To lease or not to lease? Is this the question?

A Commercial Property Leasing Guide for Landlords & Tenants

Bought to you by:

Warwick La Hood, Director

Australian Business Lawyers & Advisors

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Contents

Part 1: Pre-lease stage …………………………………………………………… 3

Part 2: Negotiating a lease …………………………………………………….. 5

Part 3: Entering binding relations to lease ………………………………. 7 Part 4: Issues commonly encountered during lease term ……….. 10 Part 5: Leasing questionnaire …………………………………………………. 14

About the author ………………………………………………………………….… 15

Australian Business Lawyers and Advisors ……………………………… 16

About NSW Business Chamber ………………………………………………. 17

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Part 1: Pre-lease stage

This section provides an overview of several key factors a business should consider before entering into negotiations on lease terms.

Why is this important?

A lease provides the tenant with an entitlement to occupy a premises and is a legally binding document setting out the rights and obligations of both the tenant and landlord in relation to a premises. It includes terms such as the rental amount, permitted use, outgoings and the consequences in the event of early termination. A commercial lease will usually be one of the main operating expenses for any business and will often be intrinsically linked with a business’ profitability, goodwill and value. Given that poor leasing decisions are often costly and difficult to overcome; a good lease could be the difference between a business succeeding or failing.

What to do?

STEP 1: Consider your leasing requirements and where to lease

Before approaching leasing agents or viewing potential premises a valuable exercise would be to firstly identify the key leasing requirements for your business. Important factors for consideration include the proposed rental amount, possible locations (including the preferred demographic and economic characteristics), space, access, visibility, and service requirements of the premises. Our sample business premises questionnaire sets out additional matters for consideration (see Part 5). Important note: when determining the suitability of potential premises you should always enquire with the relevant local council regarding matters such as:

Whether your intended use of the property is prohibited or permissible (with or without

consent);

Whether your proposed fit-out requires development consent or a fire upgrade of the

premises;

Whether the building you will occupy (or partly occupy) is compliant with all relevant

environmental planning instrument including fire regulations;

Whether any new developments or zoning changes are planned for the area you are

considering?

Whether there are any outstanding orders or restrictions on the proposed premises? and

Whether further information on any applicable legal regulations or compliance requirements

(e.g. zoning, public parking and permits) could be provided by the council?

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FAST FACT While a pre-lease agreement is not normally binding it often has the power to “shape the debate” for the drafting of the lease. If you agree to terms in the heads of agreement (or other pre-lease documentation) it can be difficult to change the terms and could place you in a weak position when renegotiating those terms for the lease.

STEP 2: Obtain pre-lease documentation

Once a suitable premises has been located and usually following preliminary negotiations

between you and the letting agent or landlord (regarding matters such as the proposed rental

amount, availability and term), you will often be given a 2-4 page pre-lease agreement to sign.

Whilst this agreement has a variety of names (including, “Heads of Agreement”, “Leasing

Proposal”, “Leasing Offer” or “Agreement to Lease”) and whilst it can differ in form and content,

generally its purpose is usually to set out the key terms of the lease proposal that will be

incorporated in a formal lease.

STEP 3: Obtain professional advice

A pre-lease agreement is normally not binding on

the parties and often contains a provision setting

out the parameters of when and how the parties

are to be bound to a lease. However, this is not

always the case and there have been a few

instances where courts have found a pre-lease

agreement to be a binding legal document or used

to define lease terms when there is a dispute as to

interpretation. Also, once a pre-lease agreement

is signed, it “shapes the debate when negotiating

lease terms” as the pre-lease agreement usually

signals that there has been an agreement in

principal on the stated terms.

We therefore strongly recommend that you obtain legal advice before signing any document in

connection with a proposed lease. A legal practitioner would be able to assist in a number of

ways including:

raising matters that may have been omitted but should be incorporated in the pre-lease

agreement;

proposing amendments to unfavorable terms incorporated in the pre-lease agreement; and

advising on the likelihood (and the extent) of a pre-lease agreement being binding.

