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Cancelling a Commercial Lease

Terminating Commercial LeaseIf a tenant defaults

In the current economic climate there are, unfortunately, increasingly more tenants unable to pay the rent on their leased commercial premises or who are breaching some other covenant under their lease. This article outlines how a landlord can cancel a lease in the event of default by the tenant and how landlords can best protect themselves from being left out of pocket.

Under the Property Law Act 2007 (the Act) a lease can be cancelled if the rent has been in arrears for not less than 10 working days or if the tenant has breached some other covenant or condition of the lease.

As a landlord, if you wish to exercise the right to cancel a lease you must first serve a notice of intention to cancel the lease on the tenant.

Notice requirements

The Act sets out the strict requirements for what must be included in the notice. These include:

  • The nature and extent of the breach complained about
  • The amount that must be paid or what the tenant must do, or stop doing, in order to remedy the breach
  • The period within which the breach must be remedied
  • The consequence that, if the breach is not remedied at the expiry of the period specified in the notice, you may seek to cancel the lease, and the
  • Tenant's right to apply to a court for relief against the cancellation of the lease, and the advisability of seeking legal advice on the exercise of that right.

You must give a minimum notice period of 10 working days to your tenant if there are rent arrears. However, the Act states that the notice period may run concurrently with the period in which the rent must be in arrears before you may exercise any right to cancel the lease. Therefore, you can serve notice as soon as the rent is one day in arrears.

Your acceptance of any rent payment after the notice has been served does not operate as a waiver of your right to cancel the lease. For any other breaches of the lease, such as your tenant's failure to pay outgoings or comply with the maintenance provisions under the lease, you must provide a reasonable notice period to your tenant for the breach to be remedied.

Any term expressed or implied in a lease has no effect if it provides that the lease is automatically cancelled by a breach of a covenant or condition of the lease or is otherwise inconsistent with the Act.

"In order to ensure your notice complies with all the Act's requirements and you can rely on it to cancel the lease, we recommended that you talk with us before serving it to your tenant"

 

Cancellation of lease

If the breach has not been remedied by your tenant at the expiry of the period specified in the notice, you can cancel the lease. In order to do this, you will have to either apply to the court for an order for possession of the land or re-enter the land 'peaceably'.
The more cost-effective and timely option is for you to re-enter the land peaceably and change the locks. However, this can prove difficult if your tenant will not vacate the premises willingly, as it is advisable you only re-enter the premises during daylight hours and you may not use force or cause a breach of the peace.

Cancellation of the lease does not prevent you from suing your tenant for any money owing or damages for any other breach
of the lease. However, you can take steps at the beginning of the lease to minimise the risk of being left out of pocket when the lease is terminated.

It is important to remember that the Act is a Code containing minimum requirements that require compliance. You should note that if the lease extends the minimum notice period then you must comply with the lease. This was reiterated in a recent Supreme Court decision1 where the lease provided that the landlord could terminate 14 days after rent had become due and remained unpaid. The landlord miscalculated and re-entered purporting to cancel the lease after 13 days. The court held that to be an unlawful repudiation of the lease and the landlord was directed to pay substantial damages. The lesson is that you need to be careful that you follow the correct procedure.

Help protect your position

When considering entering into a lease with a prospective tenant, there are some measures that can be taken to help protect your position.

  • Do your homework:

    Ask your prospective tenant for an outline of their business credentials, their business plan and for references. While in negotiations, you should consider the following security measures.

  • Persona/ guarantee/covenant

    Ask for a personal guarantee of your tenant's obligations. This is common practice and an important step where your tenant is a company or a trust. Many tenants will structure their business using a company or perhaps a trust with the intent of limiting the scope of their liability. Usually, the personal guarantee should be given by someone obtaining a benefit from the lease such as a major shareholder or, where appropriate, a director (often the person running the business). Circumstances will dictate who is most appropriate to provide the guarantee. 

    You can call upon the guarantor when the tenant defaults under the lease. For the guarantee to be binding, the guarantor must sign the lease (and agreement to lease where applicable). A guarantor will generally be bound by rent reviews provided for in the lease.

    It should be noted that there are circumstances where the guarantor may not be liable. For example, where your tenant exercises a right of renewal, a guarantor's liability might not automatically continue. Similarly, the guarantor's liability will not usually extend into any period where your tenant remains in possession following the expiry of a fixed term (holding over period). The extent of a guarantor's liability depends on the circumstances and wording of the guarantee.

  • Bond/rent deposit

    Ask your tenant to pay a lump sum up-front to be held as security for payment of rent and the performance of their obligations.

    "It is important that both landlords and tenants understand the laws surrounding breaches and the cancellation of commercial leases."

    The catch, however, is that not all tenants will be in a financial position to pay a deposit at the outset as they are likely to have significant start-up costs. Where a bond is agreed, it is important to specify the terms in the lease. For example, who holds the bond? In what circumstances will it be used? Is your tenant obliged to replenish the bond when funds are used to remedy a breach? As landlord, you should be careful that the wording of the bond clause doesn't compromise your ability to enforce other remedies, such as the right to issue a notice of intention to cancel for non-payment of rent (as discussed above). We can help you to draft a suitable clause.

  • Bank guarantees:

    Ask your tenant to arrange a bank guarantee. As the name suggests, when a tenant defaults under the lease, a landlord can make demand on the bank for payment. In most cases, you will be able to make demand on the bank without the need to give proof of the breach. If a bank guarantee is to be used, make sure you know the extent of the guarantee, ie: how much money is guaranteed and for how long does the guarantee endure?

    Although not as common, there are specialist organisations and some insurers who provide a similar service. If you are not familiar with the entity suggested, you should check the entity is robust and the security can be relied on. As with bonds, this type of arrangement will not be available to all tenants depending on their financial position and how the provider assesses the risk.

Before entering into any lease (or agreement to lease), talk with us first. We can help you in deciding what protection measures will be beneficial and can draft the lease accordingly.
It is important that both landlords and tenants understand the laws surrounding breaches and the cancellation of commercial leases. Furthermore, both parties should be mindful of what further security options are available and the implications they have for each party.

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1 Ingram and Knee v Patcroft Properties Ltd 12011] NZSC 49

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