What Are Essential Terms in Lease Agreements?

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Table of Contents

• What Are Essential Terms?
• Why Are Essential Terms Important in a Lease?
• What Happens if a Lease Does Not Include Essential Terms?
• Can Parties Agree on Essential Terms Later?
• Key Takeaways

Essential terms are the building blocks of a contract. If a contract does not include the essential terms, it may not exist at all. In this article, we unpack the key issues from Pozetu Pty Ltd v Alexander James Pty Ltd (the Pozetu case) when it comes to essential terms in retail leases in New South Wales (NSW).

What Are Essential Terms?

Essential terms form the basis of the agreement between parties.

For example, a lease agreement would include essential terms covering:

• the payment of rent to the landlord;
• the names of the parties to the lease; and
• a description of the premises which the lease is subject to.

Why Are Essential Terms Important in a Lease?

The Pozetu case highlighted that a lease agreement must contain essential terms in order for the lease to actually exist. These terms include:

• rent clauses;
• details of the premises; and
• the commencement date of the lease.

In that case, the parties had not yet agreed on what the rent would be for the option period. Therefore, the lease for the option period had no set rent and did not exist. 

What Happens if a Lease Does Not Include Essential Terms?

The Pozetu case demonstrated that if the essential terms of a lease are not in the lease agreement, the lease will not exist.

This also means that if an essential term is invalid or void, no lease will exist between the parties.

In the Pozetu Case, Alexander James Pty Ltd (Alexander) wanted to exit the lease during the option period. However, the parties had not yet agreed on what the rent would be for the option period. There was also no way to determine the rent for this period.

Accordingly, since the lease for the option period had no set rent (and was therefore missing an essential term), the lease could not actually exist. As a result, there was no enforceable lease existing between the parties for the option period. Therefore, Alexander was not bound to the terms of the lease.

Can Parties Agree on Essential Terms Later?

It is not enough to include ambiguous terms in a lease that let the parties decide on an essential term later on. In the Pozetu case, the rent for the option period was to be reviewed according to the current market value (known as a market review). The market review clause in the lease included a ratchet provision which allowed the rent to be increased by either:

• the greater of the current market rent; or
• 105% of the rent in the last year of the previous term.

But according to the Retail Leases Act 1994 (NSW), a leasing clause that allows for two methods to calculate a change in the rent according to the highest rental outcome is considered void.

As a result, the ratchet provision in the Pozetu case was void. This meant that there was no mechanism in the lease to allow the parties to come to an agreement on rent. Consequently, the lease did not exist.

Key Takeaways

For a lease to exist, make sure it includes all the essential terms. Clauses for essential terms should be drafted clearly. Avoid inserting clauses which allow parties to agree on an essential clause later on.

Additionally, watch out for clauses which may be considered void under the Act, as this could lead to other unexpected consequences in the interpretation of the lease as a whole. If you would like help reviewing your lease agreement, contact LegalVision’s leasing lawyers on 1300 544 755 or fill out the form on this page.