Leases Granted Pursuant to the Exercise of an Option

Pitfalls surrounding “Option Leases”.

Youssef Abouelnasr

In commercial and retail leasing it is common that the landlord provides in the lease to the tenant an option to renew for a further term. This provides the tenant further security regarding their potential tenure of the premises and can also save both sides costs by avoiding renegotiating a lease from scratch.

New Lease

It is important to note however that a lease granted pursuant to the exercise of an option is an entirely new lease. The landlord and tenant in the previous lease just contracted to enter into a new lease should the tenant wish to exercise the option.

However, option clauses must be drafted carefully to avoid any potential pitfalls. They should clearly state what is the mechanism do determine the starting rent of the option lease and if outgoings are payable, to clearly state the amount of outgoings the tenant is liable to pay. They should also consider whether there are any provisions in the initial lease that should not apply during the option period such as provisions that describe works to be undertaken by certain parties or provisions that provide a rent-free period. In similar vein should any provisions not apply in the initial lease but be expressed to apply in a lease granted pursuant to the exercise of an option such as a demolition clause, a right to purchase the property or amendments regarding the makegood obligations of the tenant.

Negotiation

Another misconception regarding option leases is that they are immune to change or negotiation. It is correct that generally where a tenant exercises the option the landlord must provide them a lease on the same terms for the option period perhaps subject to a new rent being agreed if the rent increase mechanism was a market review. However, there is nothing stopping the parties negotiating amendments to the option lease once the option has been exercised. For example, the landlord may wish to have the tenant begin paying for some outgoings that they had not been paying for in the initial lease. The landlord is free to offer the tenant an incentive, such as a further option to renew, in exchange for the tenant beginning to pay for such outgoings. Similarly, the tenant may wish to offer an incentive, such as paying higher rent, in exchange for the landlord inserting an option period into the further lease.

The multitude of pitfalls and issues that need to be considered in drafting leases that contain option provisions highlights the importance of having such leases drafted or reviewed and negotiated by professionals. Hansons Lawyers has decades of experience advising both landlords and tenants across all retail and commercial leases, including agreements for lease and enforcement in the case of a breach of the lease terms.  We invite you to contact us to discuss your situation with our experienced Property & Commercial Law Team.

Please feel free to contact us on 42 222 666 or by email at hansons@hanonslawyers.com.au