STEP 4: Sign a pre-lease agreement

Following completion of negotiations on the pre-lease agreement terms and once the duly

signed agreement is returned to the letting agent or landlord, you (or your solicitor) will be

provided with a draft lease for review.

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Part 2: Negotiating a lease

The focus of this section is on the lease negotiation phase. To assist with this process, an explanatory table of common terms that are often incorporated in leases has been provided below. Why is this important?

The term negotiation in this context refers to a process whereby the tenant and the landlord compromise or reach an agreement on the terms of the lease. Note: A common misconception for first time tenants is that the first lease offered by a landlord, particularly if it is presented as a standard form lease, is non-negotiable. This is actually rarely the case. Indeed, should a landlord signal an unwillingness to be open to any negotiation then the best course of action would often be to not proceed any further with the lease. Devoting the time to negotiating satisfactory lease terms from the outset would support the long-term financial success of your business and may ultimately save your business from sustaining substantial losses due to unfair or inequitable provisions. What to do? Reviewing the table below provides a useful starting point to gaining a better understanding of the type of terms commonly found in leases. The listed terms however are not exhaustive, and should not be used as a substitute to carefully reading the lease documents and obtaining expert advice. It is strongly recommended that legal and financial advice be obtained before entertaining any formal negotiations, signing any lease document, paying any deposit or entering into possession of the proposed leased premises. A sample of three key areas to consider are below:

Lease Terms Description Points to Consider

Security deposit Most leases require that the tenant pay a security deposit, often by way of bank guarantee, to the value of between 2 – 6 months’ rent. The purpose of the security is to satisfy any obligations the tenant failed to perform under the lease.

Careful attention should be paid to whether the lease enables the landlord to retain the security for an unreasonable amount of time after the tenancy has ended. Also be careful when a bank guarantee is issued without an expiry date. Your bank may be reluctant to issue a bank guarantee without an expiry date.

Outgoings The term ‘outgoings’ refer to the costs in connection with the premises that are incurred by the landlord and passed onto the tenant. Examples of outgoings include:

Council rates, water charges and land taxes

Insurances

Cleaning

Gardening and landscaping

Management, administration and marketing

Outgoings expenses are often charged in addition to rental amounts and may amount to a considerable added expense. When reviewing lease provisions on outgoings some of the key matters to note, and possibility negotiate, are:

How your outgoings contribution will be calculated.

What type of expenses are to be included as outgoings.

What rights you have to review outgoings

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Building maintenance charges.

Whether outgoings charges will be audited.

Fit-out & Make Good

Leases usually place obligations on the tenant regarding the initial fit-out of the premises, additional works during the lease term and rectification works at the end of the lease. Note: The phrase ‘make good’ refers to the condition of the premises the landlord requires after the expiry of the lease term. Examples include removal of fitting, replacing flooring, paining and cleaning of the premises.

It is extremely important that you understand and agree on the fit-out and reinstatement requirements in a lease prior to signing as these works often represent a very significant expense for the tenant. Note: if the premises already contains a fit-out then your ‘make good’ obligations should be negotiated to only require you to leave the premises clean, tidy and in good repair subject to fair wear and tear. Also, check to ensure whether a third party has a right to an existing fit-out over the landlord.

Other common clauses to keep a look out for include Rent and Rent Review clauses, term and options to renew, commencement and expiry dates, insurances, additional costs, assignment of the lease, indemnity, default and termination.

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Part 3: Entering binding relations to lease

This section covers some of the key legal formalities of leases that need to be satisfied in order for a lease to be fully enforceable. Why is this important?

Having a lease that is registered and duly consented to by the landlord’s mortgagee (if

applicable) is the best means of ensuring that your lease of the premises is recognised above any

party that has competing interests. Registration affords protection.

