What should you be aware of in the lease?
Starting a business can be a daunting process fraught with potential challenges. One of the most common and important factors in any retail premises-based business is the lease over the premises. The same is true for any site-based franchised system.
As a franchisee, it is important to ensure that you are fully aware of all of your rights and obligations under the lease so that you can make an informed business decision before entering into the lease and franchise agreement. But what should you look out for in the lease?
Who holds the lease?
In franchising there are predominantly two ways in which a franchisee can occupy business premises:
1. The franchisee enters into a lease with the landlord directly as tenant; or
2. The franchisor enters into the lease with the landlord and ‘licences’, or ‘sub-leases’, the right to occupy the premises to the franchisee through a licence to occupy.
Whether you take the lease yourself or occupy the premises through a licence or sub-lease depends on the franchisor’s business model. Generally however, most franchise brands that operate out of major shopping centres have the franchisor enter into the lease. This is because major landlords prefer to deal with franchisors, who potentially have tens or hundreds of outlets around Australia, rather than stand-alone franchisees.
Conversely, the ‘buying power’ of franchisors means that they are better placed to negotiate more favourable lease terms than franchisees.
It is important that you are across the terms of the lease, whether under a lease you occupy yourself or through a license granted to you. In general, licenses to occupy will require that you comply with all of the conditions of the lease regardless, making it important that you obtain appropriate legal advice and understand your obligations.
Your rights under Retail Leasing Legislation
One of the first things you should be aware of is that you may have rights under Retail Leases legislation when it comes to negotiating, entering into and complying with a lease.
Relevant legislation and provisions vary from state to state, but generally provide for crucial checks and balances in the leasing process and for important protections for lessees and retail businesses.
Arguably one of the most crucial elements of a retail lease, the term of the lease determines its duration and how long you can expect to occupy the premises.
The location of your business is one of the most fundamental and enduring characteristics of your business and its goodwill.
Wherever possible you should ensure that the term of the lease coincides with the term of your franchise agreement. For instance, it is not advisable to enter into a three year lease if you are entering into a five year franchise agreement. In the current retail market, most large shopping centre landlords do not provide options to renew the lease and you could be left with a situation where there is a remaining term on your franchise agreement but you do not have the right to continue to operate out of the store.
While most franchise agreements contemplate this situation by providing a right for the franchisee to find alternative premises if the landlord refuses to renew the lease, it is better to prevent any such issues through an appropriate term in your lease, if possible.
Equally as important as the term of your lease is the rent which you will be required to pay. Given that rent often constitutes the largest fixed cost of any retail business it is important that you understand how much rent is payable and ensure that your business can afford it.
Many retail landlords (for example, within most shopping centres) require payment not only of a fixed monthly base rent, but also of a proportion of the business’s takings, known as ‘Percentage Rent’.
It is crucial that you understand the types of rent which will apply to your premises and fully understand the manner in which rent is calculated. Percentage Rent in particular and its impact on your business can be difficult to calculate and it is important that you obtain business advice and undertake modelling to ensure your business can bear the cost. It is also important that you understand the associated sales and revenue reporting requirements.
Landlords often require that personal guarantees are provided by key persons of the business to guarantee compliance with the lease. In simple terms, this means that if the tenant is unable to pay the rent, or do anything else it is required to do under the lease, the landlord may pursue the person who provided the personal guarantee directly.
Even where you are only granted a license to use the premises, you should be aware that you may be required to provide personal guarantees to the landlord. Landlords generally require personal guarantees to offset the risk they face with small retail businesses.
It is very important that you understand the implications of providing a personal guarantee and we highly recommend that you seek legal advice before doing so.
Most landlords will require security under the lease to be provided in the form of a bank guarantee, usually for an amount equal to three to six months’ gross rent including outgoings. In most circumstances, you will be required to provide the bank guarantee directly to the landlord.
In the event that the business is in default of its obligations under the lease, such as by failing to pay the rent, the landlord may ‘draw down’ on the bank guarantee for the amount outstanding and require you to ‘top up’ the bank guarantee to the original amount provided. This is another risk mitigation measure employed by landlords. Franchisees should enquire if the landlord has any specific requirements as to the wording of the bank guarantee and make contact with their bank well in advance of the bank guarantee being due. It can often take some time for the bank to prepare the bank guarantee which can lead to delays in the tenant being provided access to the premises.
Fitout Contributions or lease incentives
In the current retail landscape it is standard practice for franchisors to negotiate with major landlords fit-out contribution payments to incentivise the franchisor to open an outlet in their centres. This reflects the significant clout and buying power of franchisors and the considerable investment franchisors must make in identifying and selecting appropriate retail outlets and leasing sites for their franchises. Landlords enjoy the benefits and patronage that the presence of a large franchise chain can bring to their retail centres.
In accordance with the Franchising Code of Conduct, your franchisor must disclose any such contribution and whether it will be passed on to you to allow you to make an informed decision when entering into the franchise agreement and lease.
Landlord’s Disclosure Statement
Under Retail Leasing legislation in most states, landlords are required to provide their prospective retail tenants with disclosure about the terms and conditions of the lease in the form of a ‘disclosure statement’. In most cases, even where you are only entering into a license to occupy over the premises, you should also receive a copy of the disclosure statement.
It is important to review and familiarise yourself with the disclosure statement to ensure you fully understand the terms of the lease you are to enter into and to ensure it is consistent with the actual terms of the lease.
Most landlords will pass on to tenants, as part of standard leasing practice, the costs, outgoings and other expenses of the centre. These generally include all sundry and other significant costs associated with the operation of the premises and retail centre, including air conditioning, maintenance, pest control, security and, depending upon the applicable retail leasing legislation in your state, may include items such as land tax. Landlords will often also require from tenants contributions toward the marketing and advertising costs of the centre to promote greater patronage to the centre.
Costs of this kind will generally be apportioned among the existing tenants of the centre based upon the proportion of the total floorspace of the centre that they occupy.
It is important to ensure you understand the types of costs which may be claimed and the manner in which these are calculated and allocated to your tenancy.
Many leases will have a requirement that the premises are refurbished at least once during the term.
The extent of such refurbishments can vary and are separate to any refurbishment requirements under the franchise agreement. Generally, these involve bringing the premises up to a presentable state consistent with the high standards of retail premises and presentation within the retail sector in Australia.
Franchisees need to be aware of these requirements and factor any such costs into their business model to ensure that the business will have sufficient capital to carry out such repairs and refurbishments when the time arises.
Daunting yet manageable
While the above may make the lease of a retail premises seem like a daunting and confronting affair, with the right assistance and advice and careful planning the leasing relationship becomes a very manageable process.
As with most other similar business processes, it is important to ensure that you enter the process well informed with the right advice and with adequate support and capital to ensure you can meet all its requirements.
Bianca Sevastos, Partner at Baybridge Lawyers, specialises in franchising and licensing and advises on all aspects of franchising industry compliance with the Code.
Bianca has extensive experience and advises on a range of national and international transactions, industry master and area development rights and advises both franchisors and franchisees in dispute, obligations under the Franchising Code of Conduct and the Competition and Consumer Act.
Baybridge Lawyers is a specialist corporate and commercial law firm and a leading authority on all franchise related matters. They are seen as trusted advisors to many brands nationally and internationally.