease

Leases are sometimes varied by agreement between the landlord and the tenant. When there is a variation (not being a variation contemplated by the terms of the lease – e.g a rent increase pursuant to a rent review clause) the question will arise as to whether the variation evidences a new lease.  An extension of the term or the insertion of an option to renew is likely to result in the (unintended) creation of a new lease. Various consequences may flow from the creation of a new lease e.g a Mortgagee’s consent to the old lease may no longer be valid, a five year term might be required under the Retail Tenancy Legislation.

Conclusion

This article merely touches a few of the problems which can arise. Problems with security deposits, air conditioners, restoration of the premises at the end of the term and outgoings are some other problems which commonly arise. Many potential problems can be overcome by thoughtful action when the lease terms are being negotiated.  Many other problems are dealt with specifically by the Retail Leases Act but only, of course, if the Lease is of Retail premises.