Land­lords and ten­ants need to be care­ful about incur­ring expens­es before being bound to the lease

In Brief

Both land­lords and ten­ants should take care to ensure that the oth­er par­ty is bound by the lease rather than incur­ring sig­nif­i­cant expens­es on the assump­tion that the lease will proceed.

The risk

Land­lords and ten­ants often begin spend­ing mon­ey or incur­ring costs to cre­ate and fitout leased premis­es pri­or to the com­mence­ment date of the lease. The par­ties may have nego­ti­at­ed and agreed in prin­ci­ple on the terms of the lease, and one par­ty (usu­al­ly the ten­ant) may have even signed the lease. How­ev­er, both par­ties may not actu­al­ly be bound by the lease. 

If a par­ty incurs costs in rela­tion to the premis­es before both par­ties are bound to the lease, then that mon­ey may be lost if the oth­er par­ty with­draws from the lease before the lease becomes binding.

What expens­es are typ­i­cal­ly incurred by a tenant?

A ten­ant will typ­i­cal­ly incur expens­es in con­nec­tion with the design and fitout of the premis­es. These expens­es may be sig­nif­i­cant even if only the design ele­ment is com­plet­ed. If a ten­ant incurs such expens­es before the land­lord is bound by the lease, and either the land­lord or the ten­ant with­draws from the lease (in cir­cum­stances where it is enti­tled to do so), the ten­ant may not be enti­tled to recov­er those expens­es from the landlord.

What expens­es are typ­i­cal­ly incurred by a landlord?

A land­lord may agree to car­ry out cer­tain works to the premis­es as an incen­tive for the ten­ant to enter into the lease. Com­mon exam­ples include installing inter-ten­an­cy walls to sub­di­vide a larg­er space, or redec­o­ra­tion works to upgrade the premis­es. If either par­ty lat­er with­draws from the lease, apart from hav­ing expend­ed mon­ey on the rel­e­vant works, the land­lord may also incur addi­tion­al costs to undo the works if the land­lord is unable to find a new ten­ant to lease the premis­es in the same condition.

When is a par­ty bound to the lease?

The point at which one or both par­ties are bound to a lease depends on the terms of the heads of agree­ment, the lease and any agree­ment reached between the par­ties before the expens­es are incurred. 

It is com­mon for the heads of agree­ment to pro­vide that the lease is not bind­ing until the lease is signed by both parties. 

It is dif­fi­cult to change the posi­tion express­ly set out in the heads of agree­ment or the lease sim­ply by the behav­iour of one or both par­ties or sim­ply because one par­ty has expend­ed mon­ey on the assump­tion that the lease would proceed.

To avoid sit­u­a­tions such as the ones dis­cussed in this arti­cle, land­lords and ten­ants need to be aware of when the lease becomes bind­ing. If the lease is not bind­ing before one par­ty needs to incur sig­nif­i­cant expens­es, then it is advis­able to con­sid­er enter­ing into a sep­a­rate for­mal agree­ment con­firm­ing that both par­ties are bound to the lease.

If you have any ques­tions in rela­tion to whether or not you are bound to a lease please contact: