Home Business & Company What does an Option mean in a Retail Lease?

What does an Option mean in a Retail Lease?

What Landlords and Tenants Need to Know.

In this article we will be looking at retail leases and options to renew. In particular we will be focusing on how an option to renew under a retail lease should be exercised.

To begin with we need to be clear that this article is focusing on options to renew of retail leases in New South Wales, as opposed to options to renew under a general commercial lease. This distinction is important because retail leases in New South Wales are subject to particular rules under the Retail Leases Act 1994 (NSW). This means that certain statutory requirements apply to retail leases that cannot be varied or amended by the landlord or tenant.

What is a Retail Lease?

As a guide (there are exceptions) the Retail Leases Act deems a lease, to be a retail lease if:

the premises in question are less than 1,000m²;
the business in question sells goods or services of a type listed in Schedule 1 of Retail Leases Act (being over 160 different types of retail businesses); and
the term of the lease is between six months and 25 years.

What is an Option to Renew?

An option to renew is (generally) a tenant’s right to require the landlord to grant the tenant a new lease when the existing lease term ends.

Sometimes an option can be a landlord’s right and sometimes a lease will have automatic renewal provisions, but most options are drafted as a tenant’s right.

An option to renew is an agreement negotiated by the landlord and tenant when entering into a lease, for the granting of a new lease (sometimes called a renewal of a lease) when the current lease term ends, usually on the same terms as the existing lease, except that the dates are adjusted to reflect the new term (new start and end dates) and the rent is usually reviewed and adjusted to a current market rent.

And if you want to get technical, an option to renew is what is known as a “call option” in that a tenant (generally) has the right to call on the landlord to grant them a new lease. This is important because a landlord cannot exercise the option and has no right to force a tenant into renewing the lease under an option.

Option Clauses Under a Lease

When it comes to an option clause in a lease, it is always important to read and consider the terms of the applicable clause. This is because option clauses are a negotiated term and can contain such terms as the landlord and tenant agree. That being said, an option clause in a lease usually requires that:

the tenant give written notice to the landlord stating that the tenant is exercising their option to renew,
the notice must be given during a prescribed time frame (usually no earlier than six months and no later than three months before expiry of the current term), and
that at the time of the tenant giving the notice there can be no existing breach of the lease or any outstanding payment of rent or other monies under the lease.

As a tenant do not assume that you have until the end of the lease term to renew your lease. An option clause usually requires that you give notice to the landlord well before the expiry of the current lease term (usually at least 3 months before).

Tenants should also be aware that some leases will require you to “refurbish” (clean or repaint) the premises on the exercise of an option to renew a lease.

Exercising an Option Clause

Exercising an option should be treated as a formal legal process by the tenant and the tenant should comply strictly with the requirements of the option clause.

As discussed above this will generally mean that the tenant:

gives the landlord a clear, unequivocal written notice stating that the tenant is exercising their option to renew;
makes sure that the notice is correctly addressed to the landlord and is given and correctly executed by the tenant as named under the lease.
makes sure that the notice is given (served in accordance with the notice provisions of the lease) during the applicable timeframes and before any deadline set out in the lease.

How the notice is given is important. The lease will set various methods for how a notice can be delivered, usually by post, fax or email but make sure the terms of the lease are checked and complied with.

Although email is now a commonly accepted method of communication under legal documents, it is always important to carefully consider whether the benefits of giving a notice by email are outweighed by the risk of the notice being found invalid under the provisions of the lease. If you give notice by email, make sure it is permitted under the lease, it is given to the correct email address as provided under the lease and we recommend that you follow the email notice with a written notice delivered by post.

Tenants should avoid giving a notice to renew that is conditional on the landlord agreeing to do something in return. An option to renew is a pre-agreed contractual obligation and if a tenant seeks to adjust or renegotiate it, they risk losing the option.

Tenants should not rely on verbal discussions with a landlord as to any renewal, you want the process formally documented by way of a formal Deed of Lease Renewal. Preparation of this document usually falls to the landlord to prepare noting that section 45 of the Retail Leases Act prohibits a landlord from seeking to recover any legal costs in connection with a renewal from the tenant.

Tenants need to be aware that if you give a written notice exercising your option to renew, then you are “locked in” and the landlord can then require you to enter into the new lease and comply with its terms.

Landlords be aware that if you are seeking to deny a tenant the right to exercise an option to renew on the grounds that the tenant is in breach under the lease, you must ensure that you comply with section 133E of the Conveyancing Act 1999 (NSW). This means that you must:

give the tenant written notice specifying the tenant’s breach of the lease; and
the written notice must be served in accordance with the terms of the lease; and
the written notice must be served within 14 days after the tenant gives you notice to exercise their option if the breach occurred before the giving of their notice or within 14 days if the breach occurs after the tenant has given the notice to renew; and
state that subject to any court order under section 133F of the Conveyancing Act you propose to treat the breach as precluding the tenant from entitlement to their exercise of their option (after receiving your notice, the tenant has one month within which to commence court proceedings to obtain an order for relief against the denial of the option by you).

