Make good obligations in leases: do they apply if the premises will be demolished?

Could a tenant avoid or resist their make good obligations on the basis that the make good obligations (or payment in lieu) would be of no value and give the landlord an unfair windfall?

 

In commercial leases, often the most contentious terms are the make good provisions setting out the requirements to remove the tenant’s fit-out and make good the premises at the end of the term of the lease.

Most commercial leases include a term compelling a tenant to return the premises to their original back to base building condition. Damages are payable by the tenant for breach of a covenant to make good the premises.

These obligations are often a costly exercise if the terms are not properly considered and negotiated. In many cases, tenants choose to include terms to pay the landlord a fixed lump sum amount in lieu of the tenant’s make good obligations to address the financial uncertainty.

Can a tenant escape an obligation to make good?

A tenant might want to consider the make good obligations in their lease in circumstances where the landlord intends to demolish the building, of which the premises form part, when the tenant vacates.

Could the tenant avoid or resist their make good obligations on the basis that the obligations (or payment in lieu) would be of no value and give the landlord an unfair windfall?

Possibly yes. Under section 133A(1) of the Conveyancing Act, the damages payable by a tenant for a breach of covenant to make good the premises must not exceed the amount by which the value of the reversion in the premises is diminished, as a result of the breach of the covenant.

In particular, no damages are recoverable if it can be shown that the premises, in whatever its state of repair at the time, would, at or shortly after the end of the term of the lease:


  • have been demolished; or
  • structurally altered as would render valueless the repairs that the tenant would otherwise be required to undertake.
Despite the number of commercial buildings in the Sydney CBD having been demolished to allow residential developments in recent years, tenants have rarely disputed their make good obligations under section 133A(1) and many choose to pay the landlord a fixed sum in lieu.

The difficulty is often the evidence that is available to show that the premises would at, or shortly after the termination of the lease, have been or be pulled down.

However, whilst landlords may attempt to hide this evidence, with today’s technology and legal disclosure obligations, there are many ways to find this evidence. Tenants may consider resisting their landlord’s attempts to compel them to make good in these circumstances.

The caution for landlords and tenants

Not all make good provisions are drafted in the same way, and some can be more onerous than others in requiring tenants to make repairs to their premises at the conclusion of a lease.

Before a lease ends, it is important that both landlords and tenants understand their legal rights and obligations as to the degree to which leased premises should be restored to a particular condition.

Tenants would be wise to obtain legal advice in circumstances where they believe the premises may be demolished or structurally altered at the end of the term of the lease before embarking on a costly make good of the premises.

Landlords might want to consider obtaining legal advice before insisting on make good obligations where there is a development proposal or a payment in lieu of the tenant’s obligations in these circumstances.

Contributors

Ethan Aitchison Law Graduate