Navigating Makegood Obligations in Commercial Leases: A Comprehensive Guide

Navigating Makegood Obligations in Commercial Leases: A Comprehensive Guide

When a commercial lease comes to an end, whether due to the expiry of the term or earlier termination, tenants face the critical task of fulfilling their makegood obligations. These provisions, typically embedded in lease agreements, dictate how tenants should return the property to its original state, often requiring substantial work to remove fit-outs and restore the premises to an open-plan condition. This blog aims to shed light on the intricacies of makegood clauses, the responsibilities of tenant representatives (Tenant Reps), and the importance of planning and negotiation in managing these obligations effectively.

Understanding Makegood Provisions

Makegood clauses are standard in commercial leases, obligating tenants to return the premises to the condition it was in at the lease commencement. This includes removing any installed property, cleaning, and repairing any damages, excluding fair wear and tear. These provisions ensure landlords can offer a ready-to-use space to new tenants, potentially refurbished to modern standards.

One of the standard inclusions in an offer to lease, after the commercial terms such as rent and term, is a requirement for the tenant to makegood the premises at the end of the term. This is written into the lease and requires the tenant to return the premises to the condition it was in at the commencement of the lease, which includes removing its property and leaving the premises in a clean and tidy condition.

What If the Lease Lacks a Makegood Provision?

Even in the absence of explicit makegood clauses, tenants are not off the hook. Common law obligations in various states or territories require tenants to return the premises to a similar state as at the lease's start. If the lease doesn’t contain any provision for makegood, some common law obligations state that a tenant would still be required to comply with its common law obligations, which requires a tenant to return the premises to a similar state as it was in at the commencement of the lease, except for fair wear and tear.

Breaching Makegood Obligations

If the tenant breaches its makegood obligations, having the standard inclusion in the lease gives the landlord a contractual right (usually in addition to its common law rights) to recover its costs from the tenant without being required to pursue the tenant in court. For example, the landlord can rely on a contractual indemnity. The landlord can sue the tenant at common law (rather than contract) for any loss it has suffered because of the tenant’s failure.

The Role of Tenant Representatives

A Tenant Rep may still be working with their client once they have helped them procure their office accommodation, and this may include helping to agree on the scope of works with the lessor for a makegood and helping source quotes and finalize the appointment of the contractor to do the work on behalf of the client. This could possibly be managed also by the internal Property Manager, but it is also possible that it is preferred that the Tenant Rep look after the exit obligations.

Tenant Reps play a pivotal role in navigating the makegood process. From negotiating lease terms to finalizing exit strategies, their expertise ensures tenants meet their obligations efficiently. Here's a typical process they follow:

1. Reviewing Lease Obligations: Tenant Reps begin by scrutinizing the lease to understand the scope of makegood obligations.
2. Sourcing Quotes: They obtain quotes from contractors to carry out the required works.
3. Negotiating with Landlords: Reps negotiate with landlords to agree on acceptable contractors and finalize the work.

The process is not always cut and dried when it comes to makegood, and the advice of the Tenant Rep will help the client here. Often the landlord may prefer to negotiate a fair settlement with the tenant as bringing the tenancy up to a standard that is acceptable and allowing for fair wear and tear would usually see the landlord rip out the fit out in most cases to bring the office space up to a modern standard to attract a new tenant (this is of course dependent on the market).

Reinstatement vs. Makegood Settlements

While traditional makegood involves physically restoring the premises, tenants often seek settlements to avoid the hassle and time constraints of reinstatement. Settlements can offer flexibility, allowing tenants to align their exit with new premises’ readiness. However, this requires meticulous negotiation to ensure a fair deal.

Sometimes the exiting tenant will look to negotiate and reach makegood settlements on their makegood obligations for the lease. This can remove their migration date dependency and can give them more flexibility in dates to relocate to their new premises (dependent on their fit-out programme).

In this type of situation, the outgoing tenant could tie up the furniture and equipment with the makegood settlement for the tenant/buildings, and the outgoing tenant would need to work with their finance team updating their register of company-owned equipment that may be part of this deal for traceability purposes. There are some assets that you would expect would not be part of the commitment to the landlord, but these will differ from situation to situation.

If no settlement is possible, tenants must proceed with reinstatement. Traditionally, tenants and landlords view the process as follows:

1. Review the Lease: Check what obligations the tenant has and agree on a scope of works to meet these obligations.
2. Source Quotes: The tenant sources quotes to carry out the works from a range of contractors.
3. Negotiate and Commission Work: Both parties then negotiate to agree that the proposed contractors are acceptable and commission the work.

Exiting Strategies for Tenant Organizations

Exiting a property involves more than just physical makegood. Tenants must consider several factors:

1. Cleaning and Waste Disposal: Proper cleaning and disposal of waste are critical to leaving the premises in an acceptable state.
2. Walkthroughs: Identifying items to remain and those to be removed is essential for a smooth handover.
3. ICT Decommissioning: Coordinating with vendors to remove redundant ICT equipment in a timely manner.

