Issues on executing an immovable property lease contract

In addition to sales and purchase contracts and service contracts, an immovable property lease contract is common in daily operation and management of enterprises. Whether an enterprise leases commercial property for daily office purposes, or a plant or warehouse for production activities, it generally will invest a certain amount of funds into renovation of the property or purchase of facilities and equipment.

Early rescission of the lease contract, or failure to continue to perform it, undoubtedly will cause significant actual loss or expected profit loss to the lessee. How to properly manage and control the risks of immovable property lease contracts is a topic that an enterprise has to face in daily contract management.

Confirming the legality of the immovable property

Although a dispute over the ownership of the immovable property may not necessarily invalidate the lease contract, it may result in the inability to continue to perform the lease contract, or its early termination. The lessee is advised to check with the immovable property registration centre nearest to the place of the immovable property for consistency between the statement of the lessor and the actual ownership, and jus in re aliena prior to entering into a lease contract.

In practice, the lessee tends to make the mistake that the immovable property will be released from the jus in re aliena previously created over the leased immovable property once the landlord-tenant relationship is established between it and the lessor. According to the Property Law and the Provisions of the Supreme People’s Court on Several Issues Concerning the Handling of Enforcement Opposition and Reconsideration Cases by People’s Courts, the landlord-tenant relationship may precede over the jus in re aliena on the condition that the landlord-tenant relationship is created before the jus in re aliena (whether it is a mortgage created over the immovable property or a judicial sealing up of the immovable property). Otherwise, once the mortgagee or other obligee exercises its right to the immovable property during the term of lease, the lessee not only has no right to refuse surrender of the leased property, but also may face the risk of no compensation.

To ensure the validity of the lease contract, the lessee should first choose to enter into a lease contract with the owner of the immovable property before it considers entering into the lease contract with the owner’s agent and sub-lessor. If the lessee enters into a lease contract with the agent, it should request the agent to produce the evidence of related agency.

If the lessee enters into a lease contract with the sub-lessor, it should request the sub-lessor to produce the written consent of the owner to sub-lease, and specify as much as possible in the lease contract that if the consent to sub-lease is inauthentic, the sub-lessor should be liable for the breach (higher liquidated damages may be considered).

Determining the term of lease and conditions on priority for renewal

If the term of a lease contract expires and the lessor refuses to renew the lease, in judicial practice, the courts generally will not support the claim for compensation of such economic losses as renovation and furnishing expenses, and relocation expenses incurred by lease of the immovable property, which the lessee should predict when it enters into the lease contract, unless the parties specifically agree otherwise in the contract.

On this basis, if the lessee determines to renovate and furnish the immovable property, and purchase a large number of facilities and equipment when it executes the lease contract, it should avoid renewal of the contract on an annual basis (especially for operating lease) or consider specifying in the contract the conditions on priority for renewal when the term of lease expires.

In addition, if the lessee proposes to include a provision of automatic extension of the lease term in the lease contract, the specific length of the extension should be provided so that the lease will not be deemed indefinite in its term.

Determining the extent of damages resulting from early termination of the lease contract

First, renovation and furnishing for commercial purposes are generally believed to be a normal and reasonable operation of the lessee. If the lessee renovates and furnishes the leased property upon the approval of the lessor during the term of the lease, and early termination of the lease contract makes it impossible to continue to use the fixtures, which is the foreseeable loss of the lessee, the lessee has the right to claim compensation against the lessor for the residual value of these fixtures during the remainder of the lease.

Second, in the event of an operating lease, if the lease contract is rescinded early, the lessee undoubtedly will incur the loss of close-down and relocation of facilities and equipment. If the lessee is unable to relocate the facilities and equipment, or the facilities and equipment cannot be used again after relocation, the lessee will also incur operating losses.

In judicial practice, if the lessor knows or should have known that the lessee leased the immoveable property for business operations, it should be foreseeable at execution of the lease contract that early rescission of the contract would cause the lessee loss of close-down and relocation expenses.

There is no mandatory legal provision on the compensation standards for close-down loss and relocation expenses, which are generally determined by the lessee and the lessor through negotiation, or by a third-party institution jointly entrusted by the parties through evaluation if they fail to reach an agreement through negotiation.

Therefore, when a lessee enters into a lease contract, it is advised to specify the means to dispose