[EP 021] What to Look Out for in Commercial Leases

Many business owners need to consider entering into property leases at some point in running their business. But because of the long-term nature and the obligations that come with this contract category, leases should be examined closely and, more importantly, understood completely before you even consider signing one. In this week's episode, we've invited our very own expert on commercial leases, Elizabeth Lee, to share her wealth of experience in this area of law. Tune in to find out what sorts of things you need to be checking in your commercial leases.

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JOANNA: Hi! It’s Joanna Oakey here and welcome back to Talking Law. Today we are talking about what to look out for in commercial leases and to talk about this subject I have brought in an expert today, Elizabeth Lee.

Liz is a commercial lawyer with an MBA degree who has advised businesses for over 23 years. She’s also worked as in-house counsel a little large accounting firm prior to joining us here at Aspect Legal and our heads up our contract law and business sale and purchase divisions.

Hi Liz. Thanks so much for coming along today in bringing your wealth of experience to talking about this area of law.

LIZ: Thank you Jo. Thanks for having me.

JOANNA: Great. OK. Looking at this area of commercial leases, why is this area so important to businesses? I think businesses often you know get to the point where they negotiate a transaction for taking on a lease in in premises they get to the point of agreeing the commercial terms where they’ve spent loads of time calculating sums and coming to financial arrangements that they’re happy with and then they come to the lease and there’s all of these pages of gobbledygook. And often it just doesn’t seem particularly interesting so why is it interesting for our listeners to (and important for) our listeners to be careful about commercial leases that they’re entering into?

LIZ: Well, leases tend to be fairly long term contracts and there are financial obligations and often guarantees given in relation to these leases. For that reason, I think that a great deal of importance needs to be placed on this category of contract. And as you referred to earlier, these contracts are often large documents. It runs from 30 pages up to over 100 pages.

JOANNA: I actually think that depending on how much a particular business owner wants a particular premises but often that time of that commencement of the lease of the very first initial period that they’re taking on is often the greatest opportunity that they’ll ever have to negotiate the terms of the lease right?

LIZ: Yes, absolutely.

JOANNA: Because they’re not in there. They’ve got the power often in this in this situation when a landlord wants to sign them up, as opposed to when we get to options and extensions of leases later on down the track. Often business owners at that point the businesses are in the premises and it becomes sometimes difficult for them to move. So sometimes the power balance changes and the landlords have greater power at that time so it can be more difficult for us to get changes later on if we haven’t been able to think about negotiating them at the beginning so I guess that that initial time of taking on the lease really is a golden opportunity to get the best case scenario you can organise right at that initial point.

LIZ: Yes, I agree. Having said that though, often when tenants are going into premises where the landlord is a fairly large organization, they often encounter situations where they have little bargaining power. But notwithstanding they should still give it a go because of the long term nature these contracts are. And it’s interesting because with the introduction of the Unfair Contracts Provisions in the Australian Consumer Law that’s been in place since November 2016, leases that are often put to tenants as standard term contracts could well now be subject to regulation under the Australian Consumer Law. And then this particularly applies where one party is considered a small business.

JOANNA: And it’s interesting I guess this really is important legislation for any businesses now who are entering into leases where they don’t have the opportunity to negotiate or to properly or reasonably negotiate at least some of the elements of the lease because they then potentially have this legislation to fall back on if areas that are being pushed by the landlords are seen to be unfair.

LIZ: Yes absolutely.

JOANNA: Great. OK. All right. What are some of those considerations then in relation to commercial leases that businesses should be looking out for or considering?

LIZ: Yeah. The basics are, in a commercial lease, checking that the renter and outgoings are properly reflected in the lease as understood by the tenant, that the rent review clauses are not too onerous. Have a good understanding of where the rent is being reviewed to CPI, a fixed percentage or to market, whenever it comes up, whether it has a ratchet clause – that’s a clause which says that rent can’t go below what the rent payable was before the date of the rent review. Often they exist in leases but in certain regulated areas such as retail leases, ratchet clauses are not permitted. You’ve got to look at the term of the lease whether there’s any options. So if the premises are pretty important to the business that you’re looking to operate from there, you want to make sure that there’s appropriate option periods. Also, particularly if you are undertaking a heavy investment upfront to fit out the premises, the guarantee is important. What’s the amount required? Is it to market or is it above you know what’s ordinarily found in markets?

