Why landlords and tenants face special risks when leasing strata shops, offices and industrial premises

When leasing commercial premises in a strata scheme, landlords and tenants must go beyond the commercial lease to find their rights and obligations. They must go to the strata law to find where they stand on important leasing issues such as building repairs, fit-out, outgoings, use, trading rights and restrictions. And they find that decisions on these leasing issues are made by the owners in the building.

These are the special risks that landlords and tenants face in a strata scheme.

This article covers four commercial leasing issues for strata shops, offices and industrial premises-

Building repairs
Tenant signage and fit-out
Strata Levies
Tenant use and trading

In a process designed to reform the strata law, the NSW Government has invited submissions from stakeholders affected by the strata law in a Strata & Community Title Law Reform Discussion Paper issued on 15 September 2012.

This article contains the submissions we have made to the NSW Government to address the leasing issues that landlords and tenants face when renting strata shops, offices and industrial premises.

Leasing Issue 1 – Building repairs

Most commercial leases require the landlord to maintain and repair the building - to keep the structure consisting of the roof, the ceiling, the floors, the external walls, windows and doors in a state of good condition and serviceable repair; and also to maintain the building in a structurally sound condition; and to maintain essential services. For example, clause 7.1 copyright Law Society Lease (NSW).

In a strata scheme, it is the (strata) owners corporation that owns the building - roof, walls, ceilings and floor (all as part of the common property). Under section 62 of the Strata Schemes Management Act, 1996, it is responsible to properly maintain and keep [the building] in ... good ... repair.

Therefore although the landlord has the obligation to repair under the lease, it is the (strata) owners corporation, as owner of the building fabric that is responsible to carry out the repairs. The landlord is at risk that the tenant can ask for a rent reduction or rent suspension if the (strata) owners corporation takes its time to carry out the repairs. The tenant’s ability to require the repairs to be carried out is unclear.

Water penetration is a common building defect. In Decision 2009/106 the Consumer, Trader and Tenancy Tribunal (NSW) (the “Tribunal”) ordered the (strata) owners corporation to repair the water pipes which were leaking above the ceiling of the premises. The Tribunal said that it did not matter whether the water came from the pipes, the unit above or elsewhere, the owners corporation was responsible to carry out the repair at its own cost under section 62 of the strata law.

Our submission is twofold. Firstly, that the strata law clearly recognises that the (strata) owners corporation is responsible to both landlord and tenant to maintain the building and to carry out the repairs as soon as practicable. Secondly, that the strata law make it mandatory that the (strata) owners corporation hold insurance to compensate the landlord for rent reductions and suspensions under commercial leases until the repairs are completed.

Leasing Issue 2 – Tenant signage and fit-out

Most commercial leases prohibit the tenant from making structural alterations, and require the landlord’s consent in writing for signage, fit-out and other alterations. At the end of the lease, the tenant must make good by restoring the premises to the state and condition it was first handed over, fair wear and tear excepted. For example, clauses 7.2.3, 7.6 & 12.3 copyright Law Society Lease (NSW).

In a strata scheme, the (strata) owners corporation must consent in writing to the fit-out if it affects the structure (the common property). Even minor and cosmetic alterations and installations such as signage, replacing light fittings, replacing ceilings, kitchen and bathroom renovations, installing security doors and grilles, wall and floor tiling, and painting require consent because they involve drilling into or affixation to the structure.

Model Commercial/ Retail Scheme By-law 3 sets out this requirement for consent and imposes on the owner (not the tenant) the obligation to maintain the installation in good repair; and to repair any damage caused when the installation is removed.

The procedure is that the landlord applies for consent on behalf of the tenant. Applications for structural alterations need to have an engineer’s report to accompany the application. When the consent is granted, the landlord is at risk of being held responsible by the (strata) owners corporation if the building is damaged and for failure to comply with applicable strata by-laws during the renovations.

Sometimes, it will be necessary to obtain permission to install items such as vents or an exhaust system on common property adjacent to the premises. In Decision 2011/277, the Tribunal said that it was reasonable to ask for a by-law for the exclusive use of the external wall of the premises to affix an exhaust fan and air filtration system for a restaurant. The Tribunal ordered a by-law, even though the (strata) owners corporation had opposed it. Such an exclusive use by-law will include an obligation on the person benefiting to maintain the items installed in good repair, and may be enforced by any lot owner (see Decision 2006/441).

Our submission is that the tenant be recognised by the strata law as being able to request consent for fit-out works from the (strata) owners corporation directly (with the landlord’s consent), and be responsible for damage and compliance with the applicable strata by-laws directly. This would align strata law with planning law, where the tenant makes the application to the planning authority with the landlord’s consent, and is directly responsible to the planning authority for approval and compliance. Our submission also is that the Model By-laws include a by-law for renovations.

Leasing Issue 3 – Strata Levies

Most shop leases and industrial leases require the tenant to pay outgoings, which for strata premises will include strata levies. There are two types of strata levies - the first is administrative fund levies for day-to-day expenses, including building insurance, cleaning and maintenance; the second is sinking fund levies (and special levies) to cover future capital needs for the building.

Tenants will usually not agree to contribute to the sinking fund levies, because the upkeep of the building is not their responsibility.

Our submission is that the sinking fund should remain separate from the administrative fund, and be designed to cover the section 62 responsibilities of building maintenance and repair. If there were one fund only, the landlord would be at risk that the tenant would refuse to agree to pay strata levies as a lease outgoing, because the levies would cover costs for which the tenant is not responsible.

Leasing Issue 4 – Tenant use and trading

Most commercial leases require the tenant to pay for utilities, if separately metered. Electricity, gas and communication lines are usually separately metered, but often water and drainage is not. The bills for utilities not separately metered are the responsibility of the (strata) owners corporation. The conflict that arises if the tenant has a business with a high water usage and drainage can be resolved by the installation of a meter.

Most commercial leases contain tenant use and trading provisions. These provisions allow access and car parking in specified places; restrict the tenant to a specified use; require the tenant to keep the premises clean and to dispose of waste properly; and to comply with strata by-laws and planning consents and licences. For example, clause 6.1 copyright Law Society Lease (NSW).

The strata law implies a covenant into a lease to comply with the by-laws of the strata scheme (section 44) which covers the same tenant usage and trading provisions. The Model Commercial / Retail Scheme By-laws and the Industrial By-laws (which are the same) deal with all of these requirements and restrictions, in much greater detail than a lease will normally contain. The (strata) owners corporation can enforce compliance with its by-laws independently of the lease.

The way that the (strata) owners corporation may decide to act to enforce the by-laws may not suit the landlord or tenant, particularly if the result is that they are forced to spend money or the tenant has no choice but to leave.

In Decision 2004/713, the Tribunal ordered the owner of a restaurant to upgrade the ventilation system to comply with current Australian Standards, failing which the owners corporation was authorised to disconnect the electric power supply to the system.

Our submission is that Notices to Comply issued by the (strata) owners corporation for breach of by-laws be addressed to both the landlord and tenant, and both have the right to respond; and the landlord be given the opportunity to deal with it under the lease. Also, the (strata) owners corporation should be required to notify the tenant of any proposed changes of by-laws, and give the tenant a copy of new by-laws as they are passed.

Footnote Watch this space! The NSW Government has set a timetable which extends until September 2013 to consider changes to the strata law, and to introduce legislation.

This article was first published by Cordato Partners in Lexology which is an international innovative, web-based service that provides over 200,000 company law departments and law firms around the world with a depth of free practical know-how on specialist areas of law .