AGREEMENTS FOR LEASE – WHAT ARE THEY AND WHY ARE THEY IMPORTANT?

Published 16 June 2015

Most people are aware that a lease provides the lessee with a lease term, which is a legal right to exclusive possession of land from a present or future date. In contrast, an agreement for lease is an agreement to grant a lease in the future without actually granting a right of possession to the proposed lessee. An agreement for lease will usually bind both parties, but sometimes an agreement may only bind one of them as in the case of an option for the renewal of a lease which may or may not be exercised by the lessee.

The form of the agreement will usually make clear whether it is a lease or an agreement for lease. An important indication that the instrument is a lease is that the tenant has entered into possession at the time when the instrument was executed.

An agreement for lease may be required where an instrument must be executed before a lease can be granted or before its date of commencement can be determined. Such situations may arise, for example, where:

The lessor has not acquired title to the land – for example, a purchaser of land might enter into negotiations to grant a lease before completion of the purchase, or, the land in question might be the subject of a subdivision which is not yet registered
The premises have not been fully erected or are not ready for occupation – this is probably the most common situation for an agreement for lease, particularly where the owner (the prospective lessor) is purpose-building premises for a prospective lessee
The former tenant is still in occupation of the premises
All the lease conditions have not been fully settled.
As it is not possible to grant a lease in the above-mentioned situations, an agreement for lease should be used to enable the parties to become bound to grant and receive a lease in the future.

The most common type of agreement for lease that our clients require are in the form anticipated by the second situation referred to above.

Purpose-built premises

An agreement for lease should be considered where a tenant wishes to lease a building or space in a building which is not yet constructed, or where an existing building is proposed to undergo a major overhaul or refurbishment. In these instances, it is important for a tenant to fully understand and document their requirements – especially the intended purpose for which the premises are being built – and for a landlord to fully understand their obligations to deliver the premises to the agreed standard and within the stated timeframe. Crucially, both parties should understand the consequences of not proceeding as promised under the agreement for lease.

One should expect to see a draft lease, plans and specifications, a copy of the plan of subdivision (if any) and details of any other ‘lessor’s works’ or the like attached to the agreement for lease.

Considerations which should be dealt with in an agreement for lease include:

Statutory consents
Variations
Handover provisions
Fitout works and defect rectification period
Extensions of time
Damages for delay (liquidated damages)
Achievement of practical completion
Warranties and insurance
Termination
Security (such as a bond or bank guarantee).
In this regard the agreement for lease is much like a construction contract, except between a landlord and tenant.

There is a large body of litigation surrounding agreements to lease, especially when premises are ‘built for purpose’. Such litigation is common because of the fact that both parties suffer significant loss if the building does not proceed as contemplated by the parties. As an example, if the building is delayed for some reason, the proposed lessee may need to find alternate premises with a short term lease which is likely to come at a significant cost. Another risk is that the building may not be built in accordance with the proposed lessee’s requirements and will therefore be not fit for purpose. It is common for disputes to be centered on the questions of what was required to be built and what was actually built. Properly drafted agreements can help you mitigate these risks.

It is essential that the terms negotiated in these matters allow for and require the completion of works in a timely manner and consistent with your requirements. At the very least, an agreement to lease should compensate you in the event that the building was not built in a timely fashion or in accordance with your stated requirements. In relation to the intended purpose of lessees, you should also ensure that an architect or engineer reviews any plans and specifications attached to the agreement for lease to ensure that the technical aspects of the building are satisfactory.

What happens when the premises are complete and ready for occupation?

In legal terms, this is called ‘practical completion’ and it means that the building is finished and ready to occupy notwithstanding that there might be some relatively minor ‘tidy-up’ works still to be undertaken by the lessor.

The following events should normally be ‘triggered’ by the achievement of practical completion and the receipt of an occupation certificate from the local authority:

The lease commencement date should be nominated
Liquidated damages would apply where practical completion is not achieved and an occupation certificate not obtained by the agreed date
The bank guarantee in relation to the lease should be provided by the lessee
The defect rectification period should be carefully monitored by the lessee as there are time bars on when defects can be identified by the lessee and rectified by the lessor – it is essential that lessees conduct thorough inspections prior to accepting handover of the premises.
Properly drafted agreements can deal with all of these risks.