1. What is a registered lease?

The purpose of registering a lease is to formally create an interest in the premises and to inform

anybody that searches the property register of your interest. In NSW the general rule is that a

lease term of more than 3 years (including any option period stated in the lease) must be

registered with the ‘Office of Land and Property Information NSW’. Failure to register may result

in subsequent parties registering their interest in the premises (like a buyer or mortgagee) and

those interests taking priority over your lease. For example, should the premises that you lease

be sold, you could find that it may not be possible for you to enforce the option terms contained

in the lease against the new landlord.

TIP: To ensure protection, it is recommended that a lease be registered even if it is for a term of

3 years or less.

2. How are leases executed?

If a lease is to be registered then it is required to be in approved form (namely, Form 07L) and

certain conditions would need to be satisfied such as:

the signing of the execution page of Form 07L by the parties;

the signing of the first and last annexure pages of Form 07L by the parties;

all alterations, insertions and deletions having to be initialed;

not dating the document; and

if executed by an individual, the document would need to be witnessed and the witness

having to state their name, address and occupation.

TIP: We recommend you initial all pages in a lease.

Note: in order for a lease to be validly executed by a company it does not need to be witnessed

but it must be signed by either 2 directors of the company or a director and a company secretary

(unless the company has sole director in which case only that director’s signature would be

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required). If however, a company’s constitution requires that the company execute documents

by using a common seal then the use of the seal together with the signatures of the company

directors/secretary would be required.

3. When are landlords bound?

The general starting point is that neither the tenant nor the landlord will be bound until both

parties have signed the lease. However, this may not always be the case. A great deal ultimately

turns on whether documents such as any pre-lease agreements and correspondence between

the parties reveal that the terms of the lease were agreed to, and that the parties acted upon

that agreement. When leases become binding is determined on a case by case basis and the

Supreme Court has delivered many judgments on this issue. In some cases, a landlord was

contractually bound to the lease term despite not signing the formal lease documents.

4. Why is mortgagee consent important?

In NSW if a property is mortgaged then any lease of that property has to be consented to by the

mortgagee (i.e. the entity that lent the money such as a bank) in order to be valid. Should

consent not be obtained and in the event that the mortgagee then moves in to take possession

of the premises, you would most likely be unable to enforce your lease and be left with no

premises and possibly a business of little or no value.

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CASE STUDY

McDonald’s Australia Limited v Bendigo and Adelaide Bank Limited [2013] VSC 639 highlights the risks of not obtaining the bank’s consent to a collateral agreement to the lease being an incentive deed whereby the landlord agreed to contribute money to the tenant’s fitout.. The lessee, McDonald’s Australia Limited (McDonald’s) and the lessor, Benalla Retail Investments Pty Ltd (BRI) entered into a pre-lease agreement agreeing that BRI would reimburse McDonald’s for the cost of constructing a McDonald’s restaurant. The Agreement to Lease provided McDonald’s with a right of set-off against the rent if BRI failed to reimburse McDonald’s. However, the reimbursement obligation and the right of set-off were not set out in the subsequent lease document. Rather, they were only in the Agreement to Lease. McDonald’s delayed seeking reimbursement from BRI. BRI went into default and the mortgagee, Bendigo and Adelaide Bank Limited (BAB), took possession of the property. McDonald’s attempted to set-off the rent against BAB but BAB rejected the right to do so. The Court rejected McDonald’s claim that it could set-off rent against BAB, even though BAB may have been aware of the terms of the Agreement to Lease. The Court relied on the terms of the Agreement to Lease in determining the intention of the parties. Lessons learnt: Whenever signing a pre-lease agreement, it is important to keep in mind that:

1. the terms of a binding pre-lease agreement may be critical to a Court's determination of rights of the parties;

2. the terms of a lease should properly reflect the terms in a pre-lease agreement; 3. a collateral agreement to a lease may not necessarily bind a mortgagee in possession if the

obligations under the collateral agreement are not contained in the lease agreement.

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Part 4: Issues commonly encountered during lease term

The focus of this section is on examining four key issues commonly encountered during a lease term. Namely, the assignment or subletting of a lease, the timing of market rent reviews, lease renewal and the ‘make-good’ requirements. Why is this important?

