When a business is sold or restructured, the existing commercial lease transfer can become one of the most complex, and expensive, parts of the deal. While the exchange of keys is simple, the exchange of legal liability is not. A frequently misunderstood issue that carries major financial consequences is the make good obligation.
The make good clause requires the tenant to restore the premises to a defined state, often the condition they were in before the original tenant moved in. When a lease is transferred, many tenants assume the liability resets, but this is rarely the case. Understanding precisely who holds this debt, and how to transfer it cleanly, is essential for both the incoming and outgoing businesses.
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Lease assignment: inheriting the full make good liability
A commercial lease transfer, or assignment of lease, is a mechanism where the existing tenant (assignor) transfers all their contractual rights and responsibilities to a new tenant (assignee). The original lease agreement remains in force, only the tenant party changes.
The principle of stepping into the original tenant’s shoes
The fundamental legal principle is that the new tenant, the assignee, takes over the lease as is. This means the assignee inherits the full, accumulated make good obligation, which often includes work required due to alterations, fit-outs, or damage caused by the assignor and any prior tenants.
The make good obligation is tied to the contract, not the occupant. If the contract requires the premises to be returned to a “bare shell” state defined by the original tenancy start date, that liability automatically passes to the assignee, regardless of how many tenants have occupied the space since. For the assignee, this can result in a significant, unexpected cost at the end of the term.
Why the original condition report is critical for the new tenant
The incoming tenant, the assignee, is liable for the condition of the premises relative to its state at the commencement of the original lease. If the premises were fitted out by the original tenant, and the lease requires its removal, the assignee is responsible for that demolition and restoration work.
This makes the original Entry Condition Report for the premises a critical document for the assignee. If this report is missing, the make good obligation can become ambiguously broad, opening the assignee up to excessive claims from the landlord who will likely default to the most expensive interpretation. Always insist on reviewing this report as part of the due diligence before executing a commercial lease transfer.
The financial risk for the incoming tenant (the assignee)
The financial risk for the incoming tenant is disproportionately high if the historical make good liability is ignored during the sale negotiation.
Since the assignee assumes responsibility for rectifying all historical alterations, they must fund the work required to remove all previous fit-outs and return the premises to the original base condition. In a typical scenario, the assignee pays a purchase price for the business and receives the property in its current state, but is then financially on the hook for the massive cost of dismantling all that existing infrastructure when their lease term expires.
For example, if the current fit-out cost $500,000 to install, the cost to remove and make good could easily exceed $100,000 at the lease end. This is a debt the assignee inherits simply by signing the lease assignment deed. Failing to quantify and factor this amount into the sale price is a common and costly mistake that specialists consistently see in make good disputes.
The continuing risk for the outgoing tenant (the assignor)
While the incoming tenant assumes the direct responsibility for the works, the outgoing tenant, or assignor, is not always free from risk.
When does the original tenant remain liable?
In many Australian jurisdictions, under the common law principles of property contracts, the original tenant (and their guarantors) remains secondarily liable to the landlord for all obligations under the lease for the remainder of the term, unless a specific, formal release is granted.
This means that if the assignee defaults on the make good obligation at the end of the term, the landlord may still have the right to pursue the original tenant (the assignor) to recover the outstanding costs. This continuing liability is particularly pronounced in general commercial leases, though retail lease legislation in many states provides better protection for the assignor, provided they follow the assignment process correctly.
The release mechanisms: novation vs. assignment
The only way for an assignor to guarantee a clean break from the make good liability is to secure a formal release from the landlord. This can happen in two primary ways:
- Deed of Assignment with Release Clause: The outgoing tenant must actively negotiate a clause within the Deed of Assignment where the landlord expressly releases the assignor and their guarantors from all future liability.
- Deed of Novation: A Deed of Novation is a tripartite agreement (between the landlord, the assignor, and the assignee) that legally extinguishes the old contract between the landlord and the assignor, replacing it with a new contract between the landlord and the assignee. This is the cleanest and safest way for an assignor to ensure they face no residual risk from the make good obligation years down the track.
The landlord’s role in the consent process
The landlord’s written consent is legally required to complete a commercial lease transfer. This provides the landlord with significant leverage to impose conditions that protect their interests.
During the consent process, the landlord will primarily focus on two things: the financial strength of the assignee and the make good obligation. They will ensure the assignment deed clearly passes all make good liability to the new tenant. They may also use the consent as an opportunity to demand a replacement bank guarantee or bond to cover the potential make good costs, ensuring they hold sufficient security against the new tenant. If the outgoing tenant seeks a release, the landlord may charge a premium or demand the outgoing tenant rectify existing breaches of the lease before granting the release.
Strategies to manage and quantify the inherited obligation
Effective management of the make good obligation requires both the assignor and the assignee to take proactive steps to quantify the liability and negotiate the financial handover.
Independent make good assessments: knowing the true cost
Before the sale price of the business is finalised, the most important step for the incoming tenant is to engage a specialist, like Makegoods.com.au, to perform an Independent Make Good Assessment.
This assessment:
- Interprets the exact make good clause in the lease.
- Compares the current condition against the original condition (as defined by the lease).
- Quantifies the precise cost to rectify all inherited alterations and damage.
This due diligence turns an unknown liability into a quantifiable figure, fundamentally changing the negotiation.
Negotiating an indemnity or cash contribution in the sale
Once the make good cost is quantified, the assignee should negotiate with the assignor to address it. There are two common solutions:
- Indemnity: The assignor provides a contractual indemnity within the sale agreement, promising to cover the cost of the inherited make good work at the end of the term, up to the assessed amount.
- Cash Contribution/Discount: The most common solution is for the assignor to provide a cash contribution to the assignee, or agree to a discount on the sale price, equivalent to the cost of the inherited make good liability. This allows the assignee to account for the future expense immediately, securing their position.
Secure a clean exit with Makegoods.com.au
A commercial lease transfer should facilitate a clean business transition, not a future financial disaster. Whether you are the assignor looking for a guaranteed release from contingent liability, or the assignee needing to accurately value the true cost of taking over the premises, specialist make good advice is non-negotiable.
Contact Makegoods.com.au today to secure an independent assessment.