There Be Dragons. How to avoid the traps and pitfalls of leasing transactions

Leasing transactions can often seem to our modern minds what the unexplored parts of the world were to our ancestors: a scary unknown, complex and fraught with perils. 

One way to navigate them is to understand the key documents and the do’s and don’ts of each. Not every lease will require all these documents, but most leases will require a number.

Key Leasing Documents

1. Heads of Agreement

Sometimes called a Letter of Intent or Memorandum of Understanding, this is a preliminary document that lays out the key terms of the intended agreement to follow. It allows the parties to ensure they’re in broad agreement before investing time and money into drafting a full contract.

The most common mistake people make with this document is assuming it’s not binding – they think that only happens when the Agreement for Lease is signed.  

But it’s not unknown for a tenant to sign a heads of agreement and for the landlord to later claim it’s enforceable. In such cases, the tenant may have to negotiate their way out, incurring painful legal costs. 

Never sign a heads of agreement that doesn’t state whether it’s binding.

2. Agreement for Lease

This formal agreement outlines each party’s obligations before the lease starts.

Those obligations may include the landlord or tenant carrying out certain works beforehand, the payment of incentives.

Key provisions to consider when negotiating agreement for leases include:

• The extent of and contents of plans and specifications. Ensure the building specifications fits your objectives and business needs.

• The timing of Landlord works and Tenant works and any variations.

• Security to be provided, including the amount and when it is due.

• Clarity about when the lease starts and the rent to be paid. The start date could be a hard date (for example, 30 June) or one that is contingent on another event, such as agreed works being completed.

• Practical completion of works – what they include and don’t include, who’s responsible for what, and to what standard or specifications the work is to be done.

• Practical completion date.

• A sunset date for completion of works – that is, a date from which the other party may cancel the deal if the specified works are not completed.

• What constitutes valid delays and their likely impact on practical completion and sunset dates.

• Liquidated damages and other consequences if practical completion and sunset dates are not met.

• Approvals for works and use – who is responsible for them, consequences for not obtaining them and consideration of conditions to granting approvals.

3. Incentive Deed

This document outlines financial incentives to be granted to the tenant, such as rent-free periods, rent reduction amortisations or fit out contributions.  

Key considerations for negotiating an incentive deed include:

• Timing of provision of the incentive.

• Conditions of payment of any incentive – for example, when invoices are provided or works are completed.

• Who retains ownership of works funded by an incentive.

• Whether the tenant may assign an incentive and what happens when the landlord assigns the property – will they be required to ensure their assignee honours the incentive obligations?

• Whether the incentive is repayable should the tenant assign or sublet the property, have a change of control, or default on payment.

4. Fitout Deed

This document covers landlord or tenant works, including specifications and timelines. It is similar to an agreement for lease, but is more common for retail or commercial leases, especially those for greenfield sites.

One major issue for fitout deeds is category 1 costs – that is, costs associated with altering services such as power, drainage, ventilation, etc. Will the tenant’s contribution for category 1 costs be capped?

5. Car Parking Licence

A car parking licence may be standalone or part of the lease. Key considerations:

• Will specified car parking spaces be fixed for the term or can they be altered at the landlord’s discretion?

• Where will the parking spaces be located – are stackers or tandems acceptable or feasible for the tenant?

• Are there to be any restrictions, such as parking only versus loading/unloading, storage of containers, storage of stock, and so on.

• Will the tenant be able to access the spaces easily and how far are they from the actual leased premises?

• Licence fee – amount and how often it will be reviewed.

• Commercial terms – do they mirror the lease (term, method of review, terminate when lease terminates, assignable to an assignee of the lease); versus being stand alone and being able to terminate on a month’s notice?

6. Deed of Guarantee

A deed of guarantee provides financial security for the landlord if the tenant defaults, allowing the landlord to seek recovery from the guarantor.  While the terms of the guarantee are usually documented in the lease, they may also be included in a separate deed.

Key considerations when reviewing a guarantee include: 

• When is the guarantee released – on the lessee being released or at some other time?

• Does the guarantee seek to take a charge over any of the assets of the guarantor?

7. Disclosure Statement

This document is mandatory under the Retail Leases Act (NSW).  Other jurisdictions also mandate disclosure, and their specific requirements need to be understood.  

The relevant legislation in each case sets out tests as to whether the lease is a retail lease.

Where a disclosure statement is required, it must be accurate. The consequences for failing to provide a disclosure statement or providing one that is inaccurate can be severe, including but not limited to allowing the tenant to terminate the lease and seeking damages.

8. The Lease Agreement

To draft a lease, these issues should be considered:

• The starting point for a lease agreement is always the heads of agreement. Ensure the lease agreement broadly agrees with the heads of agreement.

• Is it a retail lease versus space in a commercial or industrial building?

• Is the lease for vacant land, a building, land and building, other? Each will require specific contracts.

• The usual issues: make good and redecoration; outgoings (in particular, land tax and foreign ownership surcharges, types of strata levies and management fees); accessibility and use of common areas (including facilities); subletting, licensing and assignment; change of control; PPSR; security (calculation, expiry date and return); fire safety; services.

Mixed-use developments: Special considerations

Mixed-use developments are common in suburbs, towns and capital cities and warrant particular attention. Typically, they are buildings with a combination of retail and residential, or commercial and residential, and sometimes all three.

The complexes are usually (but not always) strata title. Key considerations include:

• Is the lease for the unit only or does it include car parking and storage space?

• What laws will apply? For example, retail leasing laws or strata laws?

Key clauses for the tenant to consider in a lease of a mixed-use tenancy:

• Outgoings – if strata levies are payable,  are administrative levies payable versus sinking fund and special levies – the lease needs to be clear on this.

• Make sure the lease requires the owner to obtain necessary approvals from the Owner’s Corporation for tenant works, council approvals, signage, etc.

• Be clear on what the zoning laws allow and whether the Owner’s Corporation needs to sign off any application for change of use or additional hours of use. Be careful if your use may have an impact on adjoining residences (smells or noise to residential by retail/commercial use, for example).

• Even if approval is given, what modifications will be required to mitigate disturbances?

• Make sure the lease cannot commence until all required approvals are obtained (including from the Owner’s Corporation).

Key clauses for the landlord to consider in a lease of a mixed-use tenancy:

• Indemnities from the tenant for breach of bylaws and damage to common areas for disturbance to adjoining tenancies or tenancies within the building.

• Disclosing outgoings in a retail lease (Disclosure Statement).

• Disclosing any planned developments.

• Demolition clause (particularly if the complex has plans for redevelopment).

• Being clear on the tenant’s liability for outgoings.

• No warranties regarding approvals from authorities or the Owner’s Corporation.

In an era of pro-forma precedent documents, process driven legal practice and the push for greater efficiencies, parties can run the risk of signing lease documentation that does not reflect the unique nature of the transaction nor the particular type of property. It is recommended that you think carefully before signing documentation and seek the advice of an appropriate practitioner before doing so.

Authors: Andrew Grima, Sara Duong, Chester Hong