A better understanding of the issues that commonly arise during a lease term may assist with

providing more favorable outcomes for your business. This guide however, is intended to be

used as a general reference only. Legal and financial advice should always be sought when

dealing with a commercial lease.

1. Can the lease be assigned or subleased?

Throughout the term of a lease a number of situations may arise - you may wish to sell the

business, you may wish to relocate to bigger or smaller premises, you may no longer be able to

afford your current premises, or you may simply no longer wish to operate your business.

Accordingly, it is important that the lease agreement contains reasonable provisions enabling

you to assign or sublease the premises in the event that your situation changes.

1.1. What is the difference between subleasing and assigning a lease?

An assignment takes place when the original tenant (the assignor) transfers the entire lease to

another entity (the assignee). In return for the assignment, the assignee agrees to move into the

premises, take on all the responsibilities of the lease and to indemnify the assignor against any

further obligation to the landlord. Whereas with subleases there are two leases in operation, one

between the landlord and the tenant and the other between the head tenant (sub-lessor) and

the sub-tenant (sub-lessee). Moreover, under a subleasing arrangement, the first tenant

continues to be entirely bound to the terms of the original lease.

1.2. Possible issues with assigning or subleasing

1.2.1 Inadequate lease provisions

It is common for leases to place restrictions on a tenant’s ability to assign or sublet a lease. When

reviewing your proposed lease some of the key matters to note are:

whether subleases and/or assignment of the lease would be permitted;

what requirements need to be satisfied before the Landlord could provide consent to a

sublease or assignment;

what costs would need to be incurred in order for the Landlord to provide consent;

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whether the lease provides that the landlord must not unreasonably refuse consent to a

sublease or assignment;

whether you could be held liable under the lease even though the lease has been assigned

and the landlord had consented to the assignment.

In the event that an assignment or sublet is prohibited under a lease, or if the conditions are too

onerous or inequitable for the tenant, it is advisable that such terms are negotiated from the

outset, before committing to the lease.

1.2.2 Non-Compliance with lease provisions

At time problems with assigning or subleasing arise, not due to lease terms, but as a result of the

failure to correctly abide by those terms. There have, for example, been cases where buyers of

businesses have entered into possession of premises only to find that they did not have a valid

lease because the landlord never consented to an assignment. In such instances the original

tenant/seller, depending on the terms of the sale agreement and the lease, would most likely be

in breach of both contracts. It is therefore essential that you are aware of, and abide by all the

requirements specified in your lease.

1.2.3 Inadequate Sublease or Assignment Agreements

Alternatively, or perhaps additionally, problems may arise between the assignor and the

assignee, or between the sub-lessor and sub-lessee. To mitigate the likelihood of later disputes it

is vital that the terms of the agreements clearly provide for each party’s duties, obligations and

liabilities. As with lease agreements, it is strongly recommended that an assignment or sublease

not be entered into without legal advice.

2. Market review and timing

2.1 What is a market rent review?

The term market review refers to an assessment of the rental amount the premises would fetch

on an open market having regard to the rent paid for similar premises in the same or comparable

suburbs.

It is common for leases to provide for a market review either during the term or around the time

an option is to be exercised.

2.2 What is the usual procedure for a market rent review?

Often lease provisions set out the following procedure for determining market rent:

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The landlord is required to provide the tenant with a rent review notice;

Following the notice, the landlord is then required to provide their determination of the

current market rent to the tenant;

If the tenant agrees with the landlord’s determination then that amount is deemed to be the

current market rent;

If the tenant disagrees and a set market rent cannot be decided between the parties then the

rent would usually be required to be set by a qualified valuer. A Landlord may seek for the

rent to be determined by the highest and best use of the premises, rather than the actual

use. This may result in much higher rent than would otherwise be appropriate.

Note: It is advisable that you make your own enquiries on the rental amounts charged for

comparable properties, as opposed to simply accepting the landlord’s assessments of current

market rent at face value. This exercise would assist you in negotiating a reasonable market rent

for the premises.

