Commercial LeasePack UPDATE

Commercial LeasePack UPDATE

Why a 'Renewal Option' is no longer viable for Commercial Landlords

Almost every tenant would like its lease to include a clause giving it the option to renew. This is particularly true in a retail environment where a considerable portion of a tenant's goodwill may be tied to the location of the premises.

But labelling a clause as an 'option to renew' does not make it so. Strictly speaking, an option to renew is an agreement all of its own. It gives the holder of the option the right, but not the obligation, to lease the premises in question for a further agreed period at an agreed rental.

Once we understand that an option to renew is an agreement all of its own, it stands to reason that an option to renew must contain all of the essential ingredients for an agreement of lease: that is to say, agreement on who the landlord is, who the tenant is, what premises are being leased and crucially, what the rental will be.

It is in respect of the rental that many so-called renewal options fall flat and, upon closer inspection, reveal themselves not to be enforceable options at all.

Shepherd Real Estate Investments (Pty) Ltd v Roux Le Roux Motors:

- As this recent judgment1 of the Supreme Court of Appeal has reminded us, our law of landlord and tenant requires that there should be agreement on the rental payable in respect of the premises before it may be said that the parties have reached a binding agreement. What is required is either an actual rental or a definite method of establishing that rental independently of the parties.

In this case, the landlord had concluded an agreement of lease with the tenant in respect of a commercial property in Paarl that was occupied by the tenant for the purposes of conducting the business of a petrol station. The case centred around the interpretation of a renewal clause:

"Such renewal for the...renewal period, shall be on terms and conditions in compliance with the Landlord's then standard letting policy, except that there shall be no right of further renewal and that the rental and costs shall be mutually agreed upon in writing between the Landlord and the Tenant when the right of renewal is exercised."

The tenant attempted to exercise its right of renewal but the parties were unable to agree on the rental payable for the renewal period. The landlord subsequently applied to Court for the eviction of the tenant from the premises.

A renewal clause is not a legally enforceable obligation:-

In finding for the landlord, the Supreme Court of Appeal characterised the renewal clause as a 'mere agreement to agree' rather than a clause containing legally enforceable obligations and reiterated the long-standing position that our Courts will not enforce such an 'agreement'. In the result, an order was granted evicting the tenant from the premises.

Thus, while most tenants are happy to find that their lease contains a clause to the following effect: 'the tenant shall have the option, by notice in writing to the landlord to renew this agreement for a further period of X years, at an agreed rental', they should most assuredly not be. This is a mere agreement to agree on the rental payable and not enforceable against the landlord.

To put it differently, if the landlord and the tenant do not agree on the rental payable for the renewal period, the tenant has no right to remain in the premises, even if it may have exercised what it understood to be its 'option'.

There is little advantage for landlords to grant an option to renew:

- Why then are so-called options to renew so often couched in non-binding language? The answer, in part, is that there is often little advantage to a landlord in granting a tenant a binding option to renew, unless the rental payable in respect of the option period is a market-related rental at the time that the option is exercised.

But if the parties have contracted on the basis of a rental in respect of the renewal period that represents poor value to the tenant at the time that the option is capable of being exercised, it will simply choose not to exercise it. There is also nothing to prevent the tenant from opening up discussions with the landlord about the possibility of concluding a new lease agreement, at rentals lower than those contained in the renewal option.

Conclusion:

- The clause that comes the closest to satisfying the needs of both landlord and tenant is a clause that contains a binding option to renew but at a market-related rental to be determined by an independent industry expert.

No benefit to the landlord unless renewed rental is market related:

- Why do we say this? Put simply: the option belongs to the tenant alone. The tenant may choose to exercise its option or not, depending on what best suits it. If the parties have contracted on the basis of a rental (in respect of the renewal period) that represents good value to the tenant at the time that the option is capable of being exercised, the tenant will exercise it. And it follows then that the landlord may lose out since - if not for the option - it may have been able to negotiate a higher rental, or even let the premises out to a third party willing to pay more for those premises.