Leasing issues for the Health Sector

The divestment of leasehold interests continues to be an issue of relevance for both landlords and tenants. An issue of ongoing relevance due to changes to the way we work and the economic impact of COVID-19 on businesses, commentators speculate we will see this issue feature with more and more frequency over the coming months and years. Accordingly, understanding the ins and outs of divesting leasehold interests is now more important than ever before.

This article is one of a four-part series which will set-out the legal requirements and factual circumstances to which parties should have regard when divesting an interest in a lease. Discussing three specific options available including surrendering a lease, assigning a lease and subletting a premises, the alerts will consider key issues for landlord also consider the differences between the law in Victoria and New South Wales and what that means for tenants and landlords in both states.

Why is divestment important, and when would it arise?

Tenants may be considering ceasing or selling their business, changing their business, or may be facing financial difficulty, which ultimately results in the need to end their lease before the term expires. The impacts of the COVID-19 global pandemic have created instability and economic pressure and caused some businesses to re-evaluate their accommodation requirements – all circumstances where lease divestiture may come into play. Even those businesses which have not been impacted economically by COVID-19, have seen a rise in employees working from home, leading to the need to downsize or cease operations and re-evaluate their leasing requirements.

This is not only relevant for tenants – landlords might want to use premises they have leased for a different purpose, redevelop the property or change their investment strategy in a way that leads to a need to divest.

In these changing times, there are myriad unforeseen circumstances which could arise and bring lease divestiture into relevance, reinforcing the importance of this issue.

How do I determine the best avenue for divesting a lease?

When determining the best approach for divesting a lease, it’s important to consider which is the most suitable and appropriate avenue. In making this decision, you should consider a number of relevant factors, including:

• determining which options are available and conducting a cost benefit analysis of each option;
• whether the entire premises, or just part of the premises is surplus;
• whether there is any critical timing for the divestment;
• the terms and conditions of the lease itself, considering whether it explicitly allows for or precludes any options for lease divestiture;
• longer term operational requirements and how they relate to any future requirements for the land subject to the lease; and
• prevailing market conditions.

Careful consideration of these factors and ultimately, selection of an option to divest, is important and will shape the outcome of any negotiation about ending a lease.

What are the relevant differences between leasing in Victoria and New South Wales?

In New South Wales, a retail lease with a term longer than three years is required to be registered, but there is no requirement to register leases in Victoria, and they are commonly not registered. These alerts will deal with this difference and focus on the protection that registration provides to tenants in New South Wales vis-à-vis the protection that the law provides to unregistered tenants in Victoria. There are also different reasons in the legislation of each state explicitly permitting assignment of leases, and these articles will explore those differences and the impacts they may have on landlords and tenants.

If a party to a lease needs to end the lease early, one option to consider is surrendering the lease. There is no ‘right to surrender’ a lease. Consequently, a surrender of lease requires the parties to reach an agreement about ending the lease on an agreed date before the term of the lease expires. This date is referred to as the surrender date. When the lease is surrendered, the parties are released from their obligations under the lease after the surrender date, and possession of the property is returned to the landlord. Practically for a tenant, this means after the lease is surrendered, they the tenant no longer has an obligation to pay rent or outgoings. For a landlord, the landlord is able to lease the property to a new tenant.

In this article, we describe the legal requirements for surrendering a lease, identifying relevant points of difference in the law between Victoria and New South Wales, and we set out the factors relevant in the negotiation of a surrender.

What are the legal requirements when surrendering a lease?

If the parties have agreed to surrender a lease, they’ll need to document this in a deed of surrender, setting out the particular agreement between the parties regarding the end of the lease. In New South Wales, it is also a requirement that the deed of surrender be in an approved form and registered. The deed of surrender should clearly identify the lease and the premises and if it only applies to part of the premises, it should specify that a new lease is being granted for the part of the premises being retained by the tenant.

What are the relevant factors to consider when contemplating a surrender?

There are several factors to consider when determining whether surrender is the most appropriate option to and what the terms of the may be. These include:

• Whether or not there is a new tenant who can readily enter into a lease with the landlord, once the existing tenant exits the premises\.This may affect the landlord’s willingness to surrender the lease and the terms they will agree to.
• Is there any critical timing for the surrender? For example, does the landlord require the premises by a particular date or does the tenant need time to locate new premises and relocate? How much time does the tenant needs to exit the premises and comply with their make good obligations? These time frames need to be considered and taken into account when negotiating the surrender date.
• Will there be a surrender fee payable by either the landlord or the tenant?
• How will property left behind by the tenant will be dealt with?
• Who will pay the costs of preparing the deed of surrender (usually the party seeking the surrender)?
• What are the tenant’s make good obligations? Is the tenant to leave any of their fitout or other items in the premises after the lease is surrendered?
• Are there any other conditions that need to be satisfied before the surrender of lease takes effect? For example, is the surrender of lease conditional on the landlord leasing the premises to a new tenant?

These factors should be carefully considered when negotiating a surrender, and should be included in the deed of surrender.

Other considerations?

Parties should also consider whether stamp duty is payable in the circumstances of the surrender of lease. This may be relevant where a surrender fee is paid, or in NSW where the surrender of lease is required to be where the surrender of lease must be registered. Parties should also seek tax advice regarding the potential tax liability that might arise out of a surrender.

