When negotiating a commercial or retail lease, the landlord and tenant will agree on an initial term. However, the landlord and tenant should also consider the future plans beyond that fixed term agreement.

For example, a tenant may want an initial term of 3 years to see if its business is going to be successful in the premises. If the business is going well then it is in the tenant’s best interest to have an option to renew the lease for another 3 years or more.

However, the landlord should consider whether it has plans to redevelop the premises before it agrees to grant the tenant an option for lease renewal.

What is an option for lease renewal?

An option for renewal for a further term or further terms, is an option for the tenant to enter into a new lease after the expiry of the initial term of the lease.

The terms and conditions of the option are included in the lease for the initial term in a clause usually known as an option clause. The option provides the tenant with a right to extend the term of the tenancy by providing the landlord with a written notice of the exercise of the lease renewal option, which needs to be effective and valid.

If the tenant validly exercises its option, the landlord must grant the tenant the further lease in accordance with the terms and conditions set out in the option clause. A validly exercised option is usually legally binding on both the tenant and the landlord, meaning that the tenant and landlord cannot withdraw from grant of the lease for the further term.

The option clause in the initial lease should set out the:

• timeframe for the tenant’s exercise of the option before the expiry of the current term.
• method for exercising the option notice (for example by email or post).
• terms of the option lease. The new lease will usually contain the same terms and conditions as the current lease, subject to certain exclusions. For example, landlords should remove rent free periods or fit out contributions from any further term to avoid providing such incentives twice. The option for the new term itself should also be removed if the parties do not contemplate having a second further term.
• rent reviews for further terms, for example Consumer Price Index, a fixed percentage increase or the market rent. A market rent review is often used at the start of the new lease.

Tenants – Tips for exercising your option for lease renewal

Before exercising your option, it is important for you to consider:

Rent at the start of the further term

As discussed above, a validly exercised option is usually binding on both parties so it is important to consider what the rent is going to be at the start of the new lease before you exercise your option. If there is a market rent review on the exercise of the option, consider the timeframes for determining the rent and if it can be determined before you exercise your option. When negotiating the terms of the initial lease tenants may want to negotiate for a right to trigger the market rent review prior to the timeframe for the exercise of option.

Breaches of the lease

Leases will often allow the landlord to refuse the grant of the lease for the further term if you fail to pay rent in a timely manner, perform all other obligations, or rectify any breaches to the lease. It is a good idea to ask the landlord to confirm in writing whether or not the tenant is in breach of the lease before attempting to exercise the option for the lease renewal process. If you become aware of a breach, it is important to rectify this as soon as possible.

Compliance with the lease

The lease obligations would normally apply up to the termination date of the fixed term lease, including obligations such as refurbishment. Non-compliance with lease obligations can be regarded as a breach of lease.

When exercising your option, it is important for you to consider:

Timeframe

The window in which you can exercise the option is usually a strict timeframe which means that the landlord is only obliged to grant a new lease when the notice served effectively within that stipulated timeframe. If the notice is served late then it is likely to not be valid and the landlord may refuse to grant the new lease. It is important to diarise these dates at the beginning of the initial lease term to ensure that they are not missed.

Notice requirements

All notices should comply with the relevant provisions of the lease to be effective. Check if notices can be served by email or if they must be sent by post. It is also important to check which address they must be sent to.

Language

Your notice should have a clear and unequivocal statement of your intention to exercise the option to avoid any doubt or issues.

If you are not sure if you are exercising the option correctly, then you should get advice from a solicitor before sending the notice.

Landlords – Tips for managing your Tenant’s exercise of an option for lease renewal

If you are not sure if an option is validly exercised by the tenant or have any concerns with the grant of a new lease, we recommend seeking advice from your solicitor prior to the new tenancy agreement or responding to the tenant.

Landlords should ensure that the correct rent review is applied on the exercise of the option. If there is a market rent review on the exercise of the option, a landlord should ensure that it complies with its obligations and timeframes set out in the lease for triggering that market rent review. Landlords should also be aware of the rights under the lease to collect an increased security bond or bank guarantee.

Remember to document the exercised option for lease renewal

It is a common misconception that if the option has been validly exercised then there is nothing further for the parties to do. Whilst the validly exercised option may mean that there is a legally binding agreement to enter into a lease, it is important that the parties document the lease for the further term.

The further term can be documented with a new lease or a variation of the current lease. If you choose to document the further term by way of variation of the current lease, make sure that you are aware of the timeframes for documenting and registering the variation. These are different for ACT and NSW.

A solicitor can assist property managers or landlords with preparing the new lease and variation documents or tenants with reviewing the documents to ensure that they are prepared correctly and protect your interests.

What if there is no option for lease renewal?

If there is no option for lease renewal and the tenant wishes to remain in the premises, then the parties can negotiate the terms of a new lease. However, subject to any protections under the relevant retail and commercial lease legislation, the property manager or landlord has no obligation to offer the tenant a lease renewal. The landlord also has no obligation to offer a lease on the same or similar terms as the current lease.

When there is no option for lease renewal and no new lease is signed, if the tenant remains in the premises then the holding over clause would usually apply. This clause will usually allow a tenant to remain in the leased premises with the consent of the landlord after the end of the lease on a periodic tenancy.

The periodic tenancy will usually be on the same terms as the lease. Sometimes the holding over clause allows for the rent to be increased during the monthly tenancy.

Subject to the terms of the lease, either party may end the periodic tenancy by serving a notice to end the periodic tenancy or by entering into a new lease. Again, it is important that this notice is served in accordance with the terms of the lease.

Whether you are a landlord or a tenant it is important to consider your future plans when negotiating the lease for the initial term. As the end of the initial term approaches, a solicitor can assist you with ensuring that the option for a further term is exercised and documented correctly.

If you need help navigating the complexities of an option to renew a commercial lease agreement, our team at MV Law is here to help. We can offer expert legal advice for commercial leases to assist you in achieving your most favourable outcome. Our team comprises of specialised lawyers who can provide guidance on a wide range of matters, including commercial law and evaluating contracts. If you need assistance, please don’t hesitate to contact our commercial lease lawyers on (02) 6279 4444.

Author:

Jennifer Jaeschke, Special Counsel
Commercial Leasing Lawyers
MV Law Canberra
ph. (02) 8355 1331

Sheng Ho, Lawyer
Commercial Leasing Lawyers
MV Law Canberra
ph. (02) 8355 1331