What is a ‘make good’ clause in a commercial lease?

If a tenant decides they will not be renewing their lease and plan to vacate the leased premises they occupy, they may have to consider their obligations to their landlord in respect of ‘making good’. Commercial and retail leases often have a make-good clause placing obligations on the tenant at the end of the lease.

The obligations set out in such a making good clause can include, for example, an obligation to return the premises in a good state of repair or reinstate them to the condition they were at the start of the lease or other specified conditions such as a ‘base building’.

Make-good clauses can lead to disputes when the parties have different understandings of what their exact obligations are especially when, for example, there have been costly fit-outs that have to be removed.

Tenants should review any make-good clauses carefully and negotiate any amendments before signing documentation. Landlords should ensure that the tenant’s obligations under the clause are clear so they are legally enforceable.

Types of Make-Good Obligations

Before signing a lease with a make-good clause, both parties should ensure the clause is clear to them, and they understand the obligations set out regarding the end of the lease. A make-good provision is negotiable. There are no limits on what obligations are to be included, but two common types are:

• to return the premises to the base building configuration;
• return the premises to the condition as at the commencement date or as detailed in a condition report commissioned on entry.

Why do disputes often arise regarding make-good clauses?

Enforcement often creates disputes where tenants are unwilling or unable to return the property to its pre-lease or other agreed state. Because of the lengthy timeframe that the tenant will have had possession, the tenant may have made substantial alterations to the property and when it is time to vacate may be reluctant to incur further costs. A landlord’s rights to enforce the obligations may turn on the wording of the clause.

Is a make-good clause enforceable?

Case law distinguishes between reinstatement and repairs:

(i) Reinstatement

Where a tenant fails to comply with its reinstatement obligations as to a specified condition, the landlord is normally only able to recover from the tenant damages relative to any reduction in value resulting from the tenant not undertaking the required reinstatement.  If there is no reduction in value, there may be no entitlement to damages. This might be the case where, for example, the landlord would demolish the premises or carry out redevelopment work.

(ii) Repairs

Where a tenant fails to comply with its end-of-lease repair obligations, the landlord will normally be able to recover in damages the amount it will cost the landlord to carry out the repair work.  In order to avoid a dispute the lease should clarify what the exact nature of any making good obligations are. Details might include the state of the premises when it was taken over, what state the premises should be returned to and what fixtures and fittings the landlord wants removed or kept. 

 In NSW, the intention contained in s133A of the Conveyancing Act 1919 is to make the position with regard to repair obligations much the same as reinstatement obligations so that a landlord cannot recover any more than the reduction in value of the premises caused by the breach.

What does it mean?

A ‘make good’ clause is a standard inclusion in many commercial, including retail, leases.

A make good clause determines what a tenant has to do with the leased property before it is handed back to the landlord at the end of the lease. If there is not a clear mutual understanding of the tenant’s obligations this can cause disputes.  Clearly it is important that both parties understand each other’s obligations.

 If you are a landlord it is a key clause you will wish to include in the lease. At the same time it cannot be assumed that if a tenant fails to comply with the make good obligations in the lease the landlord will automatically be entitled to damages. A landlord should not assume a tenant will be liable as following S133A and case law the tenant may only be liable for nominal damage.

A detailed condition report prepared by a third party taken at the start of the lease and accepted by both parties can assist in removing uncertainty and nasty surprises. The report might include photos and videos of the premises at the start of the lease.

If a landlord is unable to rent the premises because the tenant has failed to perform the make good obligations, the tenant may be liable for damages and compensation for the landlord’s lost income.

An appropriately worded provision may assist a landlord in recovering costs from the tenant where the tenant is pursuing an argument that the landlord has not suffered any reduction in the value by reason of its failure to perform its obligations. Similarly, a requirement that the tenant must continue paying rent until such time as it has complied with the obligations though the tenant may be able to argue the provision is unenforceable because it infringes the law regarding contractual penalties.

Tenants should try to ensure the relevant provisions do not require it to pay costs of repair or make good works when the landlord themselves would not be carrying out such works.  This might be the case, for example, if the premises are to be redeveloped or demolished or a new incoming tenant would be happy to take over the premises as they stand.

Contact our Commercial Property and Disputes Lawyers based in Sydney, NSW

At Szabo & Associates Solicitors we can assist with drafting and reviewing commercial and retail leases. We also have a property disputes team with wide breadth of experience in dealing with property disputes. Please contact us 02 9281 5088  or complete the online contact form.