June 28, 2013
What if my business fails?

In short, a tenant must comply with the terms of its commercial lease!

A commercial lease is a document that sets out the rights and obligations of the owner of a commercial property (known as the landlord or lessor) and a third party that has agreed to occupy the property (known as the tenant or lessee).

Apart from governing the relationship of owner and occupier of different types of property, a lease of commercial property generally differs from a lease of residential property in the following ways:

  • commercial leases are generally for longer terms (e.g. commonly for terms exceeding 10 or 20 years, as opposed to 6 or 12 months for most residential properties);
  • a commercial tenant is often required to pay rent plus outgoings (e.g. land tax, council rates, water rates), whereas a residential landlord invariably pays outgoings;
  • a commercial lease will generally specify the purposes for which a property can be used, whereas for residential properties this is obvious;
  • given the wide variety of properties that can be characterised as commercial (e.g. office space, warehouses, retail shops, factories) there are often property-specific clauses in a commercial lease.

This means that the legal obligations of a commercial tenant can be very different to those of a residential tenant.  Although the legal obligations of a commercial tenant differ from lease to lease, most commercial leases impose the following obligations on commercial tenants:

Comply with the Commercial Lease

It goes without saying, but a commercial tenant must comply with the terms of its lease otherwise there is a risk that the landlord will have the right to terminate the lease and seek damages against the tenant.  Given the length of commercial tenancies and high level of ongoing expenses that are often payable under such leases non-compliance with a commercial lease could be very expensive for a tenant.

Pay Rent

The amount of the rent payable by the tenant to the landlord is critical for both parties.  Rent represents the landlord’s return from its ownership of the property and the primary obligation of the tenant, which is a significant expense in operating its business.

The rent for the initial term is specified in the lease.  Any rent review (i.e. change in the rent) will also be specified in the lease.  The three most common review methods are CPI, fixed and market.  The relevant review method is generally applied annually throughout the term of the lease.  It is common for CPI or fixed reviews during the term of a lease and for a market review to occur at the expiry of the initial term and each option period.

Pay Outgoings

It is common practice that the tenant pays both its own outgoings (i.e. telephone, electricity and gas) and the landlord’s outgoings (i.e. rates, taxes and levies).  Which party is responsible for payment of outgoings must be specified in the lease, together with how the amount of outgoings is determined and how they are to be paid/recovered.

Security Bond

In addition to rent, the landlord will generally seek security from the tenant to protect the landlord against default of the tenant not properly performing its obligations under the lease (e.g. not paying rent).  It is common for security to be for an amount equal to 3 to 6 months rent and to be by way of bank guarantee (if the tenant is an individual) or personal guarantee (if the tenant is a company, in which case the company’s directors provide personal guarantees).  If the bond is an amount of money then the lease should set out conditions regarding use, withholding and repayment of the bond.

Legal Fees

It is common for the tenant to pay the landlord’s reasonable legal fees for preparing and negotiating the lease, which may be up to a specified limit.  The amount, if any, is a matter for negotiation between the landlord and tenant, bearing in mind that the tenant will also have to pay their own legal fees.

Repairs and Maintenance

Generally, the tenant will be responsible for repairs and maintenance to the property that is the subject of a commercial lease.  However, this does not include structural issues and capital items (e.g. air conditioning, walls and landlord’s plant and equipment), which should not be obligations of the tenant

Insurance

A lease often requires the tenant to take out and maintain insurance in relation to the building, contents and plate glass, together with public liability and other insurance types depending on the tenant’s business.  These insurances are generally available in business pack insurance.

To Conclude

Both the landlord and the tenant, but in particular the tenant, must carefully consider and negotiate the terms of their commercial lease and understand their rights and obligations under the lease to ensure that the property is suitable to their business.

By Lachlan McKnight. Lachlan is the CEO of LegalVision. He’s an experienced corporate lawyer with particular expertise in banking and finance and general corporate matters.

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