Lease options present one of the trickier areas of tenancy contracts. A critical part of most commercial agreements, lease options are often overlooked or misunderstood, leading to unwanted tensions and grievances between landlords and tenants. “One of the influencing factors of a successful tenancy is understanding how lease options work,” said Amanda Tolson, Director and Head of Commercial + Property at Clifford Gouldson Lawyers. “Regardless of whether you are a tenant or landlord people need to know how they affect their rights and responsibilities.”
Lease options are contractual rights. They give tenants the right to extend the lease for the time period stated in the contract. For instance, if a property is offered with a 5-year option, the tenant is within their rights to request an extension of their lease for that number of years. Provided the tenant has not breached their lease and the landlord has no issue with the tenancy, then the landlord is bound to honour that option.
For a tenant, a lease option is highly attractive. It gives them the security of knowing they can extend their lease term in the long run and that their request to do so will be honoured. For landlords, the hope is that providing a lease option will encourage the tenant to continue renting their premises beyond the initial lease period, thus avoiding the problem of having to search for a replacement when the lease expires. The downside for a landlord is not knowing for sure whether their tenant will extend their lease until they notify them of their decision.
The stumbling block however is failing to follow the clauses surrounding the lease options – those that state how and when tenants need to notify a landlord of their intention to exercise their option to extend their lease. The lease will generally contain a requirement for this to be done prior a certain number of months before the lease is due to expire - generally three to six months. There will also be a requirement for this to be done in a certain way, such as via a letter posted to a particular address.
But simply failing to diarise and/or take note of these requirements is a common occurrence and major cause of problems between tenants and landlords, Ms Tolson said.
“The sheer length of some leases has a lot to do with it too,” Ms Tolson said. “Some can run up to 70 pages or more especially with the larger retail centres.
“In other cases, people get to a point where they sign a lease, put it in the bottom drawer and get on with running their business. Then by the time they get to the option – whether that is in three or five or 10 years’ time – they have forgotten all about when they need to notify the landlord of their intentions.”
The danger of not meeting these requirements is that it then gives the landlord the power use this lack of compliance with technicalities to deny an extension of the lease. If on the other hand the tenant does comply with the requirements, the landlord must honour the lease option.
Ms Tolson said commercial custom is for notification to be given before the date that is at least three months before the expiry of the lease. “Landlords want as much notice as possible whereas tenants would like to leave it to the last minute.
“We also often see a requirement for written letters to be sent not just an email. Despite all the advances with electronic documentation and signing of contracts leases are still very traditional documents with very traditional requirements. They may even still require being sent by registered post.”
Property law is state-based but generally similar. If landlords wish to deny the further term of the lease due to a previous or ongoing breach of the contract they must comply with the legislation in their state. Retail shop leases in Queensland for instance have additional overlays around notifications in that they usually require landlords to send tenants notices reminding them of exercising their lease option.
“Here again most landlords don’t do this,” Ms Tolson said. “I find many retail tenants don’t remember the advice and therefore fail to avail themselves of the protections of that act which was introduced in 1994 basically to protect ‘mum and dad’ tenants.’’
Here are some handy links for more information about commercial leases in each state as well as changes recently introduced due to covid:
NSW implementation of the National Code of Conduct for Commercial Leases | Service NSW
Commercial (including retail) tenants and landlords | Victorian Small Business Commission (vsbc.vic.gov.au)
Leasing premises | Business Queensland
Small Business Commissioner (sasbc.sa.gov.au)
Understanding commercial leases | Small Business