Agreements for leases (AFLs) - Tips and Traps - part 1

In recent times, there has been a glut of commercial construction project activity across the major cities on Australia’s eastern seaboard, with many tenants seeking to relocate business operations to premises in new office buildings.

In some cases, a tenant will be negotiating new lease terms with a landlord prior to completion of the relevant building. What should the prospective tenant be aware of in these cases?

In this instalment of ‘AFLs - Tips and Traps’, I consider negotiations at heads of agreement stage, as well as key dates in agreements for lease.

Lease negotiations

When negotiating a new leasing deal, the tenant will usually receive a heads of agreement (HoA) for negotiation and execution. This document will set out the commercial terms of the transaction including the proposed lease terms, any works to be completed by the parties, financial terms (eg. incentives) and key dates. Often enough, after execution of the HoA the tenant will only be provided with a lease to review, which purports to document the agreed HoA terms.

However, if the deal includes any sort of condition(s) that require fulfilment prior to the tenant’s occupation of the premises and lease commencement, for example:

  • completion of the premises or building works
  • completion of tenant’s fitout, and/or
  • the landlord or tenant is required to obtain authority approvals (eg. approval for the tenant’s intended permitted use) or third party consents

the tenant should request that an agreement for lease be prepared and should ensure it is clear that the HoA is not a binding agreement of itself.

The landlord may wish to rely on the HoA in respect of such conditions. This is not preferable from the tenant’s perspective, as:

  • an agreement for lease will generally create immediately binding obligations on the parties. In particular, it will impose a positive obligation on the landlord to grant the lease to the tenant at a (to be determined) future date. Heads of agreement, however, are usually not binding documents and, in isolation, will not require the landlord to grant the lease to the tenant
  • the HoA will lack the detail contained in a formal agreement for lease (and potentially lead to uncertainty as to the bargain struck down the track). For example, a HoA will not generally consider a party’s assignment rights, or default provisions

the other possibility is that the HoA is a binding agreement and in that case will usually be favourable to the landlord because the tenant’s negotiating opportunity is lost or limited.

Key dates

As part of HoA or agreement for lease negotiations, the tenant should obtain a timeline from the landlord as to key dates and timeframes for the development. In particular, the tenant should be cognisant of the following:

1. Date for completion of works

A date by which the landlord must complete building works should ideally be documented in the agreement for lease. Often, the landlord will frame the requirement as a ‘reasonable endeavours’ obligation (rather than the optimal tenant position, being an absolute requirement) to complete such work by the relevant date. Whether the optimal position can be negotiated by the tenant will depend on a case by case basis, and on factors such as:

  • what timing the landlord has separately agreed in its construction contract with the builder
  • the tenant’s negotiation power (eg. is the tenant is taking one suite, or is it the anchor tenant / taking several floors in the building?)

2. Sunset date

Perhaps more critical is the inclusion of a sunset date for the satisfaction of any condition precedent to the landlord’s grant of the lease. The tenant should ensure that the sunset date is one which, if the landlord fails to satisfy its obligations, provides the tenant with an appropriate buffer under its current lease arrangements to:

  • find alternative accommodation (whether temporary or permanent) prior to the current lease expiry date
  • exercise an option under its current lease

so the tenant’s business continuity requirements are not affected, and it has a ‘home’ at all times.

Linked with the sunset date should be the ability for the tenant to terminate the agreement, and walk away from the transaction. Importantly, where the condition precedent is one that the landlord is to satisfy and/or controls, the tenant, and not the landlord, should be the party with the ability to elect whether to continue under the agreement for lease, or terminate.

3. Lease commencement

A mechanism for the determination of the lease commencement date is a standard provision in agreements for lease. It should be carefully considered, however, where the tenant is undertaking fitout works. In this context, the tenant should ensure there is an ample period between the:

  • completion date of any landlord’s works / when the tenant first gains access to the premises
  • lease commencement

for the completion of its works, and that any delay in premises handover to the tenant does not shorten the tenant’s fitout period or cut into the lease term.

AFLs – Tips and Traps for tenants (part 2)

In the next instalment of ‘AFLs – Tips and Traps’ I will consider works in more detail: landlord’s works and tenant’s works.