Landlords and tenants should diarise the important dates for any lease renewal including:

the timeframes under which the written notice to exercise an option to renew can be given,
the dates for any early determination of a current market rent (see below), and
the date of the expiry of the current lease term.

Tenants, give yourself plenty of time to exercise your option, do not leave it to the last minute.

Now What About the Retail Leases Act and Options to Renew?

The Retail Leases Act has certain key provisions that apply when it comes to the exercise of an option to renew a retail lease. They apply notwithstanding what the landlord and tenant agree to in the lease as these statutory provisions cannot be amended or varied. They legislate important protections around what is to be considered when determining a current market rent and give the tenant a right to request an early determination of the current market rent.

Determining a Current Market Rent for a Retail Lease

Section 31 of the Retail Leases Act sets out what matters are to be considered when determining a current market rent for a retail lease. We have reproduced section 31(1)(a) for you so you can see exactly what is to be considered.

The current market rent is the rent that would reasonably be expected to be paid for the shop, as between a willing lessor and a willing lessee in an arm’s length transaction (where the parties are each acting knowledgeably, prudently and without compulsion), determined on an effective rent basis, having regard to the following matters –

the provisions of the lease,
the rent that would reasonably be expected to be paid for the shop if it were unoccupied and offered for renting for the same or a substantially similar use to which the shop may be put under the lease,
the gross rent, less the lessor’s outgoings payable by the lessee,
rent concessions and other benefits that are frequently or generally offered to prospective lessees of unoccupied retail shops.

The current market rent is not to take into account the value of goodwill created by the lessee’s occupation or the value of the lessee’s fixtures and fittings on the retail shop premises.

Section 31 also provides that, if the landlord and tenant cannot agree on a current market rent, then the rent is to be determined by a valuation carried out by specialist retail valuer. And if requested by the valuer the landlord must:

supply the valuer with information (where reasonably available to the lessor) requested in a list provided by the valuer to assist the valuer to determine the current market value, including the following information about leases for comparable retail shops in the same building or retail shopping centre –

current rental for each lease,
rent free periods or any other form of incentive,
recent or proposed variations of any lease,
outgoings for each lease,

If the services of a specialist retail valuer are required, the landlord and tenant must pay and are responsible for a half share each, of the costs of the valuer.

Either the landlord or tenant can apply to have any determination of the current market by the specialist retail valuer, reviewed. To do so they must make an application within 21 days after receiving the original determination of the current market rent noting that if the current market rent is then confirmed on review as being the same or within 10% of the amount specified in the original determination, the party who applied for the review must pay the full costs of the review.

A Tenant’s Right to an Early Determination of the Market Rent

Section 32 of the Retail Leases Act allows a tenant to request (by notice in writing to the landlord) an early determination of the current market rent. The tenant may make such a request 6 months before, and no later than 3 months, from the last day on which the option can be exercised (or 3 months and 30 days for a retail lease of less than one year).

Once the current market rent is determined (either by agreement between the landlord and tenant or by the specialist retail valuer) the tenant will then have 21 days to decide if they want to exercise their option and if need be, the term of the existing lease will be extended by any appropriate period to enable a tenant to exercise its option.

Tenants, the purpose of an early determination of the current market rent is to allow you to have this information available to you to better help you in deciding whether or not to exercise your option. Just because you request an early current market rent determination does not mean that you then have to exercise your option.

What if a Retail Lease Has no Option to Renew?

For retail leases that contain no option to renew (or if the option(s) have been exercised) a landlord must, pursuant to section 44 of the Retail Leases Act, give the tenant written notice no earlier than 12 months and no later than 6 months before expiry of the current term (or 6 and 3 months for leases of less than 12 months) that:

It will offer the tenant a new lease, and on what terms including what rent; or
Inform the tenant that it does not propose to offer the tenant a renewal or extension of the lease.

Landlords be aware that if you do not give the required section 44 notice a tenant can, if they request it by notice in writing before the current lease term ends, have the term of the lease automatically extended until the end of six months after you give the required section 44 notice.

Key Takeaways

Failure to exercise an option to renew in the manner required by the lease means that a tenant will (most often) forfeit their right to the option and the landlord is then under no obligation to grant a new lease.

It is therefore critical that a tenant exercises their option in accordance with the lease terms.

This usually means (remembering to always check the relevant clause) that:

there can be no outstanding breach or monies owing under the lease at the time the option is exercised, and
that the tenant must give the landlord a clear, unequivocal written notice, in the prescribed time frames and in the prescribed manner under the lease, stating that they are exercising their option to renew.

And remember that when it comes to retail leases, a tenant always has the right to request an early determination of the current market rent and there are statutory provisions around how such a rent is determined including the appointment of a specialist retail valuer if need be.

Final Word

If you would like legal advice on your lease and/or the exercise of an option under a retail lease our commercial law team here at Roberts Crosbie Mortensen would be more than happy to assist. Please contact Amanda Crosby or Hamish Taylor in the first instance.

And remember, our approach here at Roberts Legal is to make business happen, not to get in the way.

Retail Lease Lawyers for Sydney and Newcastle

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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.