Property Services

Lease Documentation – Getting it right…

Happy New Year !…. I believe 2014 is going to be a very interesting year indeed – it will bring some big challenges to the retail sector, but equally I think it will bring big opportunities too. In particular I recommend that you watch the bond and equities markets and perhaps even the property sector, particularly in the US and other parts of the developed world, as well as Australia. I think there’s a big correction coming, however we’ll see if I am right in due course.

This month I thought I would talk about lease documentation, yes I know a fairly dry subject, but one that is very important, I hope you find it interesting.

Over the past few months I have had a number of interesting situations where I was negotiating lease renewals on behalf of retail clients. In each of these cases, my clients were in the process of or had already exercised their option to renew. The clients had engaged me to act on their behalf, as their landlords were quite difficult to deal with.  The landlords in question where not large, multinational retail property giants, but rather small private investors. Contrary to popular opinion I have found that small landlords can often be more difficult to deal with than large retail landlords.

Upon reviewing my clients existing lease documentation I noticed that they  were actually very old leases that had been extended many times over. In a number of cases the original leases dated back to the late 1990’s, but only had one option to renew for a further 5 years. At the expiry of the option term, a new lease should have been negotiated using the most current form of lease memorandum that would normally incorporate the latest changes to relevant retail lease legislation. However the landlord (or their solicitors) decided to simply extend the original lease rather than enter into a fresh new document. That practice continued for over a decade, but the landlord’s solicitors did insert new clauses stating that these leases were subject to the latest changes in retail lease legislation.

Effectively these leases were 15 to 16 years old and contained terms and conditions that contradicted current lease legislation. Whilst the old leases did have those overarching clauses stating they were subject to new legislation, it made reading and interpreting them a living nightmare.

In one particular case, a retailer had a very complex market review that was to occur as part of an option renewal process, however the mechanics of the market review contradicted other parts of the lease and the most current lease legislation. On top of this, the lease had been assigned a number of times over 15 years, which meant there were various deeds of assignment with additional little amendments to consider.

After pouring through the various documents for hours, I concluded that the relevant market review clause was simply out of date and contrary to the relevant retail leases act, so in my opinion I thought it should be ignored. However I sought independent legal advice from a prominent Sydney law firm who specialises in this area, just to confirm that I was correct. The law firm took several days to analyse the relevant clause and involved a number of senior partners, such was the complexity of the issue. Their initial comments were that they thought the documentation was very messy and not surprisingly difficult to interpret. The opinion of the law firm was that, even though they thought I was correct in my assessment of the lease contradicting the relevant act, there was a complicating issue which none of us were initially aware of.

A few months earlier in the same state where this case occurred, a very similar dispute arose with another retailer, however that particular retailer took their landlord to court on the basis that the market rent review mechanism within their old lease, directly contradicted the relevant lease legislation and was illegal. Effectively this case was about the landlord not wanting to reduce rent as part of a market rent review, even though all parties acknowledged that the rental market had declined significantly. Normally this would be an open and shut case, as ratchet review mechanisms (a conditional market review which prevents rents to go down) are illegal.

Believe it or not, the court ruled that the rent could not be reduced (as per the provisions of the old outdated lease), even though the rental market had declined and that it was in direct contradiction of the current retail leases act.  The judge ruled that it was not a ratchet clause, even though the effect of the old clause was such that the landlord could decide if the rent should go up or down. Naturally the landlord in question decided that the rent should not go down, so the retailer did not have their rent reduced even though they were paying well above market.

I could not believe it and my legal firm could not understand the logic behind the judgment either, however as it was now a case precedent they felt that my client effectively could not rely on the courts to remedy his situation if he wanted to take legal action against his landlord, as his case was identical. Even though my client was paying above market rent in a shopping centre that had it’s fair share of problems, he could not have his rent reduced to market, despite his lease contradicting the act. At best his rent could stay the same or go up by a fixed percentage, even though current lease legislation states very clearly, that such a mechanism (a ratchet review) is illegal. Needless to say my client was dumbfounded, but there was little he could do, other than taking his case to court however his chances were slim, not to mention the legal costs involved.

Why did this occur? Firstly my client was using a very old lease that was out of date, so this really complicated the situation. Secondly an unusual judgment by a court created a precedent that would have probably gone against my client, had he decided to take legal action.

So what is the moral of the story?  Well, there’s not much we can do about a case precedent, but you can ensure that when it comes to signing a lease, you obtain good legal advice.  Whilst it is important to negotiate favourable commercial lease terms, it is equally important that all documentation is correct and up to date and this includes documents such a Landlord’s Disclosure Statement.

For those retailers who have a similar situation to the above, in so far as you have an old form of lease that expires soon and your landlord (or landlord’s solicitor) wishes to extend it again, I recommend that you ask for a fresh new form of lease instead. Ask your solicitor to push back on extending the lease in favour of a new document that reflects the most current retail lease legislation. Remember retail lease legislation was created to protect retailers and is something quite unique compared to anywhere else in the world, so you should take advantage of it.

Entering into a fresh new lease maybe a little more expensive than simply extending an old lease, but in the long run it will be more beneficial to you as a retailer.