Saturday, 7 February 2015

Check Your Commercial Lease!

Image of the Cote St Luc shopping area in Quebec, Canada, which is evolving into a new type of shopping precinct with integrated housing. Read an interesting article on http://trehugger.com about this project by Lloyd Alter here: http://v.gd/NEJq93




CHECK YOUR COMMERCIAL LEASE!

A number of my clients come to me to ask questions about leases that they intend to sign, and I have a couple of clients who own property that they lease to other businesses.

Lease documents are not standardised in Australia, although there is "retail shop" legislation in force in each State and Territory that must be complied with. Certain organisations - like real estate agent associations - have have varying degrees of success getting their standard template documents accepted. The REIV in Victoria, for example, has created an excellent commercial lease template that is available to non-members for purchase and as a result has become the most common document used in that State.  In contrast, the equivalent Western Australian body does not make this document available to non-members, which may be why in the past 3 years of my legal practise in Perth I have seen it only once.

There are certain issues that crop up over and over again that both landlords and tenants in commercial leases that both groups need to keep an eye out for. The document must be checked carefully, especially if it is a non-standard document.  Here are a few of the issues.

FIXTURES

The law is that if a person attaches ("affixes") an object to another person's land, it becomes part of the land. Land law in common law countries displays its medieval origins in the English post-Norman-Invasion feudal system, and uses all kinds of antiquated words like "profits a prendre" and "encumbrances". Anyway, the traditional rule was that if Noble Warlord A mistakenly built a castle on Noble Warlord B's freehold fiefdom, that was just too too bad, the castle belonged to Warlord B. The Best that Warlord A could do was come back when the castle fell down and take away the bricks. That often took a long time to happen. Some of those castles were well-built and are still standing now.

Get into the time machine and fast forward to today. What this means today is that if a tenant goes into a building and, say, attaches a dishwasher for their restaurant to the wall with brackets and pipes, that dishwasher becomes the property of the landlord. Modern leases deal with this in a number of ways; here are three versions:
  • The landlord doesn't really want your dishwasher or any of the rest of your junk nailed to the wall - the lease says: you must remove it at the end of the lease. If you don't, we will do it, throw it away or sell it, and send you a bill for repairing the holes in the wall.
  • The landlord keeps your dishwasher and you can't remove it, unless the landlord decides it doesn't want it, in which case it orders you to remove it and option A applies.
  • Anything left behind in the building is treated as abandoned and will be removed and disposed of. By default, this means the landlord can assert ownership and keep items.
Advertisement for an ancient dishwasher. Courtesy of Wikimedia.

RENT REVIEWS

Let me know if you find any premises with a lease where the rent goes down every year. The normal thing is for the rent to increase. How this increase is calculated, however, can give people headaches.
In Australian commercial leases, there are usually 3 methods used:
  • Fixed percentage increases. The rent goes up every year, let's say by 2%, on the anniversary of the date it was signed.
  • CPI increases. The rent escalates by the same amount at the CPI has increased over the same period. This is convenient but doesn't often reflect the real change of the cost of managing a building, CPI is calculated by reference to a basket of household and grocery expenses.
  • Market reviews. This is the most mysterious method. The rent is increased to keep up with changes "in the market for similar properties in the same geographical area". Who gathers and keeps this data is usually not explained.
Now, let's say your landlord gives you a lease where you have got a discount on the first year's rent but a market review at the beginning of Year 2. Is that a good deal? Probably not. Your rent will go up a lot at the beginning of Year 2. What will probably work out better for you better is a fixed increase or CPI review, plus a rent-free period for a few months at the very beginning, which will give you money for your initial fit-out (which will belong to the landlord, see above).

The way rent reviews play out will have a financial impact of tenants. Tenants should scrutinise the rent review clauses carefully.

Rent review is an important subject for lawyers. There are entire books written on it, like this one.


RENEWAL OPTIONS

If you operate your business out of leased premises, and want to sell the business, the first thing the buyer ought to do is check what the unexpired term of your lease is. How long have you got left on the clock? And, just as important, do you have an option to renew?

As the name suggests, an option to renew is an option, which can be exercised by the tenant (or not), to extend the term of the lease by an agreed further period of years. The usual term of a commercial lease is 5 years, and options are also for 5 years each. Accordingly a 5 year lease with 2 5-year options could go for a total of 15 years end-to-end. That is great for the landlord - a tenant in place for 15 years with mysterious "market rent reviews at the end of each 5-year segment. Book the cruise now, darling!

One problem with renewal options is that they aren't always given. I recently saw an arrangement where a franchisor was giving a franchisee a 5-year franchise agreement plus a 5-year renewal of that agreement, but, in its role as landlord, was NOT giving the franchisee an option on the lease. This could result on the franchisee having to vacate the premises after 5 years only to have a new franchisee slotted in behind them, with the benefit of the goodwill (habitual customers) being given to the new tenant/franchisee for free. There was also NO provision to pay the franchisee for any goodwill.

Another problem with renewal options is that they are usually conditional. Tenants should check the fine print of their leases carefully to see what conditions they will have to meet to score the right to renew the term of their lease.

CONCLUSION

This blog post has covered three examples of issues that can arise with commercial leases (in Australia).  The subject is a complex one. If you need advice that applies to your situation, you should consult a lawyer in your jurisdiction.

- JAMES IRVING

[Not intended as legal advice, but only as educational/informational material. Liability limited by a scheme approved under Professional Standards Legislation. If you would like to see more free information on legal topics, please visit the Learning Resources page of the IRVING LAW website at http://irvinglaw.com.au ]



1 comment:

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