The ongoing COVID-19 pandemic has put commercial leases in the spotlight as landlords and tenants grapple with the impact the multiple lockdowns have had on their businesses. It comes as no surprise that there has been an increase in commercial leasing disputes as a result. Whether you are a landlord or a tenant, it is now more important than ever to ensure that you understand the terms and conditions in a commercial lease and the potential impact to your business before signing on the dotted line. Here, we outline what you need to look out for in a commercial lease.
Entering into a commercial lease
A commercial lease is a legally binding agreement between a landlord (also known as the lessor) and a tenant (also known as the lessee) to rent a commercial property. In some cases, especially where the tenant is a company, the lease may involve the director(s) or some other persons to provide personal guarantee(s) (also known as the guarantor) on behalf of the tenant.
A commercial lease is generally a more favourable option for business owners as opposed to purchasing a commercial space, as it requires less capital upfront.
How are commercial leases different to retail leases?
It is important to understand that a commercial lease is different to a retail lease. Unlike commercial leases, retail leases are governed in New South Wales by the Retail Leases Act 1994 (NSW). A lease is deemed a retail lease if it meets the requirements under the Retail Leases Act, where it is a retail lease if it is for:
- a minimum period of six months but less than 25 years; and
- a business (retail shop) enlisted under Schedule 1 of the Retail Leases Act.
There are also other requirements that deem a lease a Retail Lease within the meaning of the Retail Leases Act.
In contrast, a commercial lease generally relates to premises that are not carrying on a retail business as listed under Schedule 1 of the Retail Leases Act. However, sometimes the distinction between commercial and retail leases can be difficult to determine for certain types of businesses.
The terms of a commercial lease can often be quite complex and in many cases drafted so as to favour the landlord. However, irrespective of whether you are a landlord or a tenant, it is important that you understand your rights and responsibilities under the lease before entering into one.
Terms to consider in a commercial lease
The terms and conditions of a commercial lease will often differ from agreement to agreement. They can be impacted by factors such as the size and location of the premises, amount of rent, market demand for the premises and its permitted use (the business that can be conducted on the premises). However, there are certain recurring terms that nearly all commercial leases must include and which you should consider:
1. Key dates
There are certain key dates to note in the lease, namely:
- the handover date, which is the date on which the keys are handed over to the tenant and when, if required, the fit-out can begin. The handover and commencement date are often different in instances where the tenant is required to carry out fit-out works at the premises before the lease commences (commencement date);
- the commencement date, which is the date on which the lease officially commences and the date which the rent is usually payable from (unless a rent-free period applies);
- the renewal date, which is the date on which the lease is renewed for any additional term(s), granted this option is provided in the lease. The lease will also include exercise dates (or period) during which the option to renew the lease can be exercised by the tenant by usually issuing a written notice to the landlord;
- the expiry (or termination) date, which is the date on which the lease ends or terminates at the end of its term, including any option term.
2. Duration of the lease
Commercial leases are often fixed for a certain period of time, which may include any number of option terms. Newer businesses may favour a shorter lease (being less than five years), while more established businesses may opt for a longer lease (being five years or longer, with several options to renew the lease).
3. Option(s) to renew
If there is an option to renew the lease after the initial term expires, it is important to ensure that the option to renew is exercised within the notice period under the lease. Failing to do so can result in the tenant not being able to renew the lease or continue to operate its business from the premises.
4. Rent reviews
Irrespective of whether the lease incorporates any option(s) to renew, commercial leases will often include rent reviews provisions. These provisions will generally involve the rent reviewed annually and usually with any of these three methods: Consumer Price Index (CPI), a fixed percentage increase or a current market rent review. Check to see what rent review provisions are contained in your lease agreement.
These are expenses that the landlord incurs as the owner of the premises, which can include electricity, water rates and usage, council rates and, in some circumstances, strata levies. The lease will expressly state who is responsible for the payment of all or a portion of outgoings. In some circumstances, it will be the tenant's responsibility to pay (if not all then a portion of) or contribute towards the outgoings, so it's important that, as a tenant, you understand your responsibilities under the lease.
Often, the lease will incorporate provisions requiring the tenant to obtain and maintain necessary insurances in relation to, the building, contents, public liability, workers compensation as well as insurance specific to the type of business carried out on the premises (if required).
Fit-outs are all of the furnishings required to turn the premises into a working business. The landlord may only provide the basics - flooring, ceilings, air conditioning, lighting, and common amenities. In that case, it is usually the tenant's responsibility to organise and pay for the fit-outs, which can include workspaces, benches, kitchenettes, meeting rooms and anything else required to make the business functional. Sometimes, as a form of incentive, the landlord may agree to pay or contribute towards payment of the fit-outs.
8. Making Good
More often than not, the lease will include a "make good" provision, requiring the tenant to return the premises in a similar condition or state in which it was at the commencement of the lease, except for fair wear and tear that are usually exempt.
9. Maintenance and repair provisions
These provisions generally specify which party (either the landlord or the tenant) is responsible for repairing and maintaining the premises. For example, structural issues will generally fall on the landlord to rectify, whereas the tenant will be required to maintain the premises to a high standard for the duration of the lease. This can include walls, floors, fixtures and inclusions (fit-outs).
10. Permitted use
Generally, the landlord will specify a permitted use of the premises, limiting the tenant to only use the premises for a certain type of business or purpose. For example, café, restaurant and newsagent. Sometimes, permitted use provisions in the lease can be quite restrictive, which may potentially hamper any future growth or diversification of the tenant's business.
It is important for both parties to carefully consider the terms of the lease, and where required, negotiate the terms from the outset before signing. Once the lease is signed by the tenant, it is difficult to negotiate any amendments or variations, unless both parties agree to such variation(s). Once the lease is properly executed, it is binding on both the landlord and the tenant for the duration of the lease.
In the event that the lease is for a period of more than 3 years, including any option term(s), then the lease must be registered with the NSW Land Registry Services in order for the estate to effectively pass to the tenant.
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.