Australia: Agreements for lease: back to basics

The construction or fitout of commercial or retail premises prior to the commencement of a lease is a significant investment in both time and expense for landlords and tenants.

Where a tenant wishes to lease the whole or part of a building which is yet to be constructed or which is to undergo major renovations, it is important for both parties to fully understand and document their requirements. These include the works to be done, who will do them and when, and the extent to which completion of the works will determine when the lease starts. The parties' rights and obligations are usually documented in an agreement for lease.

This article discusses the distinction between a lease and an agreement for lease, situations where an agreement for lease is used and several matters parties should consider when negotiating the terms of an agreement for lease.

What is an agreement for lease?

An agreement for lease is a binding agreement between a landlord and prospective tenant to grant and/or to accept a lease in the future. It does not grant possession to the proposed tenant at the time it is entered into, but binds the parties to enter into the lease at some future date.

The main distinction between a lease and an agreement for lease is that a lease gives the tenant an immediate right to exclusive possession of the premises. An agreement for lease grants the same right but at some future date. However, an agreement for lease still creates an equitable interest in the land, allowing a tenant to lodge a caveat to protect its interest.

Why an agreement for lease?

An agreement for lease is normally required in circumstances where there are preconditions to be satisfied by either party before a lease can be granted, or before the lease commencement date can be determined. The most common scenario requiring an agreement for lease is where the premises have not been fully erected or are not ready for occupation. However, an agreement for lease may also be required in the following situations:

• where the landlord or tenant is required to construct a new fitout or remove an existing fitout
• where the landlord or the tenant must obtain development consent for the tenant's proposed use of the premises
• where the landlord has not yet acquired title to the land. For example, before a purchase of land is completed, the purchaser might enter into negotiations with a prospective tenant to grant a lease, and record the proposal in an agreement for lease
• where the former tenant is still in occupation of the premises.

What should be included in an agreement for lease?

Parties wishing to enter into an agreement for lease should take the following into account:

1. Statutory consents

What consents are required for the landlord's or tenant's works or the tenant's use of the premises? Who is responsible for obtaining such consents?

Development consent and a construction certificate for the landlord's / tenant's works, and development consent for the tenant's proposed use of the premises, will need to be obtained. In practice, it is usually the landlord who is responsible for obtaining the required consents for the landlord's works, and the tenant who is responsible for obtaining consents for its fitout works and its use of the premises.

2. Lease formalities

The agreement for lease should provide for the grant of the lease upon satisfaction of any conditions precedent. The agreement should also permit the landlord to insert particulars into the lease document such as the commencement date, the rent and the tenant's proportion of outgoings (if applicable), and annex a copy of the proposed lease.

3. Landlord's works

What is the scope of the landlord's works? Are there any time limits for their completion?

A concern for most tenants is that the landlord will not deliver what the tenant is expecting. If the landlord is required to undertake significant works, then plans and specifications for the works should be detailed and attached to the agreement for lease, to avoid a potential dispute. The landlord should also draw up a construction program so that the tenant is aware of the time it will take for the landlord's works to be completed.

Where the landlord is responsible for constructing the building, the agreement for lease should specify an agreed anticipated completion date. Similarly, depending on the tenant's occupancy requirements and time constraints, an agreement for lease should also include a sunset date and entitle the tenant to terminate the transaction if the construction or the lease commencement has not occurred by that date.

4. Tenant's works

What is the scope of the tenant's works? What is the required standard of construction? Are there time limits for their completion?

Depending on the scope of the landlord's works, tenants may agree to the landlord carrying out the tenant's fitout of the premises. This option allows the landlord to have sole responsibility for all contractors on site and avoids the risk of the landlord making a claim against the tenant's contractors for any delays.

Alternatively, tenants are often required to undertake their own fitouts with their own contractors after access to the premises is given. Commonly a clause is inserted in the agreement for lease requiring the tenant to submit all proposed plans and specifications to the landlord for approval prior to commencement of any tenant works.

Furthermore, a tenant's access to the premises may be governed by clauses which stipulate certain pre-conditions for handover. Pre-conditions may include:

• the landlord receiving the agreement for lease executed by the tenant
• the tenant delivering any bank guarantee and insurances required under the lease
• the issue of approvals for tenant's works with evidence supplied to the landlord
• the landlord approving the layout of the premises
• the tenant paying all costs associated with its works and relevant approvals
• all safety requirements having been met.

In order to ensure that a tenant delivers what is expected, the landlord may also wish to specify in the agreement for lease that the tenant's works be carried out in a proper and workmanlike manner, in accordance with the plans and specifications submitted to the landlord for approval, and in accordance with the landlord's fitout guide, if applicable. A copy of any fitout guide should also be annexed to the agreement for lease.

As to the timing of the tenant's works, the agreement for lease should specify the tenant's fitout period.

5. Determination of the commencement date

When will the lease commence? How will the commencement date be determined?

The term "practical completion" is used to describe when the premises are complete and ready for occupation by the tenant. It is important that the agreement for lease includes the mechanism which determines whether practical completion has been reached. At the very least, practical completion is achieved when the tenant is provided with an occupancy certificate enabling the tenant to lawfully occupy the premises, and the landlord's works have been substantially completed in accordance with the agreed plans and specifications (except for minor defects and omissions which do not prevent the premises from being used for their intended purpose).

Generally, landlords will often want the commencement date of the lease to be on practical completion of the landlord's works or as soon as possible thereafter, so that the rent commences at an early date. Landlords may prefer that their architect determines whether the landlord's works have achieved practical completion without consultation with the tenant, so that commencement of the lease is not delayed.

Some landlords may also wish to insist that the lease will commence even if the tenant's fitout has not been completed. If the landlord does not allow the fitout work to be done while the base building work is being carried out, the tenant will then be liable for rent regardless of whether the premises are ready for occupation or not. The tenant could try to limit its exposure to this risk by ensuring that the lease will not commence for a prescribed period after the landlord's works have been completed.

For retail leases, some landlords may insist that the lease commencement date be the earlier of the day after the fitting out period ends, or the day when the tenant commences trading in the premises. As to retail premises within a retail centre, a tenant could press for the centre to be completed and open or that an anchor tenant (such as a major supermarket or department store) be opened and trading as a pre-condition to lease commencement.

6. Extensions of time

If an agreement for lease stipulates a sunset date for the landlord to reach practical completion of its works, the landlord may insist on a mechanism for the specified date to be extended if there are delays in carrying out the works. Extensions may result, for instance, from delays by an authority giving its consent or inclement weather.

Liquidated damages may apply where practical completion is not achieved and an occupation certificate is not obtained by an agreed date. To avoid additional penalties for not reaching practical completion by that date, a landlord may seek to include a provision which states that liquidated damages are the only damages to which the tenant is entitled in that event.

Extensions of time may also be required where the landlord or tenant requests variations to any works. Both parties should ensure that any requests for variations do not adversely affect the lease commencement date.

If tenants commit themselves to a new building before or during construction, or lease premises in an existing building which is undergoing significant refurbishment, there is the risk of disputes arising relating to completion of the landlord's or tenant's works or the lease commencement date. Properly drafted agreements for lease assist in mitigating these risks. Parties looking to enter into such agreements should, with the advice of their legal advisors, negotiate terms in the agreement which are consistent with the parties' requirements and commercial drivers.

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.