An option is not a right to stay. It is a right to say so, on time.

An option to renew often decides what a tenancy is worth, and it is the clause least likely to be read until the year it matters. It is not a right to remain in the premises. It is a right to require the landlord to grant a further term — if it is exercised in the way, and within the window, the lease sets out. We act for landlords and for tenants on commercial premises and on retail premises, though never for both parties to the same lease.

What an option actually is

In substance the landlord has made a standing offer of a further term and the tenant holds the right to accept it. Until it accepts, there is no further lease. On valid exercise, a binding agreement for the further term arises on the terms the clause specifies — usually the current terms, without the option just used, and with rent set by the mechanism nominated.

Because it works that way, exercise tends to be all or nothing. A notice that is late, sent by the wrong means, given by the wrong entity, or given while a condition is unmet does not partly work; it generally does not work at all.

Time, form and manner

Option clauses almost always fix a window — not earlier than one date, not later than another, both counted back from expiry. Time is generally treated as being of the essence for the exercise of an option, so a tenant who gives notice after the window closes is usually in the position of one who gave no notice at all.

Form and manner matter as much, and they usually live in the lease’s notice clause rather than the option clause:

• Writing, and the right words. Some clauses require the notice to cite the clause or state the term being taken up. An enquiry about renewal is not an exercise of the option.
• The right recipient. The landlord named in the lease may no longer own the building, and notice to a managing agent may or may not reach the landlord in law.
• The permitted means. If the lease allows post and personal delivery, email is a risk. If it allows email, check the nominated address.
• Deemed service. A posted notice is usually deemed served some days after posting. The deemed date, not the sending date, has to fall inside the window.
• The right entity. The tenant named on the lease, not a related company or a trading name, signed by someone who can bind it.

The no-breach condition

Most leases make the option conditional: no subsisting breach at the date of exercise, and often no persistent breach during the term. Late rent is the usual candidate, and a tenant current on the day but persistently late before it can still find the point taken against it.

The condition is not absolute. The Conveyancing Act 1919 (NSW) contains provisions dealing specifically with options in leases. Broadly, they restrict a lessor’s ability to rely on a breach to defeat an option unless a notice specifying the breach is served within a short period after the option is exercised, and they give a court power to grant relief in defined circumstances. Both are technical, and both carry time limits.

On a retail lease, the landlord has to remind the tenant

Not every shop lease is a retail shop lease: whether the Retail Leases Act 1994 (NSW) applies turns on the definition in the Act, and that is worth settling first.

Where the Act does apply — and it applies to a great many shop leases — the landlord must notify the tenant in writing of the last date for exercising an option, within a window ahead of that date. If the notice is given late, the last date is extended, with consequences for both sides that can include a right for the tenant to bring the lease to an end. The provision exists because tenants miss options, and it shifts part of the consequence onto the landlord who stayed silent.

What the rent will be

Rent on renewal is set by the clause, and the three common mechanisms behave very differently:

• Fixed. A stated amount or percentage increase. Certain, and capable of being badly wrong for either side by the time it bites.
• CPI. Indexed movement, tracking inflation rather than the property market. The two can diverge for years.
• Current market rent. The parties try to agree; failing agreement, a valuer determines it.

A market review usually runs to a set pattern: notice of a proposed rent, a period for agreement, and failing agreement a valuer appointed by the parties or by a nominated body. The valuer determines rent on the assumptions the lease or the Act sets out — commonly treating the premises as vacant and available for the permitted use — and the determination generally binds both sides.

Retail leases are further constrained by statute — including how a valuer is appointed where the parties cannot agree, and the treatment of review provisions that can only move rent one way. There is also a route for a retail tenant to have market rent determined before deciding whether to exercise, so the option need not be taken blind. It runs to its own timetable and has to be requested in time.

What a landlord should do on receiving an exercise

1. 01 Fix the date it was received

   Against the window in the clause, and against the deemed service provision if it came by post. Receipt is usually the whole question.

2. 02 Check the notice itself

   Correct tenant entity, proper execution, right recipient and address, permitted means, and any wording the clause requires.

3. 03 Check the conditions and the clock

   Any breach you intend to rely on, and whether a notice specifying it has to be served within a short period after the exercise.

4. 04 Respond, and do not drift

   Accepting rent for the further term, or acting as though renewal is on foot, makes it harder to argue later that the exercise was invalid.

A defective exercise is not always fatal. A landlord may accept it, the parties may negotiate a fresh lease, and on a retail tenancy the notification provisions may still be running. But a tenant’s position after a missed option is nothing like its position before, and the difference is measured in rent. Diarise the window when the lease is signed.