Commercial Leases - issues to consider

 

Fiona Coughlan is an Associate at Gibson Sheat Lawyers.  She specialises in commercial work for small to medium businesses, leasing, trusts and banking and finance.  This article discusses some issues to consider when entering into a lease.

Leasing or renting a commercial property is often the largest fixed cost that a small business will face and a significant cash flow item for the landlord.  It can be a complex process and should be undertaken carefully with appropriate advice. 

The Property Law Act 2007 contains statutory provisions governing the landlord and tenant relationship, but in essence it is a matter of contract negotiation between the parties. 

Leasing a property is primarily a commercial matter.  The outcome of a negotiation over a commercial lease is dependent upon the bargaining position (commonly referred to as “leverage”) that the parties bring to the table.  The lease records the outcome of that negotiation. 

A Deed of Lease governs the rights and obligations of a landlord and the tenant to each other.  The headline commercial terms included in a lease are:

• a description of the property leased;

• the term of the lease, and whether it can be extended or renewed;

• the rent payable and whether and how it can be adjusted;

• what each party will pay in relation to the property’s outgoings (e.g. who pays the rates for the property, and who pays the cost of installing and removing the fittings);

• who has to pay for damage and repairs.

The majority of commercial landlords in New Zealand adopt the Auckland District Law Society (ADLS) Deed of Lease – now in its 6th edition, released in November 2012.  There are other standard forms of commercial leases:  Building Owners and Managers Association NZ or BOMA, NZ Property Council forms and other leases which a landlord will specifically develop for a property e.g. retail leases for shopping malls.  As a result of the Christchurch earthquakes, some unusual leasing issues have evolved and the latest ADLS lease has attempted to address some of those issues.

The current ADLS lease provides for rent reviews to be either by market review, consumer price index review or a mixture of both.  Market reviews can lead to costly disputes between parties involving valuers and lawyers.  A preferred option may be to provide for CPI rent reviews annually, with market rent reviews on the renewal dates, or, say, every second or third year.  This is to ensure the rent which the tenant pays reflects the current market.

Tenants should be aware of the provisions known as a “ratchet clause”.  The effect of such a clause is that on rent review the new rent cannot be less than the rent for the previous period.  These ratchet clauses can be negotiated for a “softer” clause under which the rent review amount cannot be less than a particular amount, often the rent at beginning of the lease.

Following the Christchurch earthquake, the ADLS lease was changed to provide that where a natural disaster or emergency occurs and the premises are undamaged but inaccessible (e.g. the premises are cordoned off) the rent is to be reduced by a “fair proportion”.  If the situation endures for a specified period the lease can be cancelled.  The period suggested in the ADLS form of lease is 9 months but the parties are free to negotiate the per

Emergency works and access

The ADLS lease entitles a landlord to enter the premises in an emergency situation to inspect and if necessary carry out earthquake strengthening works.  The landlord can require the tenant to vacate during this period.  Tenants should negotiate a provision in the lease that if this clause is invoked, the tenant is to be compensated for the disruption and for moving costs. 

A further feature of the current edition of the ADLS lease is the ability to attach a premises condition report showing the state of the premises at the start of the lease.  The report can be detailed and professionally prepared or simply comprise of photos.  The purpose of the report is to settle arguments at the end of a lease when the tenant is required to “make good”.  A condition report protects against wrongful “make good” claims by the landlord.

If the premises are destroyed or so damaged that they are rendered “untenantable” then the lease will terminate from the date of the destruction or damage.  Whether the premises are untenantable is an objective test and the current ADLS lease does not help to determine this.  It will depend on the facts, but broadly speaking, the test for untenantability is whether the property is able to be used and enjoyed by a tenant.  The Court will consider matters such as the degree of damage and length of term to run.

In the case of Russell v Robinson [2011] 2 NZLR 424 in April 2011 the High Court was asked to decide whether premises were untenantable.  A three storied commercial building was badly damaged by a fire on the first day of the lease term.  The fire was caused by painters putting masking tape over halogen lights.  The building was unable to be occupied and the insurance assessor estimated repairs would take 9-10 months to complete.  In an unusual twist, the tenant wanted the lease to continue and argued that it had the option of affirming the lease even though the premises were so damaged.  The court rejected the argument and found the premises were rendered untenantable as they were unfit for occupation by the tenant for their intended purpose.

When a lease ends there are obligations of a tenant which are the subject of many arguments – usually costly and disruptive.

Maintenance

During the term of a lease, a tenant will be required to maintain the premises in the same standard of repair and condition they were in at the commencement of the lease.  The tenant is not liable for fair wear and tear arising from reasonable use of the premises.  A premises condition report is useful to prove the condition of the premises at the outset. 

Repair replacement and redecoration

A tenant is usually required to repair any damage it causes.  A tenant may also be required to redecorate the premises by repainting and sometimes replacing carpets.  Often these obligations arise at the end of the lease.

Removal of tenant’s fixtures

At the end of the term a tenant will be required to remove its fixtures from the premises and make good any damage caused by the removal.  The timing of when to remove and make good the damage is important and the wording of the lease may dictate when this occurs.  Some require the “make good” works to be done a reasonable time after the end of the lease, others before the end of the term.  For a landlord it is preferable to have this work undertaken before the end of the term.

Reinstatement

Many leases will require the tenant, at the end of the term, to reinstate the premises (e.g. restore the premises to the state they were in prior to any additions or alterations by the tenant). 

Leases often include some or all of these obligations.  It is important when negotiating a lease to address the parties’ obligations arising at the end of the term.  If clauses relating to redecoration, remaining fixtures or attending to reinstatement are not included in a lease, a tenant is not required to do any of them.

When a tenant has taken over an existing lease (by an assignment) it will be inheriting lease end obligations.  New tenants (on an assignment) should negotiate what the lease end obligations will be and ideally limit them.

There is little case law on such obligations as there are time pressures, costs and uncertainty and these matters are often resolved by a cash settlement.