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Understanding a Commercial Lease

When renting business related property it is important for both Landlords and Tenants to understand the relationship they are entering into and the rights and obligations that they each have, the document that governs this relationship is usually a Commercial Lease.

So what is a Commercial Lease?

A lease is a legally binding contract that gives you certain rights to a property for a set term. A commercial lease is used when leasing property used primarily for a business.

You should never sign a lease without understanding all of its terms and conditions. If you don’t understand what you are agreeing to you could experience serious financial and legal problems.

It’s important to properly investigate the property and lease document before you sign. It is a good idea to ask your solicitor to explain each clause of the lease to you. Your solicitor can give you legal advice, draft new clauses and help you negotiate the terms and conditions to suit you.

Important issues to consider when entering into a lease

A commercial lease will usually contain terms dealing with items such as:

Rent

How much is the rent and when is it due? The amount of the rent will usually be calculated based on the area of the premises. This may not always be a simple as it sounds if the shape of the property is irregular or the area includes a lift, more than one floor, outdoor area or interior walls.

Rent Increases

Rent will usually increase annually during the term of the lease, with increases determined by a fixed percentage, be market based or tied to the CPI. It is common for CPI or fixed reviews to occur during the term of a lease and for a market review to occur at the expiry of the initial term and each option period.

Security Deposit

The landlord will usually ask for some form of security from the tenant in case the tenant defaults on their obligations (e.g. not paying rent). The security is usually for an amount equal to 3 months’ rent and is by way of bank guarantee. If the tenant is a company then personal guarantees from the company’s directors may also be required. The lease should also specify the terms regarding its return.

Term of the lease

The lease should set out the length of the lease and any options to renew the lease and any terms relating to the renewal. A landlord will generally want a longer initial lease term (typically 3, 5 or 10 years) whereas the tenant is likely to want a shorter period (1-3 years).

Option to Renew

An option allows the tenant to continue leasing the property on similar terms at the end of the period of the lease for a further defined period and rent (subject to any review). An option gives the landlord potential greater security of income and the tenant the ability to make longer term plans for their business.

Knowing the procedure for exercising the option especially when the option can be exercised is critically important

Improvements

A lease should address what improvements or modifications can be made to the property, who will pay for the improvements and whether the tenant is responsible for returning the property to its original condition at the end of the lease.

Description of the property

A lease should address what improvements or modifications can be made to the property, who will pay for the improvements and whether the tenant is responsible for returning the property to its original condition at the end of the lease.

Signage

Any restrictions on putting up signs, say that are visible from the street, will be included in the lease.

Use of the property

Most leases will include a clause defining what the tenant can do on the property (eg. What type of business). A tenant should ask for a broad usage clause just in case the business expands into other activities. It is essential that you check that any proposed use is consistent with the “purposes clause” in the Crown Lease that the landlord holds from the ACT Government.

Outgoings

The lease will set out who is responsible for costs like utilities, property rates & taxes, insurance, and repairs.

Insurance

You should contact your insurance company and discuss the clauses referring to insurance so you fully understand what is covered by the lease.

Exclusivity clause

This is an important clause for retail businesses renting space in a commercial complex. An exclusivity clause will prevent a landlord from renting space to a competitor.

Assignment and subletting

A tenant should maintain the right to assign the lease or sublet the space to another tenant. Usually the tenant is still ultimately responsible for paying the rent if the business fails or relocates, but with an assignment or sublet clause in place, the business can find someone else to cover the rent.

Maintenance & Repair

The lease should clearly set out who is responsible for maintaining or repairing the property and the fixtures and fittings during the term of the lease.

Termination

The circumstances under which the lease will be terminated should be set out in detail in the lease.

Costs

The landlord may want the tenant to pay some or all of his legal fees and out of pocket expenses, this should be clearly set out in the lease. Legislation in the ACT may regulate what fees a landlord can pass onto a tenant.

Retail lease or general commercial lease?

The Leases (Commercial and Retail) Act 2001 is specific legislation relating to most commercial and retail leases in the ACT. This legislation is designed to provide additional protections to tenants and impose a range of obligations on commercial landlords.

In relation to proposed leases and options:

  • the landlord must give the tenant a disclosure statement for the proposed lease at least 14 days before entering the lease.
  • The landlord should provide the tenant a copy of the proposed form of lease (usually a pro forma) as early as possible in the negotiations;
  • The tenant may vary or waive these time limits by giving the lessor a certificate signed by a lawyer stating the tenant’s intentions, but the tenant cannot extend any of the stipulated time limits.

A disclosure statement must:

  • state the lessor’s accounting period if not a financial year.
  • contain an itemised list of outgoings for the first accounting period and an estimate of the amount the tenant is expected to contribute.

The disclosure statement is a useful brief summary of the proposed lease and may contain information and mandatory disclosures of material that would not normally be contained in a lease.

Conclusion

It is very important that landlords and tenants fully understand their rights and obligations with respect to a Commercial Lease.

It is a good idea to ask your solicitor to explain what each clause in the lease means and to get their assistance in negotiating the terms and conditions that suit you.