The Importance of Option in Lease

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When a proposed Lessee negotiates lease terms and conditions with a leasing agent or a landlord directly, the proposed tenant should pay attention to the initial lease period and option/s.

An OPTION is a right included in a commercial lease (including industrial lease) or retail shop lease that allows the current tenant the opportunity to call on a further or extended lease period as long as the tenant:

1) has paid the rent on time, 

2) has complied with the terms of the lease, and 

3) gives written notice to the landlord stating that it wants to exercise the given option in accordance with the relevant clause of the lease. 

One critical provision of the lease the tenant must bear in mind is the option exercise period – normally starting 6 months and ending 3 months prior to the initial lease expiry date, which may differ depending on the individual lease. The tenant should diarise this option exercise period. 

If the tenant misses that window, the landlord can legally reject the option right and may terminate the lease at its expiry.

The consequences may be serious. It may cause ongoing business disruption to the tenant, including finding another place to do business or being forced to renegotiate terms and conditions more beneficial to the landlord.

Option to Renew

GenerallyOptions normally require that the lessee not be in default in relation to any covenant as a condition of exercising the right to renew. This is construed strictly against the lessee. An email service of the renewal may be sufficient, and a lessor may be estopped from denying the exercise of an option to renew as long as the notice is not late.

OUT OF TIME to Exercise Option to Renew

Traditionally courts have construed time limits strictly, and a late exercise will be invalid. A lessee may not be entitled to protection even just one day late. It is critical to serve a notice to renew within the timeframes and not be even a day late.

Late exercise of an option, whilst ineffective in itself, may constitute an offer to enter into a new lease, and the lessor’s acceptance may constitute an agreement for a new lease. 

Even if the lessee does not have an option, the lessor may be estopped from denying that a promise of a new lease ought to be enforced.

Once the lessee exercises the option to renew, the lessor has a contractual right to require the lessee to proceed with the renewal. The lessee cannot recall the exercise of an option to renew once notice to renew has been given.

NOTICE IF NO OPTION EXISTS

Unless the lease is a retail shop lease, the lessor need not give any notice to the lessee that the end of the term is approaching and its intentions in relation thereto.

For retail shop leases, if the lease does not contain an option, the lessor must give the lessee written notice at least 6 months before, but no more than a year, the end of the term:

1. offering the lessee a renewal or extension of the lease and detailing the terms of the offer. This offer cannot be revoked for one month after it is made or if the tenant accepts it; or

2. advising the lessee that it does not intend to offer a renewal or extension.

A shorter period applies for leases with a term of less than a year.

If the lessor does not give this notice and the lessee provides notice before the expiry of the term asking for an extension, the lease period is extended until 6 months after the lessor gives the notice. However, the lessee may terminate the lease before this extended term ends on one month’s written notice.

If the rent for the renewed term is to be reviewed at market rent, the lessee can give the lessor notice during the period commencing 6 months before the expiry of the current term and ending 3 months before its expiry, requiring the market rent to be determined. 

The Retail Shop Leases Act 1994 also provides that despite any other provision of the lease, the last day which the tenant can exercise the option is 21 days after it receives written notice of the current market rent.

EXERCISE OF OPTION

If the lease is subject to the Retail Shop Leases Act 1994, the lessor must give the lessee written notice at least 2 months, but no more than 6 months, before the last date on which the lessee may exercise the option to renew the lease.

However, if the lessor fails to send written notice of the renewal option, no protections are afforded to the lessee under the Act.

Whether a lessor is required to remind a lessee of an upcoming renewal term will depend on the terms of the lease.

Vigilantibus et non dormientibus jura subveniunt – The laws serve the vigilant, not those who sleep. 

Tony Kim, a commercial property lawyer, is part of the Stephens and Tozer Commercial and Property team. For advice on Leases and Options, please call 07 3034 3888 or email info@stephenstozer.com.au

Category: All / Commercial / Contractual Law / Property