A major consideration for many new businesses starting out is to secure premises from which to operate the business. A large number of businesses in Australia operate from leased premises, whether they are commercial, industrial or retail. Leasing of business premises is far more common, particularly commercial offices and retail shops.
The advantages of leasing of premises, include:
(a) less capital required to lease a premises;
(b) more flexible arrangement where a business owner is able to exit the premises after a set period of time without having money tied up in the premises;
(c) rent is deductible.
In basic terms, a lease is a right granted by the owner (landlord/lessor) to the occupant (the tenant/lessee) to use the land or building in return for regular payment (rent).
A lease constitutes an interest in land, which can be registered on the title of the land (registration is possible in some States, for example in New South Wales and Queensland).
When signing a lease, it is important that you make the effort to negotiate a fair lease before taking occupation of the leased premises.
Lease of retail premises is a major component of the operation of a franchise business.
Many Franchisors choose to negotiate and secure premises for their Franchisees to operate the franchise business.
Usually major shopping centre owners will insist that the Franchisor sign the head lease and then the Franchisor will license the premises to the Franchisee. Alternatively, some Franchisors require the Franchisee to enter into a direct lease with a landlord and then enter into a tripartite step in deed in the event of default by the Franchisee.
When a Franchisee is negotiating a lease directly with the landlord, it is important to obtain the consent of the Franchisor prior to any agreement being reached with the landlord, as the Franchisor will usually have specific provisions that would be required to be inserted into the lease with the consent of the landlord.
Often the Franchise Agreement will have specific provisions required by the Franchisor to be included into the lease. It is important that the Franchisee communicate with the Franchisor during the lease negotiation process.
Too often tenants concentrate on the most obvious lease terms – such as the commencing rent; rental increases and option terms – but disputes often arise between landlords and tenants regarding provisions in the lease which are generally not focused on during negotiations.
Here are some examples:
Permitted Use – make sure the permitted use under the lease is compatible with the zoning of the land. The misconception is that "permitted use" means "use permitted by both the landlord and the local authority".
The tenant is responsible for obtaining its own approval from all competent authorities for the conduct of the business. If that business may not be legally conducted in the premises, the tenant may still be required to pay rent under the lease (subject of course to any claims under misleading and deceptive conduct under section 18 of the Australian Consumer Laws).
Where the premises is for use of a franchise business, it is important to ensure that the permitted use allows for the operation of the franchise business, as most leases prohibit franchising. It is extremely important that this is negotiated and agreed from the outset so that the permitted use allows for the franchise business to operate from that premises.
Market Rent Review – many landlords will offer incentives to tenants to enter into a lease.
When negotiating it is important to understand the difference between the terms "face rent" (the rent figure written in the lease document) and the term "effective rent" (the rent figure arrived at after reducing the face rent to take account of the value of any incentive provided to the tenant).
Disputes often arise at the time of exercise of an option to renew where the rent is to be reviewed to market and an incentive was granted for the initial term of the lease to induce the tenant to enter into the original lease.
A market review mechanism in a lease usually includes a provision that protects the landlord's re-coupment of the incentive via a "face rent" determination for mid-term market rent review (ie the quoted rental rate before taking into account incentives or increases).
A tenant should therefore ensure that the lease terms provide for the market rent review mechanism to clearly reflect that there is to be an "effective rent" determination at the commencement of the option term (ie giving consideration to rent free periods or up-front incentives).
If this is not done, the tenant will find itself paying an artificially inflated commencing rent in the option term in circumstances where no incentive has been received for the option term.
Make Good/Reinstatement Obligations – often at the end of the lease term, disputes arise in relation to the extent of the tenant's reinstatement obligations.
The lease should allow the tenant to make an election to pay a "make good amount" to the landlord instead of undertaking a physical make good of the premises, which will allow the tenant to continue to trade in the premises until the end of the term rather than vacating well ahead of the end of the term (whilst continuing to pay rent) in order to undertake a physical make good.
Director Guarantees - where directors guarantees are given for the obligations of the tenant under a lease, the landlord will usually require the guarantors to "stay on the hook" on the assignment of the lease so that a guarantor is liable for the assignee's obligations under the lease.
Tenant's should consider the risk when asked to provide a directors guarantee; and should negotiate to provide a bank guarantee or security deposit as the only form of security required under the lease.
Security - Landlords of any type of premises will usually require some form of security from a tenant, in order to protect themselves where a tenant defaults under the lease. There are various forms of lease security that a Landlord my request, for example:
Bank Guarantee – Landlords favour this form of security because it is a third party undertaking from an entity of substance, and the bank is required to honour any drawdown request without first checking with the tenant.
If in the situation a Franchisor enters into a lease, the landlord will require the Franchisor to provide the bank guarantee in favour of the landlord. It is important that the Franchisor ensure that when licensing the premises for use by the Franchisee that the Franchise also provide equivalent bank guarantee to guarantee the obligations and performance of the Franchisee in the event of default.
Cash Deposit –Although landlords do not favour cash deposits because of the administration required for the landlord (or managing agent) to open and administer an account. The funds are actually held jointly on behalf of the landlord and the tenant. In regard to retail leases, the Retail Leases Act 1994 NSW, requires that the Landlord (or managing agent) deposit the cash deposit with the Office of NSW Small Business Commission for the duration of the lease term.
Encumbering the Lease – often a tenant agrees to enter into a lease which prohibits the tenant from encumbering the lease. In circumstances where the tenant has granted a PPSA charge over all its assets in favour of a financier, the tenant is placed in immediate default of the lease. It is important for the tenant to negotiate an amendment to such a restrictive provision prior to the lease being entered into so that the grant of security to its financiers is not prohibited.
Contact Rostom Manookian at Manookian Solicitors on 0416 716 960; or email us direct at rostom@manookiansolicitors.com to speak to a leasing specialist who can assist you with your enquiries or to review your lease.
We offer fixed fee legal services that will give you certainty and clarify and ensure that there will not be any hidden costs or surprises.
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