Commercial property landlords have to consider a number of key clauses to protect their income continuity from their commercial property. One of these key clauses that can be financially demanding on a tenant is the ‘make good’ clause. This Legal Kitz article will cover what a ‘make good’ clause is.
What is the ‘make good’ clause?
‘Make good’ refers to the clause/s in a commercial lease that set out how the tenant should leave a property at the termination or expiry of a lease term. This is the condition that is stipulated in the lease and can commonly cause tenants to be extensively out of pocket to reverse their alterations if not understood and agreed upon fairly when entering the lease. Pursuing legal advice when entering the negotiation of your commercial lease may be an appropriate way to avoid these repercussions.
What are the common four types of ‘make good’ obligations?
Removal of detachable property only
This obligation is the least demanding and easily understood by tenants. It only requires the bare minimum which is the removal of all detachable property including computer desks, filing cabinets, shelving or bookshelves and other furniture and free-standing items.
Removal of all property and basic repairs
This obligation is slightly more work requiring not only detachable property to be removed but any property that has been fixed to the premises. Because this ‘make good’ obligation can cause substantial structural damage by removing fixed property, a tenant will most likely have to ensure that the walls, floors and other structural elements are in the same condition as before the business commenced. This may require additional painting or sanding on the surfaces.
Return the premises to the standard shown in a condition report
This obligation can commonly be more confusing to tenants especially when fit-outs have occurred to make the property suitable for the nature of their business. It requires the tenant to return the leased premises to the condition that was set out in a report.
If this obligation is being negotiated when entering a leasing agreement, it is a great idea to discuss any future fit-out plans with the landlord at the same time. This will ensure that both parties are aware of what will be required in the future to restore the premises, and that condition reports are conducted at the best time before construction. If a tenant agrees to this ‘make good’ obligation but fails to remove all fit-outs, the landlord is likely to impose additional sanctions on the tenant and leave them unexpectedly forking out finances for the unnegotiable removals of their fit-outs.
Base building standard
This type of obligation is very common in retail shopping spaces where a landlord will request the premises to be returned in the state that it was when it was first constructed. This is because in a large retail centre, a landlord will not know what type of business the next tenant will be conducting and will want to maximise their chance of refilling the space with any business. Depending on the specifics, a tenant may need to remove all plumbing, wiring, installations and fit outs as well as attached and detached property. A base building standard clause can be a very expensive obligation. If a tenant’s lease agreement requires this ‘make good’ clause, then it is imperative that you budget accordingly.
How do I protect myself from ‘make good’ repercussions?
When drafting the lease, you should give careful consideration to any ‘make good’ requirements. Consider whether you, as a tenant, are required to leave the premises in a clean and tidy condition or whether you will need to remove all property. Many landlords will want an extensive ‘make good’ clause so that the property is left as an empty shell; leaving the landlord with a better opportunity to swiftly move in any kind of new business.
The extent of the ‘make good’ clause is a matter you must negotiate before you enter into the lease agreement. It is important that both you and the landlord both understand each other’s obligations. This will help to avoid any unpleasant surprises at the end of the lease term causing you to go over set budgets. To protect yourself from any negative financial repercussions, it is imperative that you consider the following:
1. Obtaining a condition report
In addition to being clear on the ‘make good’ clause in the lease, you should consider obtaining a thorough entry condition report at the commencement of your lease. The landlord can pass on the cost of this report to a tenant or vice versa as agreed by the parties. This would include:
- taking photos; and
- noting down details of any defects in the property.
Having a condition report removes any uncertainty when determining what the condition of the premises was at the start of the lease. This is especially the case if it is an already used and defected premises.
It is good practice for both parties to agree on the condition report by signing off on it. Both you and the tenant should then keep a copy of it to shield you from false allegations in the make-good process.
An alternative to a condition report is having an independent third party carry out a property inspection which records the property condition. This record should thoroughly detail any defects of the property and be signed by both the tenant and landlord. At the end of the lease, a party may arrange for a second inspection to take place and the preparation of another condition report. By having both condition reports available, it can be easier to determine whether you have fulfilled make good responsibilities.
In other leasing arrangements, an original tenant may assign an existing lease to a new tenant. In these circumstances, the new tenant generally takes the property in the state it is in when the original tenant assigns the lease. Therefore, the new tenant inherits the original tenant’s make good obligations which can be any of the four listed above. As a tenant, it is important that you understand all the prior make good obligations from the initial agreement which you inherent as well as any alterations and additions which have been undertaken by the prior tenant. For example, the prior tenant may have put holes in the wall to make additional shelving which you may be obligated to fix at the end of your lease to return the property to its original condition. These should be discussed with the landlord and the prior tenant when you are entering the leasing agreement as the new tenant. It is also important to document these discussions to ensure additional make-good obligations are not placed on you because the prior tenant failed to inform you of all their alterations.
You should aim to ensure that:
- all parties consider ‘make good’ in any assignment of the lease; and
- the original tenant fixes any damage they might have done.
3. Cash in lieu
A landlord may also ask you, the tenant, to make a cash payment to them in lieu of carrying out any ‘make good’ works. This removes flexibility from you as a tenant but will speed up ‘make good’ processes, allowing the landlord to take back the property sooner. This may also remove uncertainty and low the risk of disputes around what works are necessarily required. However, the costs asked for can be alarming as the tenant is not in charge of gathering and choosing the costs. The tenant may wish to negotiate with the landlord to provide multiple quotes before a cost is asked from them so that both parties can reach an agreement and the landlord does not ask for a higher cost at their convenience.
It is essential that you understand the obligations of a ‘make good’ clause, and how these obligations will affect your business continuity if you decide to terminate or to not renew a lease. If your lease is already in place it may be time to review the existing ‘make good’ clause and budget accordingly.
If you’re entering into a commercial lease, remember that hurried or pressured negotiations can lead to disaster with potentially severe financial ramifications.
Long-term business success comes from mitigating risks and making yourself less vulnerable. When considering a lease, ‘make good’ obligations should be at the forefront of your mind. Therefore, it is a good idea to:
- ensure the commercial terms in the lease surrounding ‘make good’ are clear and understood by all parties;
- consider obtaining a condition report at the start of the lease and again at the end of the lease; and
- consider any obligations to provide a cash payment to the landlord in lieu of the make good requirements.
‘Make good’ obligations can be costly and challenging to negotiate. If you’re having trouble ensuring that the clause in your commercial lease agreement is fair and reasonable, Legal Kitz is here to help with any concerns you may have! Book here now for your free consultation.