2.3 Timing considerations

Careful attention should be given to the timing provisions stated in the lease as it may make the

difference between considerable rental savings or sizeable rental increases for your business.

The following are some factors to note when considering the timing of a market review.

2.3.1 When is the landlord required to provide a rent review notice?

Often leases contain clauses that provide the landlord with the opportunity to issue rent review

notices either before or after the specified rent review date. Such provisions could potentially be

considerably disadvantageous for your business as it provides the landlord with the discretion to

issue a notice at a time more likely to yield higher market rates and therefore higher rental

charges.

2.3.2 Is the rent review set before or after the option is exercisable?

When perusing the lease it is important to note the timing for providing rent determinations and

exercising an option. It is highly inadvisable to agree to a provision that requires the tenant to

commit to an option period first and then be subject to a market rent review. Such a provision

should be amended to require that the market rent payable has to be determined before the

option term is exercised. Additionally, there should be a term in the lease providing the tenant

with the right to request an early determination notice of market rent from the landlord (for

example 6 months prior to the option date).

2.3.3 Does the lease set an unrealistic time for the tenant to respond?

Commonly leases provide that a tenant has 14 days (or sometimes even less) to respond to a

rental notice. Such a short time frame unfortunately results in many tenants not having the time

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to adequately respond. Given that such oversights may mean unnecessarily high rental increases,

it is advisable that either a greater period is agreed during the negotiation phase (for example 2

months) and/ or that suitable procedures are in place to enable an adequate and timely

response to such notices from the landlord.

3. How to renew a lease?

If the lease provides an option to renew and you are considering whether to exercise that option,

there are certain steps that should be followed to ensure that your lease is properly renewed

including:

if a market rent review is due at the commencement of the option term, market research

of comparable rents in your area should be undertaken to gauge whether the landlord’s

determination of the current market rent is reasonable;

if permissible under the lease, request an early determination of the market rent so it

provides you with sufficient time to decide whether or not to exercise the option;

if you decide to renew the lease, ensure that all specified requirements in the lease with

respect to exercising options are strictly complied with;

if a new bank guarantee is required, ensure that your prior guarantee is returned; and

once the option is exercised, it is best practice to prepare, execute and register a new

lease document which states that the option to renew has been exercised.

4. Can your business comply with the make good obligations?

Most leases contain ‘make good’ provisions that require the tenant to restore the premises to

the condition it was in before it was leased. Often the ‘make good’ provisions are quite extensive

and may require that you remove your goods as well as any fixtures and fit-outs. It is therefore

recommended that enough money and time is allocated to ensure the premises can be re-

instated to the standard specified in the lease before you lease term ends.

Disclaimer: The aforementioned information is not legal advice. If a legal opinion is sought please contact your legal advisor. While all due care has been taken in the preparation of this information, it is believed to be accurate but no warranty of accuracy or reliability is given and no liability is accepted for errors or omissions or loss or damage suffered as a result of a person acting in reliance thereon.

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Part 5: Leasing questionnaire

Matter Some Preliminary Questions Your Notes /Comments

Finances Has your business’ profit and loss figures been analysed by an accountant or financial advisor to assist with determining cash flow?

What is the rental amount range for the premises? (Note: the rental amount is often only one part of the costs payable for under a commercial lease)

What amount has been allocated for outgoings?

What insurances will be required and how much will they cost?

Licenses Are there any licenses or permits required to operate your business?

The premises

Is the space suitable for your business purposes?

What is the general appearance and condition of the premises?

Would there need to be major maintenance or repair to the premises in the near future?

Would fixtures such as piping, wiring or surfaces require modification to meet regulations?

Does the building meet regulatory fire compliance requirements?

Has the landlord agreed to undertake any repair or works and have your obtained that agreement in writing?

What are the zoning, public parking and permit requirements for the premises?

Are there any outstanding orders or restrictions on the premises?

Are the utility services such as sewerage, water, power, gas, and telephone and internet connection adequate?

