Commercial Lease Disputes

The purpose of this article is to identify issues that commercial landlords need to be aware of so that they can avoid disputes with their tenants and, if disputes cannot be avoided, navigate them in an efficient and cost-effective way.

Commercial leasing is an important part of business, both for landlords and tenants.

Disputes between commercial landlords and tenants are relatively common and can arise at different points of the leasing relationship.

This article will address:
  • The benefits of having a well-drafted commercial lease;

  • Common disputes that arise between landlords and tenants; and

  • Steps that can be taken to resolve disputes in a cost-effective way.

What is a commercial lease?

A commercial lease is an agreement between a landlord and a tenant where the landlord agrees to allow the tenant to occur its property for a business or commercial purpose. Any lease that is not a residential tenancy can be described as a commercial lease.

Why do you need a commercial lease?

Landlords and tenants in commercial leases have responsibilities and obligations. It is critical that both parties understand those responsibilities and obligations to avoid incurring unnecessary costs and potentially compromising their rights.

When entering into a lease, a landlord is trusting the tenant with a significant asset. Landlords will have the ultimate obligation to fix anything that goes wrong with the property if the tenant cannot or refuses to do so. The costs to a landlord of remedying issues with a property can be significant and it can be time consuming and expensive to recover these amounts from the tenant. This is a significant risk for the landlord.

Additionally, having a property empty for an extended period of time can be extremely damaging to cash flow. When there is an unexpected vacancy of a property or an issue caused by a tenant, it is important to quickly obtain advice, assess your rights and take action to protect your interests.

What makes a good lease

A lease is essentially a contract between a landlord and tenant setting out the parties’ various obligations in relation to the property in question. Leases are interpreted in the same way as a contract, however, there is some specific legal issues that apply to leases.

A commercial lease should always be in writing and a well-drafted commercial lease ought to be mandatory for any serious commercial landlord. Having a well drafted lease makes it easier for the landlord and the tenant to understand their obligations, making disputes less likely.

If disputes do arise, a well drafted lease will reduce the amount of argument between the parties and ultimately the time and cost involved in resolving a dispute. If a party’s obligations are clearly set out and they are properly advised, there should be less room for dispute. This should result in a quicker resolution of any issues and more time when the property is available as an income producing asset.

This article will not cover in detail what ought to be in a commercial lease, however as an absolute starting point it should contain:

  1. A clear method for rental increases that protects you from unforeseen market conditions;
  2. A strong make good obligation on the tenant by reference to an easily provable standard; and
  3. Personal guarantees in the case of a corporate tenant and bank guarantees as security for the obligations in the lease.

Even assuming you have a well drafted commercial lease, there are still issues that can arise and that will need to be navigated.

Common commercial lease disputes

We regularly see disputes between landlords and their tenants. Most often these disputes arise when:

  1. the tenant wishes to vacate the property;
  2. the landlord wishes to evict the tenant;
  3. when the lease comes to the end of its term (either in the scenarios above or simply at the end of the lease); and
  4. dealing with the tenant’s obligations to make good any damage to the property.

Each of these circumstances may give rise to slightly different issues. Some of these issues are discussed below.

Tenant leaving property

If the tenant wishes to vacate the property, the first consideration is whether there is any term remaining on the lease. Quite often we see circumstances where a commercial lease has drifted into a ‘holding over’ or month to month tenancy and the tenant is only required to give minimal notice of its intention to vacate.

This can be problematic for the landlord because it allows a relatively short period of time in which to find a new tenant so that the property can continue generating revenue. It is best to avoid this scenario by being informed about when the lease will expire and act before this time to negotiate a new lease with the tenant. Alternatively, the tenant may inform the landlord that they do not wish to continue the lease. If the tenant does not wish to enter into a new lease, the landlord will then have a better opportunity to find a new tenant prior to the current tenant vacating/lease expiry.

If the lease still has some of the term left to run, then in the ordinary course, the tenant is obligated to pay out the remaining term of the lease. However, this is subject to the landlord taking steps to mitigate your loss by finding a new tenant for the property.

Where this can become difficult is if the tenant has left the property in a poor state, such that the property is not in a condition to be offered for lease or marketed to new tenants.
While there is ordinarily no obligation on a landlord to negotiate an early surrender or termination of a lease, if the tenant does vacate the property and refuses to pay ongoing rent, the landlord would need to initiate proceedings to recover its loss. As part of establishing that loss, it is often necessary to establish that the landlord had attempted to mitigate such losses by seeking a new tenant.

It is, therefore, important that landlords seek legal advice if a tenant makes an approach seeking to exit a lease early so that you’re the rights and obligations can be understood and the proper documentation can be prepared prepared to document any settlement and surrender.

Having good legal advice throughout the process of a tenant leaving the property is critical to ensure that a landlord is pursuing the right strategy and not wasting time and effort on something that will not pay off.