Since we are talking about exit obligations, let's also discuss exiting the building from the perspective of the client organization preparing their exit strategy. Dependent on the lease terms and conditions, they may need to consider the following:

• Cleaning: Gauge cleaning requirements and timeframes.
• Waste Disposal: Arrange for general waste and miscellaneous items disposal in preparation for the clean.
• Walkthrough: Identify the items that they would expect to remain in a handover to the landlord.
• ICT: Ascertain expected exit dates for vendors to pick up retired/redundant ICT.
• Timeframes: Provide an estimated timeframe that they could give the landlord the floor, regardless of reinstatement/makegood or makegood settlement.

Owner/Occupier Exit Considerations

For organizations that own their buildings, exit strategies may differ, especially if the new owner plans significant renovations or demolitions. The focus shifts to understanding contractual obligations and ensuring the premises are left in a condition agreed upon in the sale contract. Key tasks include:

• Cleaning and Clearing Assets: Ensuring the premises are clean and free of all non-transferred assets.
• Security and Decommissioning: Addressing security concerns and decommissioning ICT systems post-sale.

What if the exiting organization owned the building? How do they leave the building, and in what manner and order? In any circumstance where the purchaser of the property may be doing a ‘knockdown’ of the property assets to meet the requirements of their needs, there may likely be less importance put on any makegood (if any at all), and there may be little requirements of the exiting organization in terms of leaving the premises, with the basic requirement being to leave the premises in a clean and tidy manner only.

Regardless of what the negotiated caveats are in the Contract of Sale, there are deliverables and milestones that the outgoing tenant/seller may need to meet or navigate. Understanding the Contract of Sale is important to understand what condition the exiting organization must leave the buildings in, at a minimum – i.e., fair wear and tear. Additionally, the new owner of the building (the purchaser) must understand what is in the Contract of Sale including furniture and fittings, and what condition the buildings must be left in. There may be an Exit Condition Report of the premises that also provides inventories of fixed assets that may be part of the sale.

If the sale doesn’t include any fixed assets, such as wall-mounted whiteboards, dishwashers, etc, then the premises would need to be stripped of all assets and left in a clean and tidy state acceptable for occupation by the incoming tenant/owner – this would mean an Asset Disposal programme would need to be undertaken by the exiting organization/seller.

Acceptable conditions of floors - handover:

• The floors to be presented “as is” which may be acceptable for occupation.
• There may be the requirement for the exiting organization/seller to remove all furniture and fixtures. This could delay occupation if there are multiple buildings, and if there are multiple buildings, this could take many months to clear the buildings out, but this of course is dependent on a well-managed exit strategy.
• If a building or level has been accepted and/or occupied, as part of the handover, the incoming owner/tenant must accept responsibility for ongoing cleaning.

Decommissioning:

• There may be required building access until the end of makegood for the outgoing tenant/seller. This may impact the incoming owner regarding ongoing security of the building. In these cases, the incoming owner may need to commence security planning for the building.

ICT:

• There may be liaison required post-sale of buildings for decommissioning of ICT equipment from the building.

Security:

• There may be security issues that need to be resolved whilst the outgoing tenant/seller removes assets, whilst protecting their assets and the assets of the incoming tenant/new owner.

There is much for the exiting organization/seller to do to exit the premises. You often hear about the best deal possible would be the incoming owner being willing to accept the buildings/floors as is (with the items identified as part of the contracted transfer of assets), and that means that the outgoing tenant/seller could start with the items identified as part of the contracted transfer of assets), and that means that the outgoing tenant/seller could start. However, this is dependent on several factors and requires careful consideration.

Conclusion

Navigating makegood obligations in commercial leases requires a comprehensive understanding of lease terms, negotiation skills, and meticulous planning. Tenant representatives play a crucial role in ensuring that tenants fulfill their obligations efficiently and effectively, whether through physical reinstatement or negotiated settlements. Additionally, exiting organizations, whether tenants or owners, must carefully strategize their exit plans to meet contractual obligations and ensure a smooth transition for all parties involved.

By adhering to best practices and seeking expert advice when needed, tenants can navigate makegood obligations with confidence, minimizing risks and maximizing outcomes. Effective communication and collaboration between tenants, landlords, tenant representatives, and other stakeholders are essential for achieving successful outcomes in commercial lease exits. With careful planning and attention to detail, tenants can mitigate potential challenges and ensure a seamless transition out of their commercial premises.

In conclusion, makegood obligations are a critical aspect of commercial leasing that requires careful consideration and proactive management. By understanding lease terms, engaging with expert advisors, and planning ahead, tenants can navigate the makegood process smoothly and minimize risks associated with lease exits. Effective management of makegood obligations not only ensures compliance with lease terms but also helps maintain positive relationships with landlords and facilitates smooth transitions for all parties involved.