There are a myriad of circumstances which may arise, resulting in a tenant or a landlord needing to divest their leasehold interest prior to the expiration of the term. One option may be to assign the lease, whereby the tenant transfers its rights and obligations under the lease to a third party (the assignee). The right to assign a lease is incidental to a tenant’s interest in the lease, but will usually be limited by the terms of the lease and, if the Retail Leases Act 2003 (Vic) or Retail Leases Act 2004 (NSW) applies (Retail Legislation), the relevant retail leasing legislation.

In this alert, we will discuss various factors the parties should consider when determining whether to assign a lease and practical tips for landlords and tenants.

What are the factors parties should consider when contemplating an assignment?

When considering whether to assign a lease, the parties should consider:

• The clause in the lease dealing with assignment and obtain advice regarding its meaning and effect.
• Whether the lease is subject to the Retail Legislation and obtain advice regarding the effect of the relevant Retail Legislation on the parties’ rights and obligations.
• The landlord should be afforded a reasonable time to consider giving consent and can withhold consent until they have received sufficient information. The effect of the relevant Retail Legislation should also be considered here, as the Retail Legislation will deem consent in circumstances where a landlord has not responded to a request for consent within 28 days.
• If the landlord must not unreasonably withhold consent, the reasons for the landlord refusing to give consent should relate to the proposed assignee, including their ability to conduct the business and whether the proposed use by the assignee is permitted under the terms of the current lease. Also relevant is the financial standing and business experience of the assignee, and how well documented the tenant’s application is, including whether they have met the criteria for assignment set out in the lease or relevant Retail Legislation.

Practical tips for tenants

Given that assignments of leasehold interests can be a complicated matter with varying circumstances and factors being relevant, we have set out a list of practical tips for tenants to have regard to when contemplating this as an avenue for lease divestment:

• Tenants should not approach their landlords to request consent to an assignment until an enforceable agreement to assign is signed by the assignee, which is conditional on consent by the landlord.
• Tenants should prepare an application for consent having regard to the terms of the assignment clause in the lease.
• The deed of assignment address the tenant’s liability to the landlord after the date of assignment, and should ensure adjustments with respect to rent and outgoings are made.
• If the lease is subject to the Retail Legislation, ensure a disclosure statement is provided to the landlord and the proposed assignee so that the tenant and its guarantors are released from their obligations under the lease.

Practical tips for landlords

Landlords should also have regard to the following matters when contemplating whether or not to give consent to an assignment:

• If the Retail Legislation applies, be mindful of the 28-day period to give consent under retail leases legislation before they are deemed to have consented.
• If the landlord is refusing consent, landlords should communicate reasons for refusal and the reasons for refusal should be in accordance with the lease terms.
• Landlords should also ensure that the proposed assignee is sound, respectable, and capable of performing its obligations under the lease.
• Landlords should not allow access to the premises until they are in possession of the deed of assignment signed by all parties, have received the requisite security, have received details of insurance from the assignee and the landlord’s solicitor’s costs have been paid.
• In New South Wales, a transfer of lease needs to be registered and stamp duty should be considered.

Another option in divesting leasehold interests is subletting the premises. A sublease does not release the tenant from its obligations under the lease with the landlord, it does allow them to rent the space or part of it to a third party. This may be a suitable option where a tenant is downsizing and wants to keep part of the space but reduce costs by leasing the part of the property which is surplus to another tenant. Most leases will contain a clause that limits the tenant’s right to sublet, either prohibiting subletting entirely or permitting it with the consent of the landlord. This alert will discuss what the relevant factors for both landlords and tenants to consider are when considering a sublease.

The following matters should be carefully considered by the parties when considering a sublease:

• The terms in the head lease relating to subletting.
• The term of the sublease must be at least one day less than the term of the head lease, so the parties should carefully consider the consequences of options to renew in the sublease and whether or not the sub-landlord is prepared to exercise further options to secure an extended term for the subtenant.
• If the sublease is only for part of a premises, there should be a plan attached to it which clearly depicts the area which is being sublet;
• The parties need to consider how costs, such as outgoings and utilities, will be apportioned between the tenant and the subtenant.
• The parties should consider whether or not the subtenant requires any fit-out and if so, what provision should be made for the removal of the fit-out in accordance with the head lease.
• In New South Wales, subleases must be registered and parties must consider issues relevant to registration of the lease, including whether stamp duty is payable.

What are the factors which tenants should have regard to when contemplating a sublease?

As discussed above, a sublease may be an ideal avenue for tenants looking to divest their leasehold interests if they are wanting to remain on the property but share the costs of rent with another party, or if they want to downsize and lease the part of the property which is surplus. Tenants should consider the following factors:

• If the premises is a retail premises, the tenant (as sub-landlord) must comply with the landlord’s obligations under retail leases legislation.
• The sublease should protect the tenant from the risk of the subtenant creating liability for the tenant under the tenant’s head lease.
• The tenant should carefully draft the sublease to ensure the tenant does not inadvertently take on the head landlord’s obligations under the head lease.

What are the factors which landlords should have regard to when contemplating a sublease?

When the landlord’s consent for a sublease is required (which is highly likely for any written lease), the landlord should have regard to the following matters when deciding whether or not to give their consent:

• The landlord should consider any covenants in the sublease they want to enforce against a subtenant and this should be properly documented in the sublease.
• The terms of the sublease should be consistent with and not contradict the terms of the head lease.
• The sublease should provide that if the head lease ends for any reason, the sublease also ends.
• Where a subtenant is required to obtain consent, it should be obtained from both the head tenant and the head landlord.