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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: