When negotiating the terms of a commercial lease, an option to renew the lease is a term which a tenant should seek to have included. However, in the current market, of increasing rent and demand for commercial spaces, landlords are reluctant to include such a term. Much of the time, a tenant simply accepts the landlord’s standard lease without negotiating key terms such as a renewal option.
An option to renew can be especially important for long-term growth, since a business that is thriving may want to keep the business going in the same commercial space without interruption. It may also be an attractive feature of a lease in the event that the tenant wants to sell the business, which may include the transfer of the lease to the purchaser.
When an option to renew is exercised by a tenant, the landlord and the tenant are creating a new lease that begins on the expiry date of the original lease. Generally, the renewed lease will contain most of the terms that were in the original lease.
An option to renew is not necessarily a simple add-in to a lease, and if not drafted correctly, can end up in costly disputes. There are three issues, in particular, that should be ironed out before a lease is signed:
- how the rent will be determined for a renewal period;
- whether the option to “renew” should be an option for an “extension of term” (the difference will be discussed below); and
- what other terms of the original lease are to carry forward in the new lease.
How the Rent will be Determined
A landlord, in most cases, will require that the rent due during the renewal period will be different than the rent in the original lease. Often, a renewal option will state that rent is to be set by the “mutual agreement” of the landlord and the tenant. This type of language is known in law as an “agreement to agree”, which is generally unenforceable and could invalidate the option to renew. A tenant should insist that either the new rent is set ahead of time or that the rent can be more readily and accurately determined. For example, the above provision can be saved by including that if the parties do not agree on the rent, then it will be determined by an arbitrator pursuant to the Arbitration Act, Ontario.
Option to Renew vs. Extension of Term
As discussed above, an option to renew creates a new lease immediately following the expiry date of the original lease. Under a commercial lease, many of the tenant’s rights and privileges, in law, do not “run with the land”. That is, certain rights do not attach to the option to renew and those rights will not flow into the new lease. Such rights may include the right of first refusal to purchase or a right of first refusal for new space. Under a renewed lease, these rights may be lost unless expressly agreed to be included by the parties.
An extension of term differs from a renewal, since the original lease does not expire, but continues without interruption during the extension period. With an extension of term, unlike an option to renew, all rights from the original lease continue during the extension period. An extension is far safer for the tenant, as all rights will automatically flow into the renewal period. Under an option to renew, the tenant must be careful to identify which rights and privileges which may not automatically carry forward to the renewal period.
Terms of the Renewed Lease
The parties must also determine what terms in the original lease make sense for the renewal period. For example, provisions that require certain works by the tenant or the landlord to be done at the beginning of the term should be removed or changed. The tenant should also be aware that the landlord is likely to remove certain terms from the renewed lease such as any rent-free periods that were offered in the original lease. The tenant will want to examine the original lease to ensure that impractical or unnecessary provisions do not make their way into the renewal period. Again, may of these issues can be avoided by having an extension of term option rather than an option to renew.
The option to renew (or an extension of term) is an important provision of a commercial lease. Once the decision is made to put it in, the tenant must ensure that the option is drafted correctly to give it full effect. A poorly drafted option can result in a voided renewal or costly litigation. A lawyer can help steer a prospective tenant through the issues and pitfalls of a commercial lease, and ultimately help create a lease that meets the tenant’s expectations.