Are there sufficient storage facilities for your business requirements?

Fit out What fit-out would be required for the business and what is the proposed budget?

Do any plans of the fit-out need to be drafted?

Are there any design approvals required in order to fit out the premises (Note: depending on the time requirements, it may be advisable to obtain approvals for fit-out plans whilst negotiating the lease)?

Does the fit-out require development consent or, if within a multi lot complex, the consent of the executive committee?

Location Are the premises visible to passing vehicle and/or pedestrian traffic?

Are there any new developments or zoning changes planned for the area?

Does the area have good infrastructure in place?

Are there any complementary or competing businesses in close proximity?

Are the premises close to your target market and suppliers?

Does the area have a good reputation and low crime rates?

Access Do the premises offer sufficient staff and customer parking?

Is there adequate off-street parking?

Is there good access to public transport?

Is there sufficient access for deliveries?

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About the author

Warwick La Hood

Director Warwick has nearly twenty-three years’ experience advising clients on property law, acting for individuals, companies and joint venture relationships. He has a practical and commercially astute approach to helping clients across a wide range of areas, including: Commercial, industrial and retail leasing - his considerable experience in leasing includes having acted for the Waterfront Action Group in relation to the leasing of land for all waterfront owners of Sydney

Harbour from NSW Maritime. He has also made submissions to the Independent Pricing & Regulatory Tribunal of NSW (IPART), which were considered and adopted by IPART. Preparation of joint ventures for the development or co-ownership of land- development -acquisitions, options, mortgages, and all matters to effect subdivisions. Financing and securities in land for lenders and borrowers. Conveyancing - acquisition and sale of land. Warwick is highly experienced in acting for developers in relation to the purchasing and subdivision of land.

Dispute resolution - Warwick acts for clients in relation to conflicting interests in property or property related transactions including leasing, strata disputes, conveyancing, joint ventures, town planning/development. Warwick is highly experienced representing clients in the relevant court, if the need arises; this has involved him appearing before the Supreme Court. Aged care - Buying and selling aged care property, advising on subsidy arrangements under the Aged Care act, compliance, development of aged care facilities and preparation of aged care residential contracts. Retirement villages - Managing legal documentation for residents, management issues that arise and compliance with the retirement villages legislation, buying, selling, financing villages, acting for owners corporations or operators in relation to disputes. Other property related matters Warwick provides advice in relation to property transactions linked to the application of GST, this includes taxable supplies, adoption of the margin scheme, GST free supplies and exemptions. He also advises on stamp duty and property transactions.

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About NSW Business Chamber

Tracing our heritage back to 1826, NSW Business Chamber’s mission is to create a better Australia by helping businesses maximize their potential. The Chamber is a passionate advocate for business in the public arena: whether standing up to government and decision makers when business interests are neglected or working together to create positive change. On a one-to-one basis, the Chamber helps all businesses from small enterprises to large corporations maximize their outcomes offering tailored business solutions. Our commercial services division, Australian Business Solutions Group (ABSG), delivers a range of business services to both member and non- member clients throughout Australia, with the operating surplus going back to supporting Chamber initiatives. Connecting to the chamber movement, facilitated networking, provision of the latest updates in government relations and business development opportunities are just some of the reasons why more than 17,000 businesses have taken advantage of our membership. Let the NSW Business Chamber team be an extension of your business so you can concentrate on what you do best – growing your business.

To find out more about how NSW Business Chamber can help your business please visit: www.nswbusinesschamber.com.au

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Ask Us How is a portal for NSW Business chamber members which houses hundreds of practical ‘how to’ articles and resources and tools designed to help our members better manage, operate and grow their business. Written by NSW Business Chamber members who are experts in their fields, and NSW Business Chamber industry experts, the Ask Us how portal includes ‘How to’ articles, Case Studies, Thought Leadership Papers and eBooks that cover the breadth of business areas. To get a flavour of the wide range of tools and information you have access to in Ask Us How please visit: www.askushow.com.au

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