Leasing or renting a commercial property is often an expensive fixed cost which a franchise business owner will face. Leasing can be a complex process and should be undertaken carefully with appropriate advice. The outcome of a negotiation over a commercial lease is dependent upon the bargaining position (commonly referred to as “leverage”) that the parties bring to the table. The lease records the outcome of that negotiation. The Property Law Act 2007 contains statutory provisions governing the landlord and tenant relationship, but in essence it is a matter of contract negotiation between the parties.
When purchasing a franchise business, often the lease is given little attention. However, the lease will provide terms and conditions of where the business operates from and often this is as important as the franchise agreement. Essential lease issues for a franchisee to consider are discussed below.
Forms of Lease
A Deed of Lease governs the rights and obligations of a landlord and the tenant to each other. The headline commercial terms included in a lease are:
- a description of the property leased
- the term of the lease, and whether it can be extended or renewed
- the rent payable and whether and how it can be adjusted
- what each party will pay in relation to the property’s outgoings (e.g. who pays the rates for the property, and who pays the cost of installing and removing the fittings)
- who has to pay for damage and repairs; and
- what type of business may operate at the premises (check whether competing businesses may operate from the same building or shopping centre).
Most commercial landlords adopt the Auckland District Law Society (ADLS) Deed of Lease – now in its 6th edition (released in 2012). There are other standard forms of commercial leases: Building Owners and Managers Association NZ or BOMA, NZ Property Council forms, and other leases which a landlord will specifically develop for a property eg retail leases for shopping malls.
Terms to Consider for a Franchisee
Does the length of the lease term (and renewals) match the franchise agreement (and renewals)? If the franchisee has renewed the franchise agreement for another term, the franchisee should also check that the lease may be renewed for the same period. Otherwise a franchisee may be left with a franchise but no business premises to operate from. Another consideration is to ensure both the franchise agreement and lease have a number of renewals, as if the franchise business is under performing, the franchisee may opt to terminate and exit the business by not renewing the lease and franchise agreement.
Special clauses required by the Franchisor
Many franchise agreements will have specific requirements around leases. Some agreements will require the franchisor takes a head lease with the landlord, and then gives the franchisee a sub-lease to operate the franchise business from the premises. This can have an impact on rent reviews, where the franchisee (as sub-tenant) has no right to object. This allows the franchisor to have direct control of the lease and direct relationship with the landlord. If the franchise agreement is terminated then the franchisor may still operate the franchise business from that site.
Other franchise agreements require the franchisee is the tenant but special clauses are included in the lease. These clauses usually specify that if the franchise agreement has been terminated, the landlord agrees to allow the franchisor to step in as the tenant and take over the franchise business. The tenant then has no rights to continue any form of business from the premises.
It is important to obtain the landlord’s approval to the sub-lease arrangement or special clauses.
Liability on assignment
When a new franchisee purchases an existing franchise business, they take over the existing lease (by assignment). However, the old tenant/exiting franchisee is still liable under the lease until the expiry date, or the date of the next renewal. To change this situation the outgoing tenant will need to negotiate with the landlord by limiting the liability on assignment to say an amount or a length of time.
The current ADLS lease provides for rent reviews to be either by market review, consumer price index review or a mixture of both. Market reviews can lead to costly disputes between parties involving valuers and lawyers. A preferred option may be to provide for CPI rent reviews annually, with market rent reviews on the renewal dates, or, say, every second or third year. This is to ensure the rent which the tenant pays reflects the current market.
Tenants should be aware of the provisions known as a “ratchet clause”. The effect of such a clause is that on a rent review the new rent cannot be less than the rent for the previous period. These ratchet clauses can be negotiated for a “softer” clause under which the rent review amount cannot be less than a particular amount, often the rent at beginning of the lease.
Following earthquake events in the South Island and the Wellington region, it has become very important for tenants to check on the soundness and structural integrity of the building, including seismic standard. Historically tenants did not worry about checking on these matters but since earthquake events have occurred in NZ, often tenants may want the option to terminate a lease. Tenants should obtain an engineering and building report for the building. If necessary the tenant’s lawyer can include additional clauses around the tenant’s ability to cancel a lease.
Emergency works and access
The ADLS lease entitles a landlord to enter the premises in an emergency situation to inspect and if necessary carry out earthquake strengthening works. The landlord can require the tenant to vacate during this period. Tenants should negotiate a provision in the lease that if this clause is invoked, the tenant is to be compensated for the disruption and for moving costs.
The above comments are general in nature for leases in relation to issues for a franchisee. Any lease which your franchise business intends to enter into should be checked by your lawyer.