When a landlord and tenant agree to sign a lease, they will agree to an initial period of time ('term') that the lease will go for. Often the landlord and tenant may contemplate a lease for a longer term but do not want to unconditionally commit to that further term right from the start. A common solution favoured by tenants and landlords is to agree on a process for renewing the lease, known as an option to renew. This refers to the optional decision whether to:
- continue the lease for a further term (generally equivalent to the first term); or
- allow the lease to come to a natural conclusion at the end of the first term (also referred to as 'expiry').
This process of deciding on an option allows the tenant and landlord to agree on what conditions or commercial terms will remain the same or change between the initial and renewal terms. This article will look at the key steps for the landlord and tenant to take when exercising an option to renew the lease.
An Optional Option?
Many commercial and retail leases include an option to renew the lease. However, such an option is not required nor mandatory. Many tenants and landlords will still include an option to renew in the original lease agreement to allow for better certainty of the commercial arrangements upon expiry. There are three main categories of options, either the:
- tenant can decide whether to exercise the option or not (provided they satisfy the landlord's renewal criteria);
- landlord can decide whether the option to renew is available at their discretion; or
- lease can be automatically renewed, unless both the landlord and tenant agree to end or vary the lease.
Generally, the first category is most common. This is because it gives certainty to the tenant for the longevity of their use of the premises. Additionally, it gives security to the landlord, knowing that they will not be stuck with a problematic tenant. This is so long as the renewal criteria are specific enough.
TIP: Any renewal criteria should have a clear commercial or legal metric and not be ambiguous or difficult to measure.
Tenant's Obligations in Renewal
In most circumstances, exercising the option to renew will have a few key steps for tenants. This includes that the tenant must:
- notify the landlord (or its agent) whether they want to exercise the option during a specified window of time. This is usually around six or three months before expiry, depending on the lease. Further, this notice is usually given in writing;
- comply with any of the pre-agreed criteria for the renewal to go ahead. This may include refurbishing the premises (if a cost estimate is properly disclosed), ensuring all rent, outgoings and other payments are up-to-date, or agreeing to a change or review rent; and
- avoid being in breach or default of the lease, up until the expiry of the initial term.
Landlord's Obligations in Renewal
Once the landlord receives notice (during the valid period) that the tenant wants to renew the lease, the landlord should either prepare a:
- renewal lease for the further term to commence as the initial term expires and facilitate signing by the tenant; or
- document varying or extending the current lease, and incorporating any agreed changes.
They should also ensure both the tenant and landlord comply with any of their respective obligations prior to the expiry.
Important: In retail leases, the landlords and tenants may also need to issue updated disclosure statements (according to requirements of the State or Territory).
What Can Change Upon Renewal?
Generally, the renewed lease will contain the same or very similar legal obligations for both the landlord and tenant but with slightly updated commercial terms. Unlike an extension and variation of the lease, a renewal is technically a new legal agreement. However, the renewed lease must adhere to any pre-set conditions. As such, landlords cannot make drastic changes at their discretion, as if they were entering into a completely new lease with new tenants. Any pre-agreed conditions that form part of the option to renew (such as a market or independent rent review) will apply and are binding upon the tenant and landlord. This is unless there is mutual agreement to change them.
However, landlords and tenants can still negotiate with each other to vary any terms of the lease upon renewal. This applies even if it was previously agreed and includes:
- changing the rent;
- varying the renewal term;
- altering obligations regarding refurbishment, repairs and maintenance; or
- introducing other special conditions to better suit their current circumstances.
For example, a tenant may want the ability to reduce the length of the renewal term due to a change in their commercial circumstances at the time of renewal. They will negotiate with the landlord on how this will work. The landlord may decide to agree to such a condition so long as they are compensated for the early exit and if continuing the commercial relationship for the further term is beneficial for them.
Exercising an option to renew a commercial or retail lease is usually straightforward, but it can become complicated if you are not aware of the process. It is key that tenants understand:
- their general rights to renew the lease;
- what steps they need to take to exercise the option to renew;
- any criteria associated with the option; and
- any clear deadlines for providing notice to the landlord.