Lease essentials – the requirements for a valid lease
Today, facility managers are getting more involved in complex and extended lease negotiations. RODNEY TIMM and MARK HICKEY present an overview of the main features of leases and agreements, and clear a path through the negotiation minefield.
Through the process of Heads of Agreement, Agreements to Lease and finally the Lease, there is often confusion about when undertakings are binding. And few understand what details are required to constitute a binding Lease Agreement.
FORMS OF AGREEMENT
After the hype of the initial search and as lease negotiations move into the commitment phase, Heads of Agreements – or Letters of Intent – or Memoranda of Understanding – start to make their appearances. These documents usually focus on the key commercial terms of the deal indicating an intention to occupy the premises subject to the finalisation of an Agreement for Lease or Lease. These agreed Heads are then usually issued to the solicitors to prepare the Lease or Agreement for Lease. Normally, Heads are not intended by the parties to be binding. Great care must be taken with these documents to be clear as to their binding or non-binding effect. The Heads must clearly state whether it is binding, non-binding or binding as to part only.
Agreements for Lease are generally pre-commitments to relocate into a new development or refurbished premises. These agreements are usually an essential requirement for developers to get funding for their project. In essence an Agreement for Lease is a legally binding contract used to commit to the terms of a lease to be granted at some future time, subject to certain conditions occurring. An Agreement for Lease will be used for premises the construction of which is not complete. At the time of signing, the detailed design and form of the premises may not be finalised and as such the agreement needs to ensure that the design elements and building specifications are able to be determined. The form of the proposed lease should be attached to the agreement – ideally all the critical clauses in the lease agreed.
Leases, simply defined, confer exclusive use of defined property on the tenant and vest in the tenant an interest in the real property, which is registrable. The leasehold interest is created immediately even though the possession may not commence until a future date. The Lease is the instrument that controls the rights and obligations of both parties to the occupancy and use. The Lease imposes legally binding obligations on both parties with financial implications that potentially may result in significant losses if not managed diligently.
Too often with Leases or Agreements for Lease during the negotiation the focus is on the core commercial terms (those mostly found on the front page and schedule of the lease); however, the detailed terms and conditions, which can vary significantly, tend to be ignored. But with no two leases being the same, the devil is usually in the detail of these clauses.
Licence Agreements are different from Leases – albeit legal obligations and rights are still established. Generally, a licence is a purely contractual right permitting non-exclusive use of a property. A licence does not create an interest in the real property. Licences are used for such purposes as access for fitout works prior to lease commencement, car parking rights ancillary to a lease and antennas.
For leases to be legally binding certain minimum requirements have to be agreed by the parties. Without these the Lease may be void or not even created. This article does not allow the detail and complexity of this area of the law to be exposed; what follows is a brief identification of these minimum requirements.
• Parties and capacity – as in all forms of commercial contract the parties need to be clearly identified and have the legal capacity (distinct from financial capacity) to contract. In commercial leasing arrangements landlords and tenants will almost invariably be companies or associations, natural persons or trustees of a trust. Although the legal capacity of parties is not normally an issue, checks should be made to verify the status of the parties. Trustees, for example, must have the express power under the trust deed to lease. The financial capacity, although not relevant to the valid creation of a lease, may be significantly different from what was anticipated through the use of a similarly named ‘shelf’ company, which is not adequately capitalised or funded.
• Term – a commencement date must be fixed and the duration should be expressed in a manner that is certain, ideally referenced to a number of days, months or years.
• Written – all legal leases are required to be in writing in the form of a deed under the Conveyancing Act or in a form registrable for land under the Real Property Act.
• Premises – the leased premises must be ascertainable with certainty. This does not require that plans of the leased premises are included. Premises descriptions are adequate if defined within the context of a building or identified by reference to the building structures.
• Rent – if the parties intend that rent be payable under the lease it is necessary that the rent payable be expressed with certainty. It is possible, however, for a lease to be granted free of rent, but this arrangement should be explicitly stated.
• Registration – Real Property Act land requires that leases, where the initial term (and any option term) exceeds three years, must be registered to pass a legal leasehold interest and to obtain protection of indefeasibility of title. If registered, any other party dealing with the property will do so subject to the lease. If the lease is not registered the third party is not required to recognise the lease. Leases with terms (including any options) of three years or less need not be registered and a person dealing with the land will be subject to such leases.
Based on war stories there are many lessons learned that can assist the unsuspecting person about to enter into a lease. Foremost is remembering that all leases are different – read the terms and conditions in detail to fully appreciate the rights and obligations created by the lease. If there is any uncertainty, get professional advice; this may be legal advice or independent commercial advice.
During the negotiations it is useful to do your homework to identify the complementary landlord and lessee objectives. By understanding and respecting the other party’s perspective – and with clever negotiation – the resultant lease agreement can be beneficial to both parties. This understanding can also provide clarity in determining the rights and obligations of each of the parties.
In finalising the lease commitment make sure that the progression from the Heads of Agreement, to the Agreement to Lease, to the Lease is managed diligently. Ensure that all the requirements of a valid lease are met. Do not be lulled into a false sense of security believing the Heads is binding when it is merely recording the intent. In addition, be certain that all outstanding landlord obligations in the Agreement to Lease are delivered or carried across to the Lease, or ensure that these obligations are not extinguished by the Lease being executed.
In finalising a Lease or Agreement for Lease based on the Heads it is prudent not to leave this task to the lawyers exclusively, ignoring the negotiating team members. The negotiators know the nuances of the commerce of the deal. They should remain engaged in the process assisting the lawyers and ensuring that hard negotiating advantages are translated into legal binding terms and conditions.
The commerce components of the lease should be fully understood. How is the rental structured for the full term of the lease? How do the rent review mechanisms in the lease operate? Linked to the rental structuring is knowing what costs can be recovered and the ability to ensure that these recoveries are correct.
In managing leases do not get caught out missing critical dates in the leases – such as rent review and option exercise dates – by not maintaining adequate diary and reminder processes. And beware the procedural requirements for these critical dates, particularly the time trap with the landlord’s extended rights to provide notification of rental increases while the tenant has only a very short time period to object.
Mark Hickey is a partner at Kemp Strang Lawyers. Call the office on 02 9225 2503 or email firstname.lastname@example.org
Rodney Timm is a director of Property Beyond Pty Ltd. Call 0425 211 967 or email email@example.com
This article first appeared in the regular Property Watch column, Facility Management, Dec 09-Jan 10 issue.