Costly make good disputes can be avoided

Better processes can help tenants and landlords avoid common pitfalls

Uncertainty and complexity around a tenant’s make good obligations can lead to costly disputes at the end of a lease – but property experts say better processes can help tenants and landlords avoid common pitfalls.

Make good clauses are written into most commercial property lease agreements. They set out a tenant’s repair, maintenance and reinstatement obligations upon a lease’s expiry, and allow the landlord to claim damages if these obligations are not met.

A common requirement is for the tenant to reinstate the property to its condition at the start of the lease, which could include anything from minor repairs through to the complete removal of the fit out.

However, uncertainty can lead to costly disputes – as highlighted by the recent $10 million court case over the contamination of leased land at Auckland’s waterfront tank farm.

Property experts Chris Farhi, Michelle Hill and David Guy

A panel of property, law and tax specialists from Colliers International, Kensington Swan and KPMG recently delved into these issues at the Make Good Made Better seminar.

The experts agree that disputes can be avoided by getting the legal framework right from the outset, keeping detailed records throughout the tenancy, setting up clear processes, and appointing professional advisors.

The law

Michelle Hill, Special Counsel at Kensington Swan’s property team, says make good provisions are underpinned by a complex and often uncertain legal framework.

“A tenant’s obligations are set out in several pieces of legislation and a plethora of case law, but the most significant factor is the lease contract between tenant and landlord,” she says.

“The wording of lease agreements can vary greatly, and there is often much uncertainty as to what the lease actually requires.

“For example, the common Auckland District Law Society Inc lease contains exclusions for ‘fair wear and tear’, but exactly how that is defined and measured is often a matter of dispute.”

A tenant’s perspective

Chris Farhi, Colliers International’s Strategic Consulting Director, says tenants are often unaware of their make good obligations.

“As the lease expiry date approaches, tenants are often caught off guard by an unexpected make good notice from their landlord.

“The shock is often compounded by the expense of carrying out reinstatement work, which can be substantial and is often unbudgeted for.”

Farhi says it is common for the parties to agree to a monetary settlement instead of the tenant completing the physical reinstatement works.

“However, the landlord is not obliged to then carry out the physical work. There are examples of landlords fighting for settlements and then immediately reletting the premises to a new tenant, completely unaltered.

“To many tenants, make good claims are blatant cash grabs at the end of the lease.”

A landlord’s perspective

David Guy, Director of Building Consultancy at Colliers International, says landlords are often frustrated by a lack of response or delays from tenants.

“The biggest issue is a lack of tenant awareness – and inconsistency among landlords is partly to blame.

“Landlords often tell me they don’t want to pursue make good claims to preserve their reputations and relationships.”

Guy says negotiations can get held up due to the ambiguity of terms in the lease.

“When landlords claim for genuine damage, tenants often cite fair wear and tear – which can lead to a deadlock in negotiations.”

A lack of evidence can also stall negotiations.

“Often, there are no clear records of the property’s condition at the start of the lease. This can lead to debate over whether damage or alterations took place before or after the tenancy commenced.”

Improving the make good process

The experts say getting the lease right from the outset is the best way to avoid future disputes.

Hill says a key consideration is how much prescription and certainty the parties would like in the lease.

“Leases can set out in minute detail the minimum standards required, such as repainting the walls a certain colour. A number of large landlords now use this approach.”

Farhi says this may not be ideal for tenants, as it locks them into precise repair and reinstatement obligations, and can limit their ability to negotiate.

The experts say keeping thorough records at the beginning and throughout a lease term can also avoid confusion at the end.

Guy says a well-prepared premises condition report (PCR), carried out by a registered building surveyor, is invaluable.

“The PCR should clearly document ownership of each building element. Any subsequent alterations, and their associated make good obligations, should be recorded in a deed of variation.”

All documents, including photo and video evidence, should be organised and stored electronically to make them easily accessible at the end of the lease.

Guy says clearly agreed processes can also help to avoid disputes. For example, a good lease might include specific timelines for landlords to serve claims and for tenants to respond.

If disagreements still arise, then clear dispute resolution processes can help.

Hill says a good lease might contain clauses requiring a process similar to that used to settle rent review disputes.

“The landlord could be required to serve a PCR on the tenant, who would then be able to dispute the report within a set timeframe.”

Farhi says larger tenants are more likely to use their bargaining power to opt out of make good clauses altogether, by agreeing with their landlord to hand back the premises as is.

“A number of large banks and government departments have gone down this route, but smaller tenants may not have that bargaining power.”

All three experts agree that appointing professionals can ensure landlords and tenants receive the best advice.

“Specialist property lawyers, tenant representatives, and building surveyors can all play a role in helping to avoid disputes when the lease is over,” says Farhi.

Tenants: Find out more about Strategic Consulting and Building Consultancy.

Owners: Find out more about Strategic Consulting and Building Consultancy.

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