Cost traps for tenants

Landlords and tenants should be aware of the costs they might incur when leasing commercial premises. This is all the more important in the current economic climate as landlords and tenants need to know what costs to plan for. Each lease is different, so the landlord and tenant’s respective obligations will depend on the terms of the particular lease. My opinions in this blog are primarily based on the Auckland District Law Society (5th edition, 2008) standard form of lease.

Primary obligation to maintain

The tenant’s primary obligation is to maintain the premises in the same state that they were in at the commencement of the lease. This obligation is now implied in all leases by the Property Law Act 2007. This primary obligation is essentially backward looking and may or may not be onerous depending on the length of the lease and the extent of the tenant’s obligations.

Other major obligations for tenants typically include repairing damage and breakages and maintaining the landlord’s fixtures and fittings which are likely to be middle ground obligations in terms of costs. The main exception to the tenant’s obligations is fair wear and tear, which allows for wearing out of an asset by ordinary use.

However that is only the starting point; tenants potentially have other obligations which can drastically increase costs, for example, redecorating and reinstating the premises.

Maintenance of landlord’s fixtures and fittings

At first glance, under the Auckland District Law Society (‘ADLS’) standard form of lease there seems to be a conflict between the landlord and tenant’s obligations with regard to maintaining the landlord’s fixtures and fittings. The lease states at clause 8 that the tenant is required to ‘keep and maintain… the Landlord’s fixtures and fittings’, and then at clause 11 ‘[the] Landlord shall keep and maintain… the Landlord’s fixtures and fittings’.

This apparent conflict can be explained by considering the fair wear and tear exception that underpins the tenant’s repair and maintenance obligations, ie the primary obligation is on the tenant to maintain the landlord’s fixtures and fittings at the tenant’s cost, however if they break or need to be replaced as a result of fair wear and tear only, then the landlord will be obliged to fix them at the landlord’s cost.

Insurance can also impact on tenants’ obligations, whether in respect of landlords’ fixtures and fittings or otherwise.

More onerous obligations

Tenants’ general obligations are spread throughout the lease. Some of these obligations go beyond mere repair and maintenance and require the tenant to carry out potentially costly works reinstating the premises (following alterations or fit-out works) or redecorating the premises (often to the landlord’s specifications).

Landlords can also require tenants to pay for matters which fall within the definition of outgoings payable by the tenant. Under the standard ADLS lease outgoings include redecoration of the premises. This is not limited to the interior (which means a landlord can claim costs of painting the exterior). This may come as a surprise to many tenants who may think that because of the express term of lease regarding interior painting, the tenant is only responsible for the interior.

Most leases require the tenant to reinstate the premises to the state it was in at the commencement of the lease. That means removing all the tenant’s chattels, fixtures and fittings as well as any improvements, alterations or additions made to the premises during the term of the lease. If the tenant fails to reinstate the premises by the required date (usually before the end expiry date) the landlord may reinstate the premises and recover the cost of doing so from the tenant.

Depending on the nature and extent of the works carried out by the tenant, reinstatement can be a very time-consuming and expensive obligation and one the tenant should address when considering carrying out any alterations.

Insurance exception

A major factor that impacts on the tenant’s repair and maintenance obligations is the landlord’s insurance. Tenants should get to know the exact nature and scope of the landlord’s insurance cover and know what damage will be covered. Why? Because the landlord is prevented from claiming any repair costs from the tenant where the landlord has insurance cover.

As a result of recent changes to the law landlords are now required to have cover for the following unless they expressly agree otherwise with the tenant: damage caused by fire, flood, explosion, lightning, storm, earthquake or volcanic activity. Under the ADLS lease, tenants will usually be responsible for repairing any damage to the premises at the tenant’s cost. However, where the landlord’s insurance cover extends to damage of that nature, the tenant will be entitled to the benefits of the landlord’s insurance.

Usually the tenant is required to pay the excess (up to $500) so the tenant will need to weigh up whether it is worth making a claim.

Failure by tenant to repair

Tenants should familiarise themselves with their obligations as well as the consequences of failing to meet those obligations. Typically, if tenants do not repair in terms of the lease obligations (after receiving notice from the landlord) the landlord will be entitled to enter the premises, carry out the repairs and recover the costs incurred from the tenant. In such cases, tenants lose control over the cost of repairing.

Continuation of liability post-assignment

Tenants typically remain liable under the tenant’s obligations in the lease even after they assign the lease to someone else (usually only until the lease is renewed). If there are no further rights of renewal then the tenant will remain liable after assignment to the end of the lease and will remain liable for all lease end obligations such as reinstatement and redecoration to the extent the assignee (the new tenant) does not fulfil those obligations.

Tenants who have assigned a lease will usually have recourse against the assignee but will want to keep in contact to ensure the assignee is fulfilling, or is going to fulfil, its obligations before the lease ends. Failure to do so could result in the landlord attending to lease end obligations, at greater cost to the tenant and/or the assignee under the landlord’s recovery rights, than would have been the case if the tenant or assignee had personally controlled both the works and the cost.

Assumption of liability via assignment

When a lease is assigned the assignee generally takes on all of the tenant’s responsibilities under the lease, including the obligation to pay for reinstating or redecorating the premises. Due to the possible extent and expense of these works, potential assignees of leases should be careful to enquire about obligations being assumed such as reinstatement which could come as a very expensive surprise at the end of the lease.

Prepare for the end at the beginning

To manage costs tenants need to familiarise themselves with the terms of the lease and consider their obligations under the lease before they sign the lease. A tenant planning to carry out considerable fit-out or modification works may not want to have to reinstate the premises at the end of the lease. Fit-out may be of benefit to the landlord and the parties may both be willing to negotiate at the start of the lease, for example that the landlord will purchase the tenant’s fit-out at end of lease.

It is very much in the interests of both parties to prepare for their obligations at lease end (i.e. reinstatement and redecoration) well before the lease ends to allow them sufficient time to carry out the works and manage the costs involved. By allowing time, the tenant also allows opportunity to negotiate matters with the landlord, for example paying instead of reinstating or redecorating or selling fit-out to the landlord.