Tackling conflicts of interest in commercial building renovation

By Yang Fan and Wu Hao, Leaqual Law Firm
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As one of the important forms of real estate, commercial buildings comprise a high proportion of the total of urban real estate. The long-term stable attributes of real estate make it impossible to carry out large-scale adjustments to the structure of buildings within a certain period, while the function of business districts requires buildings to serve new commercial attributes and meet new commercial needs.

Yang Fan, Leaqual Law Firm
Yang Fan
Senior Partner
Leaqual Law Firm

In addition, supporting facilities of real estate in popular business districts will depreciate faster than that of general premises due to a large amount of foot traffic and high utilisation rate, particularly in first-tier cities. Taking Beijing as an example, the government has explicitly banned the construction of new large commercial buildings within the Fourth Ring Road in its planning. All these factors require commercial property management to adjust strategies in a timely fashion, regularly rearrange business formats and update their building layouts.

An operator-led building renovation usually involves multiple commercial tenants whose lease terms vary in length, while the overall renovation plan must be carried out uniformly as scheduled due to constraints such as the construction time limit. Such different stances and demands may lead to an antagonistic relationship between the property owner and commercial tenants. For the operator, efficient handling of the relationship with commercial tenants is critical to timely reopening of the renovated property, so it is necessary to formulate a coping strategy in advance.

STRATEGIES FOR OPERATORS

Operators and their commercial tenants have established a leasehold relationship, but they may have signed multiple agreements with conflicts between them. Therefore, the first step is to review these agreements at the time of signing to make sure later agreements are as valid as amendments to earlier ones, and what rights and obligations the parties have ultimately established.

Second, it is necessary to review whether operators have reserved their right to renovate buildings based on the “overall interest”, and what obligations of the lessee are defined to ensure the exercise of such rights in these agreements. Usually, this right is one of the standard terms for the lessors and is also the basis for any subsequent discussions. Since this right significantly impacts the interests of the lessees, certain prerequisites should be met for its exercise.

Wu Hao, Leaqual Law Firm
Wu Hao
Associate
Leaqual Law Firm

(1) Effective implementation of notice obligation. The impact of overall renovation on the lessees is not just impaired efficiency and benefit, the most serious consequences could be closure and dissolution. To balance the interests of both parties, the lessors generally have an obligation to give advance notice, which is also a prerequisite for the lessors to fully exercise the right of renovation. Therefore, in such disputes, the timeliness of the notice, the clarity of its content, and the accuracy of the notified parties’ understanding and awareness of the specific impact will affect the conclusive judgment of cases.

Hence, before starting a renovation plan, major matters, including the renovation plan itself, should be clarified through a complete internal decision-making procedure, based on which the main content of the notice should be prepared, stating the lessor’s needs and the basis for its claim of renovation right, and listing specific co-operative measures that the lessees are expected to take. Meanwhile, it should be ensured that the notice is effectively served on the lessees and is made known to them.

(2) Proper attribution of liability for damage. Commercial tenants are not the direct beneficiaries of building renovation, which will reduce their expected earnings and impair their fixed-asset investment during the term of their lease. Theoretically, the lessors’ building renovation is the main cause of their commercial tenants’ loss. However, this is not entirely the case.

Reserving the right of renovation is a well-established business practice and a learned pattern for the lessors, in most cases corresponding to a concession of rights to the lessees in other terms. However, the background to the contract’s conclusion could gradually blur with time, thus, during the review, it is necessary to combine the investment promotion requirements over the same period and compare the different treatments provided in the same batch of commercial tenant contracts to get insight to the existence of any current losses due to unfavourable terms and conditions of contracts concluded in the past, which can be remedied in advance.

(3) Exclusion of suspicion of unenforceable standard terms. There is no doubt that lease contracts of the same property are basically similar in terms of content, especially in standard terms, taking a form that has to be adopted to balance demand and efficiency. Therefore, there could be suspicions of “unenforceable standard terms”.

However, in fact, an unenforceable standard term has three constitutive elements, which are not owned by all pre-defined and reused clauses. The key criterion to determine an unenforceable standard term is excluding the parties’ consensus to the contract. In judicial practice, clauses formulated with room for selection in the contractual content are generally not determined to constitute unenforceable standard terms.

REFLECTION AND SUGGESTION

In practice, in order to reduce the cost in time, the lessors often prefer to terminate the original lease through negotiation. However, for economic benefit, the negotiation should be based on a perfect litigation response plan formulated by the lessors.

Naturally, negotiations do not preclude the lessees from going back on their word to maximise their profits. Therefore, the conclusion of negotiations should be confirmed in the form of a supplementary agreement.

It is also important to keep a record of the negotiation process, and before the final document is signed it should be stated that all commitments are subject to the premise of the “unanimous agreement to the termination of the lease relations”, with the signing of the supplemental agreement as an effective condition.

Furthermore, the lessors are also suggested to make necessary amendments to those agreements that may be misunderstood as “unenforceable standard terms” according to the judicial judgment standards, to avoid expanding the scope of damages and increasing the project costs caused by such clauses.

Yang Fan is a senior partner and Wu Hao is an associate at Leaqual Law Firm

Leaqual Law Firm

12/F, Tower A, ZT International Center

10 Chaoyangmen South Avenue

Beijing 100020, China

Tel: +86 10 5365 2379
E-mail:

realwbl@163.com
justicesroh@163.com

https://www.lglawyer.cn/

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