Re-instatement obligations under a commercial lease

A Minefield for both Parties: When a Lease Ends
By Franklin Law Solicitors Paranpal Singh and Daniel Cowan

Running a business (for the most part) requires premises to operate from.

Entering into a commercial lease with a landlord, unless you are fortunate to own your own premises, is one of the most important contracts your business will enter into. However the lease agreement is one of the most underestimated contracts by both landlords and tenants which, if not considered carefully, can create significant obligations for one or both parties.

One obligation which is frequently overlooked is the tenant’s reinstatement obligations when the lease comes to an end (Termination).

The current version of the commonly used Auckland District Law Society Deed of Lease (ADLS Lease) provides that at Termination, the tenant has the obligation to return the premises to the same clean order, repair and condition as at the start of the lease (subject to fair wear and tear). This includes the removal of any chattels, additions and/or alterations made by the tenant (unless allowed to remain by the landlord). All of this is at the tenant’s cost and should the tenant not comply the landlord is entitled to recover the cost of reinstatement from the tenant (or any guarantor).

As the lease term (and renewals) can run for many years, disputes often arise as to what condition the premises were in at the start. This is easy when dealing with a brand new building but more difficult when dealing with older buildings. The ADLS Lease provides some assistance for this by including a Premises Condition Report (Report). This Report, as the name suggests, is to record the agreed condition of the premises. The Report can be a detailed written description, photographs or a mixture of both. While this can (potentially) avoid disputes at Termination and be evidence if there is a dispute, the Report is nearly always overlooked. Disputes will inevitably lead to costs being incurred by both sides which frequently are not recovered.

When entering into a new lease the tenant will be able to easily see the current condition of the premises. However what is commonly overlooked is the tenant’s potential reinstatement obligations when they take over an existing lease (commonly called an assignment). An everyday situation where this arises is when a business is sold and the original tenant assigns their lease to the new business owner who becomes the new tenant. The assignment means that the new tenant assumes all the obligations of the original tenant under the lease. At Termination it is now the new tenant who has the obligation to return the premises to the same condition they were at the start of the lease. Despite this, many new tenants, who may be aware they have some level of reinstatement obligation, are under the misconception that their obligation is to restore the premises to the same condition when they took over the lease which is incorrect. This can be a costly surprise to some tenants at Termination.

With the costs of restoration being potentially significant, a Report can provide insight to a tenant’s obligations on Termination and certainty for a landlord for both a new lease or an assignment of a lease.