Let’s talk AFL: agreement for lease

by FM Media
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The purpose and intent of agreement for lease is not widely understood, but issues can arise. Here, some practical and commercial issues are outlined.

In committing for new business premises, tenants anticipate that a lease agreement will eventuate, signed by both parties as a binding legal agreement. The lease governs the occupancy of premises, detailing the obligations of the tenant and the landlord. Usually as part of the negotiating process, a heads of agreement or term sheet is agreed to between the parties covering the main commercial terms of the lease. Although these ‘heads’ can extend to over 20 pages, it is usually not structured to be legally binding, but rather indicating the ‘serious intent’ of the parties to contract. The process then progresses through board approvals and the finalisation of the other terms in the lease. On occasions, in the transaction process, there is a need for an agreement for lease (AFL). This document is less well understood, often leading to issues for unsuspecting tenants.

Development or major changes
An AFL is only required when the lease for premises commences at some future date related to a building under construction or undergoing major refurbishment. The AFL is structured to be legally binding and govern the obligations of the parties between the date of signing and the occupancy of the premises. The transaction is based on the landlord or developer agreeing to build or refurbish the building to meet defined specifications as at a defined completion date. Following completion of the building, the tenant takes occupancy as detailed in the pre-committed lease. It sounds very simple. However, during this period prior to occupancy by the tenant, there are major obligations that have to be met by the developer in delivering the premises as agreed.

The purpose and intent of the AFL is not widely understood in the market and may result in it being too simplistic or a very lengthy and expensive negotiation process between lawyers about the key provisions covering the rights and obligations of the parties. Many potential issues may arise, only some of which are discussed below, to draw attention to the types of practical and commercial issues that need to be considered.

Base building works
Provided a tenant commits to a lease at an early stage in the development process, there may be an opportunity to request changes to the base building construction works. These changes may be enhancements to improve building performance, such as the installation of a raised floor, or works to facilitate the tenancy fitout, such as leaving an opening in the floor slab to permit the construction of an internal staircase. In structuring the AFL, the implications of these requested changes needs to be considered to avoid legal issues arising.

First, what are the cost implications of these changes and are the savings to be paid to or cost increases recovered from the tenant? In support of these outcomes, the AFL needs to clearly state how the cost variations, whether savings or extras, are determined. Ideally, these are determined by an independent quantity surveyor. Second, the impact on the construction program and the resultant implications need to be structured into the AFL. With key construction milestones needing to be met, developers will not delay a construction program while the tenant considers fitout requirements. Dates for key decisions, therefore, have to be agreed and documented in the AFL.

Practical completion and fitout works
Occupancy in terms of the lease usually starts as at ‘practical completion’ of the building. This concept and process for determination whether achieved, needs to be defined in the AFL. For example, if two floors leased to a tenant are complete while the rest of the building is still a construction site, will this meet the definition of practical completion? Practical completion determination should not be left to developer, but should have a check list with an independent certifier’s confirmation. This process may require, for example, the commissioning and testing of the mechanical services, the provision of ‘as built’ drawings, and the issuing of the occupational certificate and all other statutory permits.

The process of handing the premises to the tenant to fitout to their own requirements needs to be documented. Avoid the situation where the tenancy fitout is complete, but an occupancy certificate cannot be issued because other base building works are not complete and yet the lease period has commenced. No tenant should be required to start paying rent when in their opinion the building is not ready for occupancy, yet in terms of the AFL the lease period can commence.

Whether fitout works are integrated with the base building works and delivered by the developer or by the tenant after completion of the relevant base building works, this should occur before the lease period has started. However, with the lease not having commenced, the rules around how the works are to be performed and the responsibilities of the parties need be included in the AFL. In particular, considerations should include access arrangements, site control and safety. For example, there is no point in being given access to the premises for fitout if the lifts are not operational and the builder is not obligated to provide reasonable access via the temporary construction lifts or hoists.

Delays and damages
In committing to a lease, a tenant will have specific expectations as to the occupancy date of their new premises. This date is usually aligned to existing lease expiry dates, but should also include some buffer period for unexpected delays. Every AFL must have a ‘sunset date’. If it is evident that the building will not be ready for occupation as planned, the AFL is then terminated and the tenant is not obligated to proceed with the lease. At this point the tenant can search for alternative premises. However, occupation date delays can have a significant impact on the tenant, causing operational issues and resulting in considerable costs.

In the AFL, delays are defined as allowable or not allowable. Allowable delays are events that are beyond the control of the developer, such as force majeure events and excessively bad weather preventing works from occurring. Also, if a tenant requests a base building variation, this may be linked to an extended completion date. Occupancy date delays that are not allowed, relate to those caused directly by the developer. However, if there is industrial action on the site that causes the cessation of construction work, should this delay be allowed? Generally, the approach taken is if there is no fault by the developer, then this would probably be allowed, but if caused by the direct action of the developer, then probably not. This is a problematic proposition often leading to disputes.

Any damages resulting from delays ‘not allowed’, should reflect the actual cost the tenant will likely incur. Punitive damages, not reflective of actual losses, are unlikely to be enforceable. However, the financial implications of delays need to be carefully considered and are unlikely to be constant, varying according to the severity of the delay. Costs in having to seek alternative premises can be significant, particularly if this results in business interruptions.

Carry over obligations
Typically, an AFL is structured to govern the contractual obligations until the lease commences. As such there is usually a clause stating that the AFL contract is terminated on the commencement of the lease. Although in principle this appears to be acceptable, there may be unintended consequences. The landlord may have had obligations in the AFL in completing the building that have not been done, and unless there is an express requirement that these obligations are carried over into the lease, they will no longer be enforceable. There are many other similar practical and commercial provisions that need to be agreed for inclusion in the AFL, but are often ignored during the negotiation of commercial terms of the future lease. Caveat emptor.

Rodney Timm and Mark Daniel are directors of Property Beyond Pty Ltd. Mark is a co-author of this article.

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