// Social Icons // Caden Icons

The Importance Of Your Covenant In A Commercial Office Lease

Proving your commercial office lease covenant is a step in the leasing process that landlords may take to ensure the financial stability of a new tenant.
The following information is provided to assist businesses in understanding the task and processes associated with proving their covenant. Proving your commercial office lease covenant is a step in the leasing process that some landlords will take in order to ensure that the incoming tenant has the right financial foundations and history to meet its pending rental obligations ongoing.

A lease agreement presents itself as one of the largest overhead costs required of a business across its lifetime. With this commitment comes a legal obligation to fulfil the financial requirements expected of the business during the course of the lease.

On the other hand, a lease commitment is in equal measure a significant commitment for the Landlord. Building owners are required to continually service the ongoing needs of their tenants throughout the duration of their lease to ensure all terms uphold the advertised product, but to also continue to be attractive amongst other competing assets within the market. This requires the asset to not only be continually serviced but also maintain compliance with the expectations set and agreed to by both parties throughout the lease. Landlords also bear the risks associated with committing funding towards fit outs for new incoming tenants. For this process to be successful it is absolutely essential landlords retain the necessary securities to ensure their investment is protected, including ensuring new business covenants are reliable.

Fundamentally, proving your covenant is a process that the Landlord may require prior to executing an agreement. The proper execution of this component will satisfy the following two (2) items:

  • Landlord – Satisfy their expectations that the tenant/business is able to pay its rent and other financial duties throughout the lease;
  • Tenant – It may provide the tenant with a greater scope for negotiations, given their sound financial history.

The strength of your covenant will also have a large effect on the security period of your bank guarantee. The bank guarantee can be reduced to a shorter period, ensuring there is less sunk capital, however, is achievable on a case by case basis.

Proof of Financial Performance

In order to prove your covenant, financial statements for the preceding two (2) years are required as the nominated practice to show recent business performance. These must be ATO approved documents. In differing circumstances, the Landlord reserves the right to request a longer statement period of authenticity to ensure that their expectations and reservations have been met in specific circumstances. Should your financials not meet the requirements of the Landlord, the tenant may be liable to put in additional directors guarantees which are subject to each lease.

Businesses that are acting start-ups or subsidiaries will not be able to negotiate certain terms without authentication of performance for previous financial years – which for the former is largely unachievable, leaving them with little room for flexibility. Subsidiaries, however, may rely on parent companies acting as a guarantor for their liabilities by presenting the same documents of proof.

Bank Guarantee

The Bank Guarantee acts as the sole form of security a Landlord has against the business during the lease. The Guarantee is provided by the tenant to the Landlord with a number of conditions to ensure it meets the fair representation required to establish confidence between parties. These conditions for the Bank Guarantee include:

  • The Guarantee is to be made out in favour of the Landlord;
  • Illustrates the agreed period of security;
  • Certified by a recognised Australian Bank; and
  • Should have no expiry period listed.

The Guarantee may be actionable in the event a business is unable to fulfil the following:

  • Meet its financial obligations (e.g. pay rent); and/or
  • Unable to cover damage/make good costs post lease expiry.

A business that is able to provide sound financial records will afford itself the ability to negotiate reduced guarantee periods. While this is not definite and is subject to a case by case scenario’s, successful results of late have seen businesses secure anywhere between 1 to 3 month deductions on the standard 6 month requirement.

Additionally, substantiating the financial competency of the business will play a significant role in determining a successful applicant for office space. In the event that there are multiple interested parties in one (1) tenancy, the Landlord will scrutinise each aspect of the following criteria to choose the best-suited party:

  • Competitive deal parameters (i.e. agreeable rates, suitable commencement date);
  • Historically financially sound; and
  • Responsiveness to the execution of documents.

Furthermore, businesses that perform well in their first term within a building will have greater say in discussions and possible negotiations when lease expiry or renewal occurs. Should the business intend on remaining within the current building and forgoing a relocation to another asset, the Landlord will consider the performance in the initial term and seek to improve the business’s lease parameter’s within the asset on a secondary lease term to retain the tenant.

In essence, proving your covenant as a sound and robust entity is not only of benefit to the Landlord’s interests but also to that of the business going forward. The process creates a line of transparency between the two entities that acknowledge their abilities to perform their duties in full, and subsequently develop a foundation of trust. The Landlord’s concerns are satisfied, and the tenant’s scope of negotiation is expanded. As a result, both parties are therefore more amiable in discussions and are able to establish a relationship that will better suit their combined interests going forward.

Not sure how much office space you need? Our calculator could help.