Landlord evicting tenant

There are two common reasons why a landlord may look to evict a tenant:

  1. First, if there is breach of an obligation to pay rent.
  2. Second, if there is a breach of some other clause of the lease.

If a landlord is terminating or taking back possession of the property for the tenant failing to pay rent, they ought to be aware of the principle of relief against forfeiture. Relief against forfeiture is a principle that, in summary, provides for a tenant to be ‘relieved’ from forfeiting the lease provided that it pays the landlord the outstanding rent.

Provided the landlord and other persons concerned can be put in the same position as before the re-entry, a Court will usually grant relief against forfeiture upon payment of rent, costs, interest and other expenses: Pioneer Quarries (Sydney) Pty Ltd v Permanent Trustee Co of New South Wales Ltd (1970) 2 BPR 9562. If those terms are offered, it is only in a rare case that a Court would refuse relief against forfeiture.

A breach of some other clause of the lease may give the landlord a right to terminate, however this is dependent on the terms of the lease in question. If there is not a specific right in the lease to terminate and take possession, a landlord should exercise special care before terminating because a wrongful termination can mean that the landlord is liable for loss that the tenant suffers.

Whenever a landlord is considering terminating a lease, they should seek legal advice from a specialist in commercial leasing disputes.

End of lease

When a lease ends at any time, there are two key issues that we commonly see arising:

  1. First, whether the rent and outgoings are up to date; and
  2. Second, what is the tenant required to do when vacating and have they complied with those obligations.

When a tenant is vacating a property, the landlord (or their agent) should undertake a detailed review of the rent ledger to ensure that all rent and outgoings are up to date. This may seem like a simple task, however it can become complicated very quickly. Some factors that may complicate this task include:

  1. If the rent has changed over the lease period;
  2. If the lease period has been over many years;
  3. If the tenant has been late in paying rent at time over the course of the lease period;
  4. If the timing or frequency of the rent payments has changed from that contemplated in the lease; and
  5. There have been periods of reduced or waved rent (for example, as a result of COVID-19).

Reviewing the rental ledger periodically, and as the lease is coming to an end, can save a lot of time and energy later. Additionally, it may avoid an incorrect rental statement or ledger being sent to the tenant. Sending a rental statement or ledger sets the tenant’s expectations about the amount owing under the lease, sending an incorrect statement can cause a dispute to arise where it may have otherwise been avoided.

Engaging with your legal advisors at the end of a lease will ensure that the correct messaging is given to tenants with clear references to their obligations under the lease.

Make Good

The precise scope of a tenant’s obligations when exiting a property can vary based on the terms of the lease. However, generally there is some obligation on the part of the tenant to undertake some form of make good.

The make good obligation can vary from ‘restoring to an empty shell’ to ‘restore the property to condition it was in at the commencement date’ to no make good obligation at all. Additionally, there may be specific obligations to re-paint or re-carpet the property.

In many cases the obligation to make good is subject to an exception for ‘fair wear and tear’. But what is fair wear and tear?

Fair wear and tear has been described as:

‘the reasonable use of the [property] by the tenant and the ordinary operation of natural forces’

Precisely what is fair wear and tear will depend on the nature of the property and its condition. Relevantly, the onus is on the tenant to prove that the damage they have not repaired falls within the definition of fair wear and tear. For more information see our Hamish Taylors article here.

Resolving disputes

If a landlord thinks that there may be a dispute with a tenant they should take steps to protect their position as soon as possible. Using an experienced lawyer will make the process of resolving a dispute much easier and can avoid the parties doing something that will ultimately harm their interests. Having legal advice is important for any dispute, however it is particularly important for leasing disputes due to the complexities with the law in relation to leasing.

Practical steps may include putting the tenant on notice of their obligations and the landlord’s rights, taking steps to protect any security that was provided (for example, a bank guarantee) and taking steps to protect the property.

Once the landlord has protected their position as much as possible, the parties should attempt to resolve any dispute by way of agreement.

Commonly, this may involve a formal mediation or informal settlement discussions between the lawyers for the parties. In most cases a mediation will be required, whether by reason of legislation such as the Retail Leases Act or by order of a Court when a proceeding is commenced.

Accordingly, taking this step early may see the dispute resolved before the parties have incurred significant costs.

Retail Leases

This article does not specifically deal with leases that fall under the various Retail Leases Act in Australia. Landlords and tenants should be aware that their rights and obligations under a Retail Lease are impacted by legislation and may differ from the matters set out above in relation to commercial leases.

If you are unsure of whether your lease is a Retail Lease, you should seek advice immediately and before taking any steps to enforce the terms of the lease.

If you are a commercial landlord our experienced Solicitors can assist you to avoid and mitigate disputes with tenants.

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The information in this article is not legal advice and is intended to provide commentary and general information only. It should not be relied upon or used as a definitive or complete statement of the relevant law. You should obtain formal legal advice specific to your particular circumstance. Liability limited by a scheme approved under Professional Standards Legislation.

Principal Solicitor
Accredited Specialist (Commercial Litigation)