Retail leases – what do demolition clauses mean for tenants?

Retail leases often contain demolition clauses which give landlords the right to terminate a lease and demolish premises if the landlord wants to carry out substantial repairs, reconstruction or renovation. Tenants can easily overlook such clauses, particularly if no proposal for demolition has been discussed. 

It is important however to understand the effect of demolition clauses as these clauses can leave a tenant without premises and with very limited compensation.

Application of the Retail Leases Act 1994 (NSW)

All demolition clauses in retail leases must be read in conjunction with section 35 of the Retail Leases Act, which sets out:

• the scope of what constitutes a “demolition” – which includes repair, renovation and reconstruction of part of a building

• the preconditions to termination for proposed demolition

• the limited circumstances where a landlord must pay compensation to a tenant.

When can a landlord terminate your lease for proposed demolition?

Under the Act, a landlord can only terminate a lease under a demolition clause if:

• the landlord can demonstrate to the tenant that it has a ‘genuine proposal’ to demolish the premises within a reasonable time of termination

• the proposed demolition cannot be carried out without vacant possession of the premises

• the landlord gives the tenant at least 6 months written notice (except where the lease term is 12 months or less, in such case this period is reduced to 3 months.)

What is a ‘genuine proposal’?

In the case of Wynne Avenue Property Pty Ltd v MJHQ Pty Ltd (2019) NSWCATAP 14, the panel considered what factors constitute a ‘genuine proposal’ for demolition, being:

• there needs to be sufficient details, but not necessarily every detail of the proposed demolition

• the exact date does not need to be specified, but demolition must take place within a reasonably practicable time period

• the commercial motivation of the landlord for demolition is irrelevant in determining whether the proposal is genuine.

Early termination by tenant

Once a tenant has received a demolition notice, the tenant can choose to terminate the lease earlier by giving the landlord at least 7 days written notice within 6 months before the proposed termination date, otherwise the lease will terminate on the date specified in the landlord’s demolition notice.

Payment of Compensation

In most cases, where a lease is terminated on the grounds of demolition, tenants are not entitled to any compensation except in the limited circumstances as set out under the Act. These are as follows:

• if the landlord terminates the lease but does not carry out the demolition within a reasonably practicable time, the landlord must pay reasonable compensation for damage suffered by the tenant as a result of the early termination, unless the landlord can prove that at the time notice was given there was a genuine proposal to demolish within that time (section 35(3))

• if the tenant was required under the lease to fitout the retail shop, the landlord must compensate for the fitout costs, whether or not the proposed demolition is carried out (section 35(3A)).

Compensation for fitout

Notwithstanding section 35(3A) of the Act, mentioned above, a tenant will only be entitled to compensation for fitout costs if the items cannot be removed, reinstalled or sold and the tenant suffers a loss as a result.

In Tabbouche Enterprises Pty Ltd v Cromwell Seven Hills Pty Ltd [2016] NSWCATCD 51, the decision of Harrison J in Softwash Castle Towers Pty Ltd v Queensland Investment Corporationwas considered in determining the compensation payable for fitout. It was considered that the value of plant or equipment installed as part of the fitout would be the value given to that item in the tenant’s financial, accounting and taxation records. If the fitout can be removed and reinstalled or sold and the tenant does not suffer a loss, the tenant will not be entitled to any compensation.

Disclosure of demolition in disclosure statement

The lessor’s disclosure statement, which must be given to a tenant at least 7 days before a retail shop lease is entered into, must disclose whether or not a proposed lease will contain a demolition clause.

If there are current proposals to demolish the premises at the time the disclosure statement is prepared, the landlord must disclose this information to the tenant in the statement.

Note however that even though a landlord may not have any current plans to demolish premises, a demolition proposal can arise at any time, even after the lease has been entered into.

Advice for tenants

Tenants should always check and obtain legal advice in relation to demolition clauses before entering into a lease, regardless of whether the landlord has any current plans to redevelop the premises.

Tenants should also be aware that if demolition is proposed, there are very limited circumstances for compensation and they may be left without premises and without compensation.

The inclusion of demolition clauses and the provisions regarding notice periods and agreed compensation in the event of demolition are things that can be negotiated with the landlord at the outset. It is important to ensure your lease reflects all agreements reached with the landlord as the Retail Leases Act only offers some protection.

It is always best to seek to delete any demolition clauses, however if a landlord does not agree, a tenant should always make further enquiries.

Tenants entering into commercial leases should be even more careful when agreeing to demolition clauses, as you will not have the protections offered by the Retail Leases Act.

Authors: Stella Stun

Contributing partner: Melissa Potter