The 5 Commercial Lease Clauses That Can Cost Your Business Thousands

Co-authored by Vishaal Kudupudi

KEY INSIGHTS:

• The rent stated on the first page of a commercial lease is only one part of the true cost of occupying business premises.

• Rent review provisions can significantly increase the amount payable during the lease, particularly where rent is reviewed by reference to market rent or another formula.

• Outgoings can represent a substantial additional expense and, for retail leases, the Retail Leases Act 1994 (NSW) contains specific requirements about disclosure and recovery.

• A make-good clause can leave a tenant responsible for substantial reinstatement, removal and repair costs at the end of the lease.

• Personal guarantees, default provisions and termination rights can expose business owners to personal financial liability if the business cannot meet its obligations.

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The Trust Cost of a Commercial Lease

When a business owner looks at a commercial property, the first question is usually:

“How much is the rent?”

But the rent is often only the beginning.

A commercial lease can contain a range of provisions that determine what the tenant will actually pay during the term and when the lease ends.

For a business owner, failing to understand those provisions before signing a lease can result in costs running into thousands of dollars, or significantly more.

The five clauses that deserve particularly close attention are:

1. Rent reviews

2. Outgoings

3. Make-good obligations

4. Personal guarantees

5. Default and termination provisions

 

1. Rent Review Clauses

A commercial lease may provide for rent to increase at specific points during the term.

The method of increase will depend on the lease and may involve a fixed percentage, the Consumer Price Index (CPI), another agreed index, or a review based on current market rent.

Market rent reviews can be particularly significant for tenants because the extent of the increase may not be apparent when the lease is first signed. Unlike a fixed increase, the new rent will depend on market conditions at the time of the review.

For retail shop leases governed by the Retail Leases Act 1994 (NSW), section 19 establishes a specific framework for rent reviews based on current market rent. The Act provides that:

“The current market rent of premises is the rent that would reasonably be expected to be paid for the premises if they were unoccupied and offered for renting by a willing lessor to a willing lessee in an arm’s length transaction.”

This means the rent is assessed by reference to what the premises would reasonably command on the open market, taking into account factors such as the terms of the lease and comparable premises.

If the parties cannot agree on the new rent, the Act provides for the rent to be determined by a specialist retail valuer.

For tenants, this means the rent they are paying today may not be the rent they pay after a market rent review. Understanding the review provisions before entering into a lease is therefore important when assessing its long-term cost.

 

2. Outgoings

Outgoings are another major cost for tenants and can significantly increase the overall cost of a lease.

They may include expenses such as building or centre management, maintenance and repairs, rates, taxes, insurance and other costs associated with operating the premises.

For retail shop leases, section 12A of the Retail Leases Act 1994 (NSW) provides that:

“A lessee is not liable to pay an outgoing unless the liability to pay the outgoing was disclosed in the lessor’s disclosure statement.”

In practical terms, this means a landlord generally cannot require a retail tenant to pay an outgoing that was not properly disclosed before the lease was entered into.

The Act also regulates how outgoings must be accounted for. Section 28 requires the lessor to provide an outgoings statement setting out the expenditure to which the tenant is required to contribute, while section 29 provides for adjustments based on actual expenditure properly and reasonably incurred.

For tenants, the important point is that the cost of a lease is not just the rent. Before signing, it is important to understand the estimated total occupancy cost, including the outgoings the tenant will be required to pay.

 

3. Make-Good Obligations

One of the most commonly underestimated commercial leasing costs is the make-good obligation.

A make-good clause determines what condition the premises must be returned in at the end of the lease.

That may mean more than simply removing furniture and handing back the keys.

Depending on the lease, the tenant may be required to:

• Remove partitions and fit-out;

• Remove signage;

• Remove fixtures;

• Repair damage;

• Repaint;

• Remove cabling;

• Reinstate services; or

• Return the premises to a base-building or other specified condition.

The NSW Small Business Commissioner specifically warns that make-good obligations can involve stripping premises back to a “base building (or bare shell) condition” and recommends that tenants document the condition of the premises at the beginning of the lease.

