Australia: Do you have permission? Navigating "permitted use" in a lease

When committing to a lease, a tenant usually has in mind the purpose for which the premises will be used. However, this does not always lead to an appropriate statement of the "permitted use" in the relevant lease.

The permitted use is often no more than a few words in a lease, but it is an important commercial term that parties need to consider in balancing their competing interests. Usually tenants prefer to have a broad definition which will allow a range of activities to be carried out, while landlords will often aim to be more prescriptive in order to maintain control over both the use of the premises and the tenancy mix within their building or centre.

In last month's article we discussed the need for both landlords and tenants to take care when considering whether a permitted use is intended to be an "exclusive use". In this article we share why it is also important to properly define the permitted use itself.

Why is the scope of the permitted use relevant?

1. Future assignment

Having a highly restrictive permitted use may affect the tenant's ability to assign the lease in future, if the landlord is not prepared to agree to any change to that use.

While this may not be too much of an issue in a commercial context as the permitted use is usually described as "commercial offices" or "office use", it may be very relevant in a retail complex where a landlord has a strong desire to maintain a certain retail mix or to exclude certain types of businesses from operating.

2. Market rent review

The market rent review clause may refer to a determination being based on the specific permitted use nominated in the lease. If the particular use is very prescriptive, a lower market rental may result.

Both parties should consider the impact of the permitted use on any market rent review provisions in the lease. The landlord may consider whether the permitted use should be described in wider terms (for the purposes of the market rent review), or alternatively ensuring that the market rent review provision takes into account the best use to which the premises could be put, rather than the stated permitted use.

3. Infringing on an exclusive use

Where a landlord grants a tenant an exclusive use within a building or retail centre, care should be taken in describing uses which are permitted in each successive lease in that building or retail centre.

This can be a particularly complicated issue in a retail context. For example, if a landlord has granted an exclusive use to a tenant for "the sale of men's clothing and fashion items", would another tenant who is proposing to operate a "shoe shop" be infringing on that exclusive use? What about another tenant who proposes to sell "Australian souvenir items including sports jerseys, t-shirts and hats"?

It can also be an issue in a commercial context. Consider a landlord who has leased a number of floors in a commercial building to a banking tenant who also operates a branch on the ground floor. In the lease, the landlord has agreed that "whilst the lease to the bank is current, the landlord will not lease any other premises within the building to another tenant for the purpose of carrying on banking activities". What if that landlord receives a lease proposal from a prospective tenant which describes the permitted use as "commercial offices" but the landlord knows that the proposed tenant operates a financial advisory and broking business? Is that likely to infringe on the banking tenant's rights?

Landlords should take care in both drafting exclusive uses, and in granting subsequent leases to other tenants who propose similar (but not identical) use.

4. Bringing the lease under the retail leases legislation

The retail lease legislation in most Australian jurisdictions covers all tenancies within a retail centre. However, the legislation can also extend to stand-alone premises and non-retail type premises where the permitted use under the relevant lease is a "retail use" as prescribed by the legislation.

Take, for example, a small commercial building containing primarily office space. One of the tenancies is occupied by a book trader who does not have a traditional shop front but carries on the business of selling highly specialised antique books to exclusive clients. Even though the tenancy is not open to the public and operates more as an office than as a shop, the Retail Leases Act 1994 (NSW) (RLA) includes a "bookshop" as a prescribed retail use, and so it is possible that the tenancy would fall under the RLA, despite the nature of the building and the type of other tenancies within it.

Another example could be where a prospective tenant intends to use stand-alone premises for a "tattoo and piercing parlour". Under the RLA, "beauticians", "beauty shops", "beauty therapists", "cosmetics shops", "jewellery shops" and "nail shops" are all prescribed retail uses, but there is no mention of tattoo or piercing shops. Could that use properly fall within the description of one of those other uses?

Often the issue of whether or not a tenancy is caught by the RLA is not straightforward, particularly where the permitted use description is ambiguous as to whether it is a prescribed retail use as defined under the relevant legislation. One way that this has been resolved in the past is to determine the predominant use of the premises. In the example above, if the main revenue of the shop is actually derived, not from the piercing services, but from the sale of the jewellery associated with those services, then perhaps the actual permitted use is as a "jewellery shop" (which is a retail use).

If there were a dispute, a Court would generally look at the permitted use as stated in the lease, and so it is important to have a clear description. Where the description is unclear, the Court may have regard to, and analyse, the actual use.

5. Permitted use with a liquor licence

Another area where consideration of the permitted use is also particularly relevant is when the use may include a liquor licence.

As a starting point, the landlord should consider whether it will, in fact, allow a use which would permit the consumption or sale of alcohol at the premises. If the landlord is open to such a use, at the time the lease is being negotiated the parties should decide who will actually own and control the liquor licence, rather than simply including "licensed premises" in the permitted use description.

In most cases the tenant will be the licence owner and the landlord will have little control over the liquor licence (other than to specify the permitted trading hours and include an obligation on the tenant to comply with the relevant licensing legislation). The landlord may, however, wish to specify certain requirements regarding the transfer of the liquor licence, including that the licence is to be transferred to the landlord or its nominee when the lease ends.

6. Uses in an industrial context

In an industrial context, landlords should give thought to the breadth of the description that they are prepared to allow for the permitted use. Simply describing a permitted use as "any industrial use permitted by the local authority" may open the gates for the tenant to commence a heavy or bulky use (as permitted under the relevant planning instrument), which may not be attractive to the landlord.

While the landlord is likely to be protected by the usual lease covenants that the tenant must maintain all necessary licences and approvals and must carry out the use in accordance with relevant laws, it may be that, had the landlord known the full details of the tenant's intended use, the landlord would have included some restrictions or qualifications in the lease.

Key take aways

When a lease is being negotiated, landlords should consider whether the description of the permitted use:

• is sufficiently prescriptive or if it is too general
• may potentially impact any market rent reviews
• could be interpreted widely and potentially impact on an existing exclusive use
• could bring the lease under the retail leases legislation
• should be described in narrow terms (for example, in a retail context, specifying the exact menu items that can be offered or the specific type of goods that can be sold from the premises).

When a lease is being negotiated, tenants should consider whether the description of the permitted use:

• is broad enough to adequately cover their core business and any ancillary activities
• will impact their ability to assign the lease or sublet the premises.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.