Licences to Occupy: A viable alternative to Leases?

22/12/2020

Property Law

Licences to Occupy: A viable alternative to Leases?

COVID-19 has created a lot of empty buildings - There is a solution!

Many a good business idea has died on the hill of “too much effort”. This is no disparagement of the businessperson-in-thought-only; there are plenty of roadblocks to establishing a new business - time, money, physical and mental fatigue, risk etc.

Another roadblock is finding the right location. Whilst physical premises may be less important for the ever increasing catalogue of online-based businesses, for the vast majority of brick-and-mortar shops, having the right place, at the right time, on the right terms, and for the right length of time remains vital.

In light of this, strange as it may sound, now might be the best time to start or expand a business.

Amongst the many by-products of COVID-19 has been its impacts on the property market. Granted, much of the media attention on the property market during COVID-19 has focused on the residential context, though the retail property market has shared much the same trends. Retail vacancy rates spiked dramatically upwards in the first half of 2020, reaching upwards of 10.0% in CBDs across Australia. Whilst vacancy rates had been secularly trending upwards across both CBD and regional retail spaces since 2010, the market is now carrying more spare capacity than at any time in the previous 25 years.

Figure 1 (Source: RBA)

It is no longer a landlord’s market. Admittedly, retail rental prices have shown a tendency to be “sticky”; that is, they are often not all that responsive to oversupply and high vacancy rates, with landlords preferring to wait out such periods for occupants who will eventually match their rental demands, rather than to risk revaluation of their property on account of lowering rental demands.

That said, the severity of market conditions have shifted the impetus onto landlords to be flexible as to occupancy arrangements, in order to better attract occupants. And with talks of a vacancy tax having been mooted in 2019, in recognition of a problem evident well before COVID-19, soon it may well be that the law also compels landlords to find occupants. In any case, speaking from my own experience, prior to COVID-19, I had never seen “For Lease” signs openly admitting a willingness to accept “pop-up” occupants.

The advantage of such a shift in market dynamics also accrues to existing businesses. The US particularly, has seen many businesses renegotiate the terms of their lease; it is not just the “hardest-hit” businesses that have enjoyed the benefit of rent reductions. Threatening to terminate an existing lease is a genuine threat in negotiations where there are net benefits to a business in terminating and finding a new location.

Moving Away from Leases

So, how might a prospective entrepreneur or existing business capitalise on the relative position of strength they find themselves vis-à-vis landlords?

Perhaps by giving serious thought to the use of a licence to occupy, over its more widespread incumbent cousin, the lease.

A lease is often quite a significant obligation for a business. It is both a financial commitment, and a time commitment. Traditionally, a business would look for security of tenure, and a landlord for a long-term tenant. The lease was an appropriate arrangement suiting the needs of both parties equally.

However, an insistence on occupancy by way of a lease on the part of landlord prevents businesses from engaging in more experimental ventures. With smaller or newer businesses particularly, risks cannot be taken with their business model when they have rent to pay for the coming fortnight; and so rental obligations may push them into a certain conservatism with their business, a reluctance to try different things and be different, for fear of insolvency.

A licence to occupy goes some way to reduce such risks. A licence affords an occupant may of the same rights as a lessee; in fact, a shopper would be hard pressed to find a discernible difference between a shop occupied through a licence and a shop occupied through a lease. Importantly, though, licences are, in general, a much simpler form of agreement to give legal effect to, making them more cost effective as well as more appropriate for short-term occupancies. There are other legal distinctions between the two, and we have included a table below to summarise their key differences:

Table 1 - Licence to Occupy and Leases Comparison Table

Despite the identifiable differences listed above, the High Court of Australia in Radaich v Smith (1959) 101 CLR 209, was keen to note that the determinative element as to whether an agreement gives rise to a lease or a licence is exclusive possession. Where an agreement confers on the occupant a right to exclusive possession, the law will classify that agreement as a lease, even if the agreement purports to be a licence.

As per Taylor J at 217: “It will be seen that I have treated the question in the case as concluded by the fact that the instrument conferred upon the appellant the right to exclusive possession for the specified term. And, it seems to me, that where, as in cases such as the present, it becomes necessary to identify a particular transaction as either a lease or licence this factor must be decisive.
As per Menzies J at 220: “… what I regard as decisive in favour of its creating the relationship of landlord and tenant is that it gives the “licensee” the right of exclusive possession.
As per Windeyer J at 222: “What then is the fundamental right which a tenant has that distinguishes his position form that of a licensee? It is an interest in land as distinct from a personal permission to enter the land and use it for some stipulated purpose.

The other differences noted in Table 1 are, effectively, consequences that flow from the lack of a possessory interest for licensees; the flexibility of licences, or their better fit for short-term agreements is a symptom of the fact that a licensee is not given an interest in land, but only a right to use it.

Circumventing Retail Lease Legislation

To the businessperson, the more important difference may well be the commercial advantages a licence can have over a lease in particular circumstances.