This is one reason a condition report is so important.

If the tenant does not understand what “make good” means when the lease is signed, it may be too late to negotiate when the lease is ending and the landlord is demanding that work be carried out.

 

4. Personal Guarantees

A personal guarantee can significantly increase the risk of entering into a commercial lease.

Although a business may operate through a company, a landlord may require its directors or shareholders to personally guarantee the company’s obligations under the lease.

If the company defaults, the guarantor may become personally liable, depending on the terms of the guarantee. For a business owner, this can turn a business liability into a personal financial risk.

The guarantee should therefore be reviewed carefully alongside the lease before it is signed.

Key questions include:

• What obligations does the guarantee cover?

• Is the liability capped?

• Does it cover rent only, or other amounts as well?

• Does it continue if the lease is assigned or the tenant remains in the premises after the lease expires?

• When and how is the guarantee released?

Understanding the scope and duration of a personal guarantee before signing can help a business owner avoid unexpected personal liability.

 

5. Default and Termination Provisions

Another important part of a commercial lease is understanding what happens if the tenant defaults.

Leases commonly deal with defaults such as:

• Non-payment of rent or outgoings;

• Other breaches of the lease;

• Insolvency;

• Unauthorised use of the premises;

• Unauthorised assignment or subleasing; and

• Failure to maintain required insurance.

Depending on the lease and applicable legislation, a default may allow the landlord to issue a notice, terminate the lease, recover outstanding amounts or take other legal action.

This means the landlord’s rights following a default may depend not only on the lease itself, but also on the requirements of the legislation.

Tenants should therefore understand what constitutes a default, what notice must be given and what consequences may follow before signing the lease.

 

A Recent NSW Case Shows: Why the Wording of a Lease Matters

In Doman v Young Scholars @ Glebe Pty Ltd [2024] NSWSC 1266, the NSW Supreme Court considered a commercial lease dispute involving unpaid rent and outgoings, termination following tenant breach, loss of bargain damages and a market rent review.

The landlord claimed unpaid rental and outgoings and other losses. The Court found, among other things, that the landlord had not established that the market rent review had occurred and had also failed to establish entitlement to various outgoings claimed.

The case is a useful reminder that even where a landlord believes amounts are clearly owing, the contractual and evidentiary basis for those amounts matters.

It also demonstrates why lease provisions dealing with rent reviews and outgoings should be understood before a dispute arises.

 

What Should You Check Before Signing?

Before signing a commercial lease, a business should consider the total financial exposure, not just the advertised rent.

At a minimum, review:

• The starting rent;

• Every rent review and the method used;

• Estimated and actual outgoings;

• Insurance requirements;

• Make-good obligations;

• Fit-out and reinstatement requirements;

• Personal guarantees;

• Security deposits or bonds;

• Default provisions;

• Termination rights;

• Options to renew; and

• Any representations made by the landlord or agent about the premises.

For retail premises, the disclosure statement should also be carefully checked against the lease.

 

Recommended Next Steps

Before signing a commercial lease, a tenant should:

• Calculate the true cost of the lease, including rent, operating expenses, fit-out costs and other charges.

• Understand future rent increases and how each review could affect the overall cost of the lease.

• Review operating expenses carefully and confirm exactly which costs the tenant is responsible for.

• Document the condition of the premises before taking possession, including photographs and a detailed condition report.

• Understand the make-good requirements before carrying out any fit-out or alterations.

• Review any personal guarantee and understand the extent of the personal liability being accepted.

• Understand the default provisions, including what constitutes a breach, what notice must be given and what remedies may be available to the landlord.

A commercial lease can create significant financial and legal obligations. Getting legal advice before signing can help identify potential risks, negotiate more favourable terms and ensure you understand your obligations before you commit to them.

 

How Can Coutts Help?

Coutts Lawyers can assist landlords and tenants with commercial lease negotiations, lease reviews, rent and outgoings disputes, make-good disputes, lease enforcement and commercial leasing litigation.

A commercial lease is a long-term financial commitment. Understanding the legal obligations before signing can help prevent an expensive dispute that may occur later on.