The issue of make good is often not given much consideration at the time a lease is being negotiated, but rather only considered as the expiry date of the lease approaches or when the lease has already ended. Partner, Tony Britten-Jones, and Associate, Adam Rinaldi provide an overview of make good considerations that should be addressed by landlords and tenants when negotiating a lease to avoid unexpected surprises.
The scope of a tenant’s obligation to make good at the expiry or earlier termination of a lease term is often a source of dispute between a landlord and tenant. Disputes regarding make good can be costly and time consuming for both the landlord and tenant.
The issue of make good is not always given sufficient consideration at the time of entering into the lease. At this stage, the parties’ attention is usually directed to negotiating the more contentious issues such as the commercial terms of the lease (i.e. rent, security and term) and the scope of the indemnities. The issue of make good is often not given priority until the expiry date approaches or the lease has already ended.
The current trend in most leases is for there to be a covenant requiring the premises to be reinstated to “open plan presentation” which requires the tenant to remove all plant and equipment irrespective of whether it has been installed by the landlord or tenant.
It is also common for a lease to state that the tenant is required to make good the premises to their condition at the commencement date of the lease subject to fair wear and tear. Where this is the case, a condition report (usually containing photographs of the premises at the date of occupation) should be prepared evidencing the agreed state of the premises at the time the tenant takes occupation to avoid dispute as to the tenant’s reinstatement obligations.
The landlord may want to vary the default position where the landlord does not require the tenant to remove its fitout. The landlord may require the tenant’s fitout to remain where a fitout is particularly suited to a specific use and substantial capital works are required to change that use. Examples include restaurants, medical centres, food outlets, fitness centres, bars and other purpose built facilities. In these circumstances, the landlord may prefer the tenant to leave all or part of its fitout in the premises as this may benefit a future tenant.
The cost of removing a fitout can in some cases exceed the value of using or on-selling the fitout. This is common with office fitouts. In these circumstances, the landlord may prefer to have the tenant remove the fitout so as to reinstate the premises to an open plan presentation. However, especially in the cases of restaurants and bars, the fitout may have value and be capable of being sold. For example, there is a secondary market for large items of equipment such as fridges, ovens, fryers and other similar items. In these circumstances, the tenant may prefer to carry out an extensive make good of the premises so as to be able to re-use or sell such valuable items.
It is therefore important that the terms of the lease clearly define the scope of the tenant’s make good obligations as there will invariably be competing interests on the issue.
Where a lease is not clear in relation to the ownership of the tenant’s fitout or where the lease does not clearly state what is to happen with tenant fixtures and alterations, disputes are likely to arise in relation to the scope of the tenant’s make good obligations and the issue of whether a part of the tenant’s fitout constitutes a fixture may also need to be addressed.
The general law position in relation to fixtures is that a fixture becomes part of the premises and must be left behind by the tenant when the lease ends. The fixture therefore becomes part of the land and owned by the landlord regardless of who owned the item and affixed it to the property. As such, an item of fitout may become a fixture by virtue of the manner it is installed.
In determining whether an object has been converted from a chattel to a fixture, the Court generally has regard to the following:
- The degree of annexation and physical attachment of the object to the land – if an object is fixed to the land to any extent by any means other than by its own weight, then generally it is a fixture.
- The intention of the parties in affixing the item to the land – if the item is attached with the intention that it will remain in position permanently or indefinitely or for a substantial period of time, then generally it is a fixture.
However, it needs to be borne in mind that the general law position can be changed by including appropriate wording dealing with this issue in the lease document.
Landlord considerations: The landlord will own chattels installed by the tenant that have been converted into “fixtures” unless the lease provides otherwise. It is therefore important that the extent of the tenant’s make good obligations is clearly stipulated in the lease. It is a good idea to agree up front which items of a tenant’s fitout are to remain the property of the tenant and must be removed by the tenant at the end of the lease. Conversely, clear up front agreement as to items which are to be owned by the landlord and remain affixed to the premises at the end of the lease is also important.
Tenant considerations: The cost of making good the premises can be a very expensive process for a tenant. This cost should be taken into account when negotiating the commercial terms of the lease. In some cases, it may be prudent to agree to leave items such as air-conditioning units or alarms which have little resale value but which may benefit a future tenant. If there are any items of equipment that the tenant does not intend to become fixtures and wishes to remove from the premises upon the expiry date, this should be addressed at the lease negotiation stage, or at least, prior to installation. An express acknowledgement as to the ownership of any items of property that the tenant wishes to remove from the premises at the end of the lease as well as ownership of or obligations in relation to items the tenant does not wish to remove at the end of its occupation should be included in the lease or in some other written form.
It is also important to ensure that photographic and other evidence of the property condition at the commencement of the tenant’s occupancy is retained by both the landlord and the tenant until the tenant has vacated and completed its make good.