Retail lease legislation across the states and territories of Australia treat leases and licences synonymously; that is to say, retail licenses can attract the application of the retail lease legislation in every state and territory listed below:

ACT - Leases (Commercial and Retail) Act 2001 (ACT)
NSW - Retail Leases Act 1994 (NSW)
NT - Business Tenancies (Fair Dealings) Act 2003 (NT)
Queensland - Retail Shop Leases Act 1994 (Qld)
SA - Retail and Commercial Leases Act 1995 (SA)
Tasmania - Fair Trading (Code of Practice for Retail Tenancies) Regulation 1998 (Tas)
Victoria - Retail Leases Act 2003 (Vic)
WA - Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA)

Importantly, however, each of the above Acts (with the exception of Tasmania and Western Australia) provide for an exemption from application for short-term retail leases (and licences). The table below summaries state by state, when such an exemption will apply:

Table 2

These laws exist, in part, for the purposes of protecting the interests of businesses. Deliberately trying to avoid their application would not be advisable in most circumstances. However, given how onerous some of their provisions can be, they are often an impediment for both landlords and prospective short term business occupants.

Hence, where a business requires flexibility, minimal compliance costs, or is otherwise looking only to operate for the short term, it may well be advantageous to escape the application of retail lease legislation by forming an agreement that falls within the short-term exception period for a given state/territory.

A preference for licences over a lease is informed by similar considerations of flexibility, costs, and short-term need; there are, in general, fewer hoops that need to be jumped through to make a licence work as compared to a lease. The execution of a licence to occupy (where an adequate template may be found) may not require much intervention from a lawyer. In comparison, a lessee looking to properly enjoy the benefits of a lease (such as exclusive possession) may well find themselves having to go additional paperwork such as for registration of their possessory interest.

The Pop-up Shop and the Possibilities of a Licence

Understandably, you may not be looking to test out ideas for the short term; maybe your particular business idea is reliant on goodwill and integration into the community that comes with having fixed, long term premises. Or maybe the capital outlay needed to get your business up and running just doesn’t work well with short term - it wouldn’t make much sense to set up a fully featured bowling alley or swimming pool as a pop-up shop. The licence is not a suitable alternative to the lease in all instances.

But for an entrepreneur looking perhaps only to test out a business idea for a couple of months, or capitalise on a fad / seasonal spike in demand, it is usually going to be faster and more cost effective not to have get bogged down with all the formalities of a lease. And as pointed out in this article, short-term licences can figure in the long-term planning of a business, especially for businesses which experience predictable peak and off-peak cycles.

So we have seen with the relatively recent proliferation of the pop-up shop. Pop-up shops are temporary retail spaces, operational only for a short period of time by design. They can range from days at the shortest to several months, though of course a landlord and a business may be happy to keep up a temporary shop front for longer (how long is a piece of string?).

The brevity of pop-up shops often translate to lower initial investment costs to get started; a business does not need to make investment into permanent fixtures without a permanent home.

Additionally, pop-up shops can often occupy non-traditional retail spaces. Given occupancy happens by way of a licence, the landlord of a shopping centre is free to contract out rights of use to areas such as walkways, where it would not make sense to give a right of exclusive possession, as with a lease. This can mean lower rental costs for occupants.

But COVID-19?

Of course, none of the preceding can take us away from the fact that the seismic changes in the retail property market are very much the product of an economy ravaged by COVID-19. For many businesses, no abundance of retail space options can compensate for depressed levels of consumer demand. In the March 2020 - June 2020 quarter alone, Australia’s GDP fell by an incredible 7.0%, and retail turnover by 3.5%.

Figure 3 (Source: ABS)

On the other hand, more recent statistics look far less dire. GDP growth in the quarter ending September 2020 has bounced back to 3.3%, which is still ways below pre-COVID levels of activity, but nonetheless provides some welcome reassurance as to the 7.0% regression in the quarter prior being something of an anomaly. Yet more encouragingly, turnover for retail businesses not only recovered from its dip in April 2020, but a strong (if inconsistent) month on month growth has translated to stronger "through the year" turnover growth when compared to 2018 or 2019 (though there is some suggestion this was largely driven by turnover growth for large businesses, with turnover for smaller businesses being somewhat stagnant). Retail was hurt by COVID-19, but the way it bounced back suggests the pandemic did little lasting damage.

Monthly Turnover
Figure 4 (Source: ABS)

Conclusion

Not every business will benefit from a licence to occupy. The licence is an instrument that works in specific situations, particularly suited to address the current retail vacancy problem as Australia continues its recovery from COVID-19. It is not a solution for a business looking for firm foundations, but is a device more than sufficient for businesses looking to gauge the viability of their ideas, or launch a new product, looking to get operational as soon as possible.

If you are a prospective entrepreneur considering setting up a pop-up shop, or a landlord needing to occupants even if only for the short term, please do not hesitate to interact with out online portal / get in contact with us.

Further learning:

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Credits:

This article was written by Suk Jae Chung | PLT Placement, Blue Ocean Law Group℠.

Cover Image:

Photo by Mike Petrucci on Unsplash.

Important Notice:

This article is intended for general interest and information only. It is not legal advice and nor should it be relied upon or used as such. Always consult a lawyer for specialist advice specific to your needs and circumstances.