Option clauses can be (and usually are) advantageous to both lessor and lessee in a commercial lease. While option clauses are fairly standard in most commercial lease agreements, the way an option is drafted is what makes all the difference. In this article, we look at the operation of option clauses and how they should be drafted to ensure maximum protection to both parties.
What is an option clause?
An option clause is a term in a commercial (or retail) lease agreement that permits a lessee, upon meeting certain conditions, to have the term of the agreement renewed for an agreed period of time.
Is an option to renew a requirement in commercial leases?
No, it is not. Landlords do not have to offer any renewal option, however, it is most likely in the interests of both parties to do so.
Having an option in the commercial lease agreement means the landlord will have more financial security in the future and a more valuable property overall. Even more so when the lease term is particularly long, as there is obviously less risk involved with long-term tenants. The tenant benefits from building a strong reputation and goodwill by maintaining the same location for the business.
Is it a problem if I do not have an option in my commercial lease?
This means that the tenant does not have any automatic right to renew the lease and if both parties wish to do so, they will need to enter into negotiations to establish both the term of the new commercial lease and the rental amount.
What do you do to exercise an option?
The way in which a tenant exercises an option comes down to the way the option clause is drafted. In most commercial leases, the option clause will require a tenant to notify the landlord if they wish to exercise an option to renew. To avoid confusion in how an option is to be exercised, the clause of the commercial lease agreement should be expressed in clear terms.
The clause should identify the form the notice should take, as well how it is to be communicated to the landlord. For example, the notice should be made to the landlord in writing, should be delivered or posted to the landlord’s business, and should detail the tenant’s address, full name and business name, and be signed. This helps to avoid confusion between landlord and tenant.
Failure to exercise the option in the required manner set out in the clause results in the forfeiture of the right to exercise the option. Landlords are required to make sure that their tenants have conducted themselves in accordance with the terms of the option to renew.
Are there any time limitations?
Almost always there will be a time limit on when an option can be exercised. This may be expressed in the commercial lease agreement as a specific date or as a period of time within which the option must be exercised. This period of time is typically from 3-6 months prior to 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. This means that the landlord is under no obligation to offer the same terms of the renewal expressed in the original commercial lease agreement.
Is an option a new lease?
Despite referring to an option as a ‘further term’ or ‘lease renewal’, by exercising an option, you are essentially entering into a completely new lease with the landlord that is binding on, and enforceable by, both parties.
Until the deed of renewal/new lease has been created and signed by landlord and tenant, there is only an agreement to lease. It is important to have your leasing lawyer draft these documents once the notice to exercise the option has been delivered to the landlord.
If you need assistance in drafting the option clause in your commercial lease, or simply wish to review your existing option clause, contact LegalVision on 1300 544 755 and speak with one of experienced leasing lawyers.