New Zealand: Why agreements to lease are important and necessary

Commercial Property Newsletter - June 2016

Before a landlord and tenant enter into a deed of lease the parties will often enter into a separate agreement to lease document, especially if the lease is negotiated through a real estate agent.

Clients will often ask us 'Why do I need to enter into an agreement to lease? Why can't I just enter into a deed of lease?' The answer is that it depends on your circumstances. In certain situations you can proceed directly to an unconditional deed of lease. However if the parties still need to reach a final consensus on the lease's terms then we would recommend that an agreement to lease is entered into first.

There are two scenarios that immediately come to mind where the parties would benefit from this approach:

  1. A tenant may wish to undertake due diligence investigations of the premises to make sure it will be entirely suitable for their business needs. If the tenant enters into a conditional agreement to lease this will allow them time to assess the premises, while giving the landlord some comfort that the tenant is serious about leasing the property rather than just speculating.
  2. The landlord may need to build the premises or complete certain works to the existing building before the premises is ready to be occupied by the tenant. An agreement to lease can be entered into which clearly sets out the works which the landlord (or the tenant) are expected to do, how the works will be paid for, and when the works will be completed. The agreement to lease would record that the lease will commence once the works are completed. The parties would then enter into the final deed of lease which records the agreed commencement date of the lease, and records the extent of the completed works (as well as who owns each item of fit out).
  3. The benefits of entering into an agreement to lease in this scenario are clear. A landlord will be able to carry out their works in the comfort of knowing that the tenant is legally bound to lease the completed premises. A tenant will know how the premises will look before they take possession.

Important considerations before entering into an agreement to lease in a post-earthquake environment.

  1. Business Use

A lease will set out the purpose for which the tenant is allowed to use the premises. Once this 'business use' is agreed and recorded in the lease document, the tenant will only be allowed to use the premises for a different purpose if the landlord agreed. It is therefore important that the tenant carefully considers what 'business use' is recorded in the lease to ensure that it will be suitable, both now and in the future.

For example if the business use is defined as "retail of footwear" then the tenant would arguably need to ask his landlord to agree if the tenant's business evolved to sell clothing and other accessories as well as shoes. Furthermore such a restrictive business use may make it difficult for the tenant to assign or sublease the premises as any new tenant would also be constrained to selling footwear unless the landlord agreed otherwise. A more general business use of just "retail" would be preferable.

  1. Personal guarantees and lease assignments.

If the tenant is a company or a trust, the landlord will usually require a personal guarantee from either the company's directors or shareholders or the trust's trustees. It is important for any person signing a guarantee to fully understand what their obligations are, and seek the appropriate advice, especially in cases where the business is sold and the lease is assigned to a new owner. It is sometime possible to limit the extent of the guarantee, or have it agreed that the guarantee will be automatically released in certain circumstances.

  1. Term of lease

Lease terms vary and are often subject to changes in the market. However, each lease term should be negotiated on an individual basis. For example, it might not be appropriate for a tenant with a new business to sign up for an initial 6 year lease term given the risk that the business might not succeed beyond the first year or two. The same applies if a tenant with an existing business expects the volume of business to decline in the future.

On the other hand, a lot of the value of a tenant's business may be tied up in the location and the resulting goodwill. In such a scenario the tenant may want to have the option of multiple rights of renewal.

In either cases, the tenant will benefit from negotiating a set of lease terms and renewals that suits their personal circumstances.

From a landlord's perspective, if the tenant wishes to sign up the lease for a long term with multiple rights of renewal, then the landlord may wish to insert a redevelopment clause into the lease. A redevelopment clause will allow the landlord to terminate the lease early if the landlord required the premises for their own purposes.

  1. Care should be taken when using the standard lease forms

The ADLS lease is a specific form of lease which is used in a wide variety of commercial leases throughout New Zealand. Another type of common lease are the Property Council leases which come in a variety forms depending on whether the premises is a retail, office or industrial building.

The standard ADLS agreement to lease contains a clause that states the parties are committed to entering into an ADLS deed of lease. In fact this clause states that the parties have agreed to be bound by the terms and conditions of the ADLS deed of lease whether or not such a document is actually signed.

Both the ADLS and Property Council lease forms are well understood and are perceived to be fairly weighted between the needs of a landlord and a tenant (more or less!). However this does not necessarily mean that it is appropriate to use the standard forms without giving any consideration as to whether they need to be amended to suit the individual circumstances of the lease.

It is important that any further terms or amendments to the eventual deed of lease documents are negotiated before the agreement to lease is signed, or at least agreed during any conditional period of an agreement to lease.

Final words on agreements to lease

There are many benefits to entering into an agreement to lease before proceeding directly to a deed of lease. Regardless of how the parties choose to proceed, it is important that each party obtains separate legal advice before signing any lease document.

You will save time and money by getting the right advice up front, rather than being trapped later on in circumstances which haven't been considered or contemplated. Cavell Leitch are experts in negotiating and advising on lease documents and can assist in negotiating terms that suit your circumstances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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