As a general rule of thumb, we see bank guarantees of three to six months being required by landlords. It can come in the form of a bank guarantee or a cash deposit. And sometimes landlords require a personal guarantee on top of that. As a tenant you really want to try and avoid giving personal guarantees where possible.

JOANNA: It’s a really sticky issue isn’t it, because of that personal guarantee. We have in entities like for example company structures that help to separate the exposure of liability for the business owner from the business. But when we get to this area of personal guarantees it really starts to piss some of those protections of using structures like for example companies. Understandably it’s a source of concern to many business owners and often, business owners don’t realize that these areas are often quite negotiable. So a landlord’s requirement for a personal guarantee might be dealt with in other ways like for example increasing security in the bank guarantees or simply pushing against it if you have more power than the landlord.

LIZ: Yes that’s right.  Or providing trading history of previous businesses or other record of all of having been a good tenant in the past or in other premises.

JOANNA: And financial capacity. Because I guess you know at the end of the day that’s what the landlords are particularly concerned about that they only have this this company on the hook. And if they can’t be confident about financial capacity moving forward then this is a risk to them. So I guess it’s about understanding what the landlords need to make them feel comfortable in this transaction as well.

LIZ: And some of the other provisions in the commercial lease that you would watch out for are the redecoration obligations and make good. That is often a very expensive obligation to fulfill at the end of the lease or during mid-term. And so you want to check that the provisions are appropriate that the requirements of the landlord.

JOANNA: Absolutely. Great. OK.

LIZ: And last but not least is you should check the assignability clause because often you’re in a business where you may need to assign the lease to a third party and you want to make sure that the provisions relating to assignment are not onerous.

JOANNA: Absolutely, because part of the value in the sale of a business can often be the value of the location that you’re occupying at the time.

LIZ: Yes correct.

JOANNA: And often we see that the values of a business is tied to the way these leases have been dealt with right in the beginning. I think it’s really important, you make a great point there, it’s really important that we emphasize to our listeners that this point of your initial negotiation of these commercial leases can be important sometimes later on down the track if you’re looking to sell the business.

LIZ: Yes absolutely.

JOANNA: Great. OK. All right. And so then I guess the last area that we should probably talk about is the commercial term. So ensuring that the commercial terms reflect in the lease itself because it’s one thing to sign a heads of agreement that sets out the commercial terms but I guess it’s another for businesses entering into these leases to ensure that those commercial terms are reflected properly in the lease in an unambiguous way.

LIZ: Yes correct.

JOANNA: Great. Okay. All right. So I think that’s a really good overview then of this area of commercial leases and the sorts of things that our business owners should be looking out for.

So just as a bit of a recap of where we’ve been today, if you’re looking at engaging in a commercial lease remember that the initial period of engagement might possibly be a period of time where the balance of power is in your favor and it might perhaps be one of the only points in the interaction with the landlord where the balance of power is skewed to that extent in your favor. So take advantage of it at that point and use that as a way to negotiate at the initial outset.

The sorts of things that you will need to be checking or ensuring that your legal advisers are checking for you are ensuring that outgoings are properly dealt with, that rent reviews aren’t too onerous, that terms and the options reflect what you require into the future, particularly if you’re thinking of sale into the future. The area of guarantees, and particularly that thorny issue of personal guarantees, and also make good clauses. And there’s also other sticky items in leases that really need proper attention, like the indemnity in liability clauses and other areas that might be relevant during the term of your lease.

So the important lesson I think is to take advice early, to make sure it’s good advice – people who have dealt with this area many times before. And make sure you’re thinking commercially about each of these areas when you’re going in to do the deal right from the beginning.

Great. OK. Well I think that was a really good overview. Thanks so much Liz for coming along and talking to all of our listeners today about this topic.

LIZ: Thanks Jo. It’s been a pleasure.

JOANNA: Great. All right. Now if you’d like more information about this topic head over to our website at talkinglaw.com.au. There you’ll be able to download a transcript of this podcast episode if you want to read it in more detail. You’ll also find there details of how to contact our lawyers that Aspect Legal including Liz and the rest of the team, if you’d like help with any of the items that we covered today. And finally if you enjoyed what you heard today please pop over to tunes and leave us a review. Thanks again for listening in and see you next time.