6 min read

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Make Good, the divorce settlement

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A lease is like a marriage, the Tenant is given an incentive to entice them to the Landlord’s building, but as soon as the Tenant decides to leave, at the end of a lease, the relationship can deteriorate as some Tenants want to avoid their make good obligations and some Landlords want to extract as much cash as they can from a departing Tenant. I use the word ‘some’ as many Landlords and Tenants behave responsibly and fairly. It is an area that is largely misunderstood and disputes and frustrations occur when the obligations within the lease are not aligned with what is morally right, or the lease obligations are ambiguous. To ensure both parties do what’s right, better drafting within the lease, or an industry code of conduct, would greatly improve the process. Here are several tips to a successful make good experience.

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1. If at the start of the lease the Tenant is undertaking general and non-tenant specific improvement works to the base building, then the Tenant must ensure these are specifically excluded from the make good obligations in the lease.
2. Ensure the lease drafting is very clear. If you need to engage a lawyer to advise on the interpretation of a make good clause then it is probably not clear. Either party will always be able to find a lawyer who will argue a different interpretation if it is ambiguous.
3. When Tenants price their fit out, they should include the cost of its removal and make good. Installing the fit out is only part of the full cost of the alteration.
4. Tenants should make sure they create a provision on their balance sheet for their end of lease obligations. Without a make good provision the decision whether to relocate can be skewed if a relocation results in a charge to the P&L because of no make good provision on the balance sheet.
5. There is a difference between removal and reinstate. A lease that obligates the Tenant to remove and reinstate is more onerous than just remove only.
6. Fixtures and fittings are not loose furniture and personal effects. Fixtures and fittings includes all partitioning, supplementary airconditioning, Tenant installed floor coverings, lighting and other alterations installed by the Tenant. Sometimes Tenants agree in the Heads of Agreement to remove furniture and personal effects, but this gets drafted as removal of fixtures and fittings.
7. ‘Fair wear and tear’ is to put the premises to a condition that is commensurate with its age. Therefore, to repair or replace a damaged carpet after the expiry of a 10 year lease means the Landlord gets a 10 year old carpet, not a brand new carpet, unless there is a specific obligation to replace all carpets with new.
8. Landlords will generally prefer a cash settlement as it allows them to select which works to undertake and perform base building upgrade works at the same time. Tenants should be prepared to undertake the make good works and allow enough time to complete the works in the event a cash settlement cannot be agreed to.
9. Whilst you, as Tenant, think your fit out has value, and would be wanted by the next Tenant, that is generally not the case.
10. Don’t invite a building contractor to advise on the cost of the make good. First seek advice on what your exact liability is having regard to the lease, legislation and case law. Only once the scope of make good is known should you get it priced by a contractor.
11. If the leased premises is anything other than new then always prepare a schedule of condition, include plenty of photographs. Ideally it should be included in an annexure to the lease but not essential. The date of the report and the photo’s will be hard to dispute that the condition of the property was different at the start of the lease.
12. Tenants should be wary of a lease that gives the Landlord the option of electing a cash settlement or the works being undertaken. If the fit out does have value then you will not be able to negotiate the liability down, unless the make good is a fixed amount to be paid and is sufficiently discounted from the true cost of make good.
13. Fixed make good amounts that are detailed in the lease and automatically paid at the lease expiry provides the Tenant with certainty but removes the flexibility to negotiate if that fixed cost is higher than what a negotiated settlement would be.

 
Ex-british practitioners will be familiar with the term “diminution in the value of the reversion’. This is where the Landlord’s make good claim cannot be more than the reduction in the value of the Landlord’s property as a result of make good not being carried out, ie the Landlord can only claim what they has lost. However, this is only legislated in certain states and only relates to repairing obligations, and not to an obligation to reinstate. To apply this principle to reinstatement obligations we need to look to case law. Unfortunately, there is limited case law on the topic in Australia and looking further afield will produce some case law that can assist and reduce a Tenant’s liability.

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Getting good advice before the lease is signed and at the end of the lease will dramatically reduce costs for Tenants and reduce the risk of a dispute that may escalate.

Property Beyond can provide specialist advice with regard to negotiating leases, interpreting leases, make goods and lease disputes.  If you are a Tenant seeking to minimise risk and cost then please contact Property Beyond on 02 8094 1999.