In Short
- Option clauses allow tenants to renew a lease, offering benefits for both parties if drafted clearly.
- Tenants must meet specific conditions and deadlines to exercise an option, or they lose the right to renew.
- Without an option clause, lease renewals require negotiation, which could result in higher rent or new terms.
Tips for Businesses
When negotiating a lease, ensure the option clause is clearly defined and specifies how and when it can be exercised. Missing deadlines or unclear terms can lead to complications. Both landlords and tenants should regularly review the lease and its conditions to ensure smooth renewals and avoid disputes.
Option clauses in commercial leases can benefit both landlords and tenants. Although these clauses are common in most commercial leases, the specific wording is crucial in determining their effectiveness. But what exactly is an option clause? This article explains how option clauses operate and how they should be drafted to protect both parties involved.
What is an Option Clause?
An option clause is a commercial or retail lease provision allowing the tenant to renew the lease at the end of the original term, provided certain conditions are met. Some common conditions include:
- exercising the option during the time frame that the lease specifies (usually between three and nine months before the end of the lease); and
- not having breached the lease at any time during the lease term.
Are Option Clauses a Requirement in Commercial Leases?
Landlords are not obligated to offer a renewal option. However, it is most likely in the best interest of both parties, especially if they want a long-term commercial relationship. Including an option in the lease provides financial security for landlords, increasing the property’s overall value, particularly with long-term tenants. For tenants, staying in the same location helps tenants build their business’s reputation and goodwill.
However, not all tenants want an option clause.
Continue reading this article below the formWhat Happens if There is No Option Clause in the Lease?
If there is no option in a commercial lease, the tenant has no automatic right to renew the lease. Therefore, if both parties wish to renew the lease, they will need to enter into negotiations to establish both the:
- length of the new lease; and
- rental amount.
For example, a tenant has a three-year lease on a premises without an option. Therefore, they must negotiate a new lease with the landlord if they want to stay on the premises. This opens up the possibility of the landlord adding new lease terms.
In addition, a higher rate of rent may be applied. This could not have happened if the rental increase had already been agreed upon in an option in the original lease.
Leveraging Option Clauses in Negotiations
Option clauses can be valuable during lease negotiations. For tenants, securing favourable option terms, such as rent caps or specific property improvements, can provide long-term stability for their business. Offering attractive option terms can help landlords retain high-quality tenants, increasing the property’s value and stability.
By understanding the strategic importance of option clauses, both parties can negotiate terms that support their long-term goals and foster a mutually beneficial lease agreement.
How Do You Exercise an Option Clause?
The way that a tenant can exercise an option depends on how the option clause is drafted. Most commercial leases require a tenant to notify the landlord if they wish to exercise an option to renew.
To avoid confusion, your lease should clearly express how a tenant will exercise an option. A clause should identify what form the tenant’s notice to exercise the option should take and how they should communicate it to the landlord.
For example, the tenant should draft the notice in writing and deliver it to the landlord’s business.
The notice to renew should be signed by the tenant and detail their:
- address;
- full name; and
- business name.
Failure to exercise the option in the required manner in the clause means that the tenant has forfeited their right to exercise the option. Landlords must ensure that their tenants have conducted themselves according to the terms of the option clause.
Can You Withdraw a Notice to Renew?
While most leases do not allow the withdrawal of a notice to renew, tenants may be able to do so in certain situations. If the notice’s wording is unclear, the tenant could argue they did not intend to exercise the option. Additionally, a tenant may withdraw the notice if it is conditional upon something the landlord cannot fulfil. If the landlord delivers the notice incorrectly or at the wrong time, (while rarely seen) a clause may allow a tenant to withdraw their notice to renew
A factsheet that sets out the three ways to end a commercial lease in Australia: surrendering your lease, assigning it or subletting it.
Are There Any Time Limitations?
There is almost always a time limit for exercising an option, typically specified in the lease as a date or a time period. This period usually lasts three to nine months before the lease term ends. If the tenant misses this deadline, both parties must renegotiate the lease. Here, the landlord is not required to offer the same terms as before.
Is an Option a New Lease?
You are essentially entering into a completely new lease by exercising an option. Until the landlord and tenant have created and signed the deed of renewal deed and the new lease, the new lease does not yet legally exist. Therefore, completing these documents as soon as the tenant delivers the notice is essential to exercise the option.
Potential Pitfalls
While option clauses offer significant benefits, they can cause issues if not carefully managed. For example, if a tenant misses the deadline to exercise the option, they lose the right to renew, which could disrupt their business. Additionally, ambiguities in the clause could lead to disputes between the landlord and tenant. To avoid these problems, tenants should precisely track essential deadlines and follow the required procedures. Landlords should regularly review and update lease agreements to ensure compliance with current laws and business practices.
Key Takeaways
Option clauses allow landlords and tenants to maintain a long-term commercial relationship. While they provide security for tenants, their usefulness depends on the tenant’s business needs. Both parties should review the lease terms carefully to ensure the option clause is drafted correctly and exercised.
If you need help drafting or reviewing the option clause in your commercial lease, our experienced leasing lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
An option clause is a term in a commercial or retail lease, permitting a tenant to renew their lease at the end of the initial lease period.
No, landlords do not have to offer a renewal option. However, it is usually in the interests of both parties to do so if they would like a long term commercial relationship.
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