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Funds Management - Real Estate & Superannuation

Focus on Leasing – October 2000

In this issue: We highlight the risks for landlords of 'keeping your options open' when it comes to negotiating tenancies; and examine a case that underlines the importance of observing strict formalities in the landlord-tenant relationship.

Make good goes bad

In brief: Landlords often seek to re-lease premises with fit-out in place while at the same time retaining the right to require the recently vacated tenant to make good. A recent Queensland Court of Appeal decision illustrates the pitfalls.1

Mercantile Credits leased commercial premises in the Brisbane CBD which, having become surplus to requirements, were sublet to 3 different sub-tenants. The subleases ended on the day before expiry of the headlease.

Mercantile's headlease contained relatively standard 'make good' provisions:

  • requiring Mercantile to give back the premises in good condition at the end of the term;
  • requiring Mercantile to remove its fittings and fixtures and make good any damage; and
  • allowing the landlord to (at the tenant's cost) remove and dispose of, or retain for its own use, anything not removed.

Nearing the end of the term, the landlord commenced negotiations with the 3 sub-tenants directly. Each sub-tenant ultimately agreed to take short term tenancies (ranging from a month to month tenancy to a 12 month lease). Two months before the end of the term, the landlord wrote to Mercantile requiring it to make good or offering to accept payment of $38,450 instead.

The Court found in favour of Mercantile. The landlord had 2 distinct choices at the end of the term. It could have either:

  • insisted on removal of the fitout; or
  • treated the fitout as its own.

It was required to decide which course of action to take within a reasonable time.

By entering into arrangements directly with the sub-tenants, the landlord effectively prevented Mercantile from removing the fitout and treated it as its own. It could not require money from Mercantile in lieu of the make good obligation, nor could it insist on Mercantile or the (former) sub-tenants making good when they vacated.

Tips for landlords

  • Keeping options open (ie looking for potential tenants whilst keeping the option of offering the existing fitout or a vacant shell) is a risky strategy. Landlords who adopt this approach should obtain written acknowledgement from the tenant that the landlord does not lose its right to require the tenant to make good whilst seeking a new tenant to take over the fitout;.

  • When leasing premises including fitout which has been abandoned by a previous tenant, landlords should ensure the lease includes a provision clearly identifying the fitout and requiring the tenant to remove it and make good at the end of the term..

Footnote
  1. Quadra Pacific (Australia) Corp Pty Ltd v Mercantile Credits Limited, Supreme Court of Queensland, Court of Appeal, 25 June 2000

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Notice the difference

In brief: Landlords and tenants are used to dealing with each other on a relatively informal basis. However, there are times when it is important to strictly observe the terms of the lease2.

Mr & Mrs Lamb and Mr & Mrs Newell were partners in a business known as 'Moruya Furniture and Bedding'. They leased premises under a 3 + 3 lease. Evidence at the trial indicated the landlord was anxious to have the tenants exercise the option for renewal and pressed them for written confirmation. The tenants were negotiating for a lease of alternative premises but, as those negotiations were not concluded, did not want to relinquish their existing premises. Mrs Newell wrote to the managing agent:

'We intend to exercise the option to renew our lease ... With the current economic conditions ..., we would expect little or no increase in rent.'

The tenants subsequently moved to the new premises and the landlord sued them for damages. The Court found in favour of the tenants on several grounds including:

  • Mrs Newell's letter did not constitute 'a clear and unequivocal election' to exercise the option to renew. The use of the words 'we intend to' (which indicate an intention to do something in the future rather than a present decision) were not, by themselves, fatal to the landlord's case. However in all of the circumstances, the judge found Mrs Newell's intention was 'to hold her position with the landlord by giving a written but non-binding statement of intention to renew'.

  • In the absence of a provision allowing it, service of the letter on the managing agent was not sufficient to amount to service on the landlord and was therefore not effective.

  • To be valid, the notice had to be signed by all of the tenants or by someone authorised by them. Although the manager had always dealt with Mrs Newell in matters relating to the premises and payment of rent, that did not imply any authority on her part to take such a major step as exercise of an option.

Lessons for landlords
  • If you intend relying on notices of exercise of option as binding the tenant, ensure they are unequivocal and unconditional. Consider forwarding a pro-forma notice of exercise to tenants before the time for exercise expires.
  • When required to serve a formal notice under a lease, check the lease and ensure the notice is signed and served strictly in accordance with the relevant provisions.
  • When dealing with more than one tenant or a company, take care in relying on a notice signed by one person. Make sure that person has the authority of the tenants named in the lease. At the very least, require the signatory to warrant that he or she has the authority (ie require them to sign, 'X on behalf of XY & Z – the signatory warrants his/her authority to sign on behalf of the tenants').
    This may at least allow a claim against the signatory for breach of warranty.
Footnote
  1. Young v Lamb, New South Wales Supreme Court, Austin J, 27 July, 2000

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