How can landlords and tenants avoid ‘make good’ disputes?

Services: Real Estate & Construction
Industry Focus: Real Estate & Construction
Date: 30 August 2017
Author: Kerri-Ann Martinus, Associate
Associate
T +61 2 8233 9698
Partner
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M +61 417 080 350
Senior Associate
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Partner
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M +61 408 123 967

What you need to know

  • Leases frequently contain ‘make good’ provisions which specify what a tenant must do before vacating the premises, which might include taking steps to return the premises in good repair and condition.
  • When make good provisions are not properly considered at the beginning of a lease, disputes can arise down the track when landlords and tenants discover they had different ideas about what would constitute compliance.
  • By asking several key questions during the negotiation stage, landlords and tenants can ensure expectations are clear from the outset which will help reduce the risk of delayed conflict.

When a lease is being negotiated, landlords and tenants often pay little attention to the ‘make good’ provisions in the lease. As these clauses relate to what the tenant must do at the expiry or earlier termination of the lease, they are often glossed over as something that can be dealt with later.

But upon expiration or termination of a lease, disputes between the landlord and tenant commonly arise because:

  • each party has interpreted the make good obligations differently, or
  • the parties have not considered the actual impact that the agreed clause will have on their business at the end of the lease.

It is important for both landlords and tenants to ensure they understand what a make good clause means in their particular circumstances, what consequences will follow if the tenant does not comply with its obligations, and what steps the parties can take to reduce the risk of disputes arising.

What does ‘make good’ really mean?

Make good refers to the condition in which a tenant must leave the premises when it vacates them. Such provisions commonly require a tenant to:

  • reinstate the premises to a ‘base building condition’ or a ‘basic shell’
  • reinstate the premises to the condition they were in on the date the tenant first took occupation, with fair wear and tear often excluded
  • return the premises in good repair and condition with any approved structural alterations left in place.

Unless the make good requirements are clearly defined, disputes will almost certainly arise. This is because a landlord will want the tenant to do as much as possible in making the premises fit for the next tenant, whereas the tenant will want to do as little as possible.

What happens when the tenant does not make good?

Courts are generally reluctant to make orders requiring specific performance of covenants to repair. The remedies granted are usually in the form of damages.  

At common law the measure of damages for failure to make good at the end of a lease is the cost of putting the premises into the state of repair in which the tenant was bound to leave them. However, the measure of damages for failure to repair during the currency of a lease term has been held to be the diminution in the value of the reversion, i.e. the amount by which the value of the freehold reduces. This is an important distinction because, while the cost of the repair works might be substantial, there will be no reduction in the value of the freehold if the landlord’s intention is to demolish the premises as soon as the lease is at an end. 

It was to remedy these differences of approach that legislation was enacted in New South Wales (see section 133A Conveyancing Act 1919) and Queensland (see section 112 Property Law Act 1974). There is no corresponding provision in Victoria.[1]

Furthermore, it may be argued that where a landlord has an express right under the lease to enter the premises to effect repairs at the expense of the tenant, then the landlord’s claim will be for payment of a debt due under the lease. In those circumstances the rules relating to a damages claim will not apply. 

Where a tenant fails to comply with its make good obligations, the landlord will often seek to negotiate a cash sum in settlement or enter and carry out work on the premises with a view to recovering the cost from the tenant at a later stage. The alternative to be followed will often depend upon the landlord’s future plans for the premises which may include those of any prospective new tenant. Before making any decision, the landlord should ensure it understands the legal position that applies in the circumstances. 

How can landlords and tenants reduce the risk of disputes?

The best way for landlords and tenants to avoid disputes in relation to make good clauses is to ensure they are properly considered early on, during the negotiation of the lease. There are several key questions that landlords and tenants should ask themselves.

Key questions for both parties

  • Have relevant terms been clearly defined?

    Parties should carefully consider what is intended and this should be clearly reflected in the lease. For example, if terms such as ‘base building condition’, ‘basic shell’ or ‘good repair’ are used, has the meaning of those terms been clearly defined within the lease? If it is intended that particular items or fitout are to be removed or are to remain within the premises, has this been clearly documented?
  • What is the reference point for make good and maintenance clauses?

    Are the make good and maintenance clauses drafted with reference to the condition of the premises on the date the tenant first took occupation of the premises, or to some other fixed date such as the commencement date? The latter approach can be problematic when a lease goes through a series of renewals, because the landlord might argue that ‘commencement date’ refers to the very beginning of the tenant’s occupation, whereas the tenant might argue that it only needs to return the premises to the condition they were in at the commencement date of the most recent renewal.

    Parties may also want to arrange an appropriate consultant to prepare a detailed report which includes photographic evidence, showing the condition of the premises as at the date the tenant first took occupation.
  • Are the tenant’s make good obligations to be settled by a payment to the landlord at the end of the lease?

    If so, will such payment result in a partial or complete release of the tenant? For example, does the tenant still need to remove its items from the premises and leave the premises in a clean and tidy condition or can the tenant simply walk away from the premises and leave these items in place? Does the lease include a mechanism for the determination of the cash payment and the agreed scope of works?

Key questions for landlords

  • Does the lease expressly entitle the landlord to recover its costs in respect of carrying out make good on behalf of a tenant?
  • Does the lease impose an obligation on the tenant to continue paying rent until it has complied with its make good obligations?
  • Does the lease require the tenant to provide the landlord with a bank guarantee?

    If so, such a bank guarantee preferably should not have an expiry date and should be security for all breaches of the lease, including the obligation to make good, and not just the non-payment of rent.

Key question for tenants

  • If a tenant is permitted to sublease the premises, will the sublease expire shortly before the headlease?

    If so, has the tenant ensured the make good obligations under the sublease mirror those under the headlease? If not and the tenant is willing for the subtenant to carry out a reduced make good to that which exists under the headlease, will the tenant have a sufficient period of time to comply with the make good obligations under the headlease after the sublease ends?

Key takeaways                   

When landlords and tenants are negotiating leases within tight timeframes, it can be tempting to gloss over or rush through the issues that have no immediate consequences. In these circumstances, make good clauses are often casualties in the negotiation process, but they can cause problems down the track where the parties have different expectations that have not previously come to light.

By properly considering make good clauses during the negotiation of a lease, landlords and tenants can work together in clarifying their expectations and reducing the risk of delayed conflict.

For more information, please contact:

Bill Burrough | Partner

T +61 3 8640 1001 | M +61 417 080 350

E bill.burrough@dibbsbarker.com

Steven Askew | Senior Associate

T +61 2 8233 9737

E steven.askew@dibbsbarker.com

Kirsten Pike | Partner

T +61 7 3100 5054 | M +61 408 123 967

E kirsten.pike@dibbsbarker.com

Footnotes

1. See our Landlord & Tenant Alert dated 25 June 2014, Assessing damages for breach of make good obligations which includes commentary on the approach taken by the Victorian Supreme Court in the case of Gimtak Pty Ltd v Cathie.

The information in this document, broadcast or communication is provided for general guidance only. It is not legal advice, and should not be used as a substitute for consultation with professional legal or other advisors. No warranty is given to the correctness of the information contained in this document, broadcast or communication or its suitability for use by you. To the fullest extent permitted by law, no liability is accepted by DibbsBarker for any statement or opinion, or for an error or omission or for any loss or damage suffered as a result of reliance on or use by any person of any material in the document, broadcast or communication.
 
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