Are lease make-good provisions enforceable? Costs of repair or reinstatement

Typical make-good provisions

Commercial leases usually contain provisions requiring the tenant to make good the premises at the end of the lease.  There is no limit on the extent of the obligations that can be covered, but common examples are:

• An obligation to hand back the premises in good repair; or

• An obligation to reinstate the premises to the condition that they were at the start of the lease; or

• An obligation to reinstate the premises to a specified condition such as “base building”.

Disputes about make-good obligations are common.  Tenants should review make-good provisions carefully and negotiate required amendments and clarifications before they sign leases.  Landlords should ensure that the obligations of the tenant are sufficiently clear as to be legally enforceable.

What if the tenant fails to make-good

It might be assumed that if a tenant failed to comply with the make-good obligations in the lease at the end of the term, the landlord would automatically be entitled to recover as damages the amount it would cost the landlord to perform the tenant’s make-good obligations.  However, the legal position is not that simple:

• The case law distinguishes between a tenant’s obligation to carry out repair works and a tenant’s obligation to reinstate premises to a specified condition at the end of the lease.  Where a tenant fails to comply with reinstatement (rather than repair) obligations, the landlord is normally only entitled to recover from the tenant as damages the reduction, if any, in the value of the premises resulting from the failure to carry out the reinstatement works (James v Hutton and J Cook & Sons Ltd [1950] 1KB9;[1949] 2 All ER 243).

• If in fact the failure to carry out reinstatement works does not result in any reduction in value, then the landlord is not entitled to damages for breach of the reinstatement obligation.  Evidence that a landlord intended to demolish premises, or to redevelop them, could be given to demonstrate that a landlord had not suffered any reduction in value.

• Under common law, where a tenant fails to comply with repair (rather than reinstatement) obligations at the end of the lease, the landlord will normally be entitled to recover from the tenant as damages the amount that it would cost the landlord to carry out the repair works (Joyner v Weeks [1891] 2 QB 31).

• In New South Wales, section 133A of the Conveyancing Act, 1919 was enacted to address what was thought to be the unfairness to tenants of the case law in relation to failure to carry out repair obligations at the end of a lease.  This section was intended to make the position in relation to repair obligations the same as the position at common law in relation to reinstatement obligations and is to the effect that a landlord cannot recover from a tenant for breach of a repair obligation any more than the reduction, if any, in the value of the premises resulting from that breach.

Take-home points

Take-home points from the above include the following:

• Landlords and tenants should consider whether make-good provisions should include a right for either or both parties to elect that the tenant’s make-good obligations be settled by the tenant paying the cost of the make-good to the landlord at the end of the lease.

• For the landlord, an appropriately worded provision may assist the landlord in recovering the costs from the tenant where the tenant is arguing that the landlord has not suffered any reduction in value by reason of the tenant’s failure to perform its obligations.

• On the other hand, the tenant should ensure the relevant provisions do not require it to pay costs of repair or make-good works where the landlord would not be carrying out such works (for example where the premises are to be demolished or redeveloped, or an incoming tenant would be happy to take over the premises without repair or make-good works).

• A provision to the effect that the tenant must continue paying rent until it has complied with its make-good obligations may assist the landlord.  Tenants should resist the inclusion of such provisions.  Depending upon the circumstances, a tenant may be able to successfully argue that the provision is unenforceable because it infringes the law against contractual penalties.

• Landlords and tenants, and their advisors, should not assume that a tenant will be liable for substantial damages if it breaches lease make-good provisions.  Under section 133A of the Conveyancing Act, or relevant case law, the tenant may only be liable for nominal damages.

 Author: Jack Gordon

Contributing Author: Melissa Potter