Option clauses can be (and usually are) advantageous to both the landlord and tenant in a commercial lease. While option clauses are relatively standard in most commercial lease agreements, the specific wording of the clause is what makes all the difference. But, what exactly are option clauses? In this article, we look at the operation of option clauses and how they should be drafted to ensure maximum protection for both parties.

What is an Option Clause?

An option clause is a term in a commercial or retail lease that permits a tenant to renew their lease at the end of the initial lease period. However, they must meet certain conditions.

For example, a three-year lease may also have one three-year option, making it six years if the tenant chooses to exercise the option.

Some of the conditions that the tenant may have to meet 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 do not have to offer a renewal option. However, it is most likely in the interests of both parties to do so if they would like a long term commercial relationship.

Having an option in the commercial lease means that the landlord will have more financial security and a more valuable property overall. This is heightened when the lease term is particularly long, as there is less risk involved with long-term tenants. In turn, the tenant benefits from building a strong reputation and goodwill by maintaining the same location for their business.

However, some parties do not want an option.

For example, if a tenant is in a business that is expanding and will outgrow their premises within a few years, an option may not be attractive as they know that they will not need to exercise it. 

Is It a Problem if I Don’t Have an Option Clause in My Lease?

If there is no option in a commercial lease, it means that the tenant does not have an 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, if they would like to stay on the premises, they will need to negotiate a new lease with the landlord. This opens up the possibility of the landlord adding new lease terms. In addition, a higher rate of rent may be applied. This couldn’t have happened if the rental increase had already been agreed upon in an option in the original lease.

How Do You Exercise an Option Clause?

The way that a tenant can exercise an option comes down to the way that 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 any confusion, your lease should clearly express how a tenant is to 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 should be signed by the tenant and detail their:

  • address;
  • full name; and
  • business name.

Failure to exercise the option in the required manner set out in the clause means that the tenant has forfeited their right to exercise the option. Landlords must make sure that their tenants have conducted themselves as per the terms of the option clause.

Are There Any Time Limitations?

There will almost always be a time limit on when a tenant can exercise an option. This may be expressed in the commercial lease as a specific date or as a time period. This time period is typically from three to nine months before the end of the lease term.

If the tenant misses the opportunity to exercise the renewal option, the parties may renegotiate the terms of the lease. If so, the landlord is under no obligation to offer the same renewal terms that were in the original lease.

Is an Option a New Lease?

By exercising an option, you are essentially entering into a completely new lease. Until the landlord and tenant have created and signed the deed of renewal and the new lease, the new lease does not yet legally exist. Therefore, it is important that these documents are drafted as soon as the notice to exercise the option has been delivered to the landlord.

Key Takeaways

Option terms in leases are a way for both a landlord and tenant to maintain a long commercial relationship. While options are favourable for a tenant if they require security of the premises, they largely depend on the tenant’s business circumstances.

You should examine the terms of the original lease to ensure that the tenant can correctly exercise an option. If you need assistance in drafting or reviewing the option clause in your commercial lease, contact LegalVision leasing lawyers on 1300 544 755 or fill out the form on this page.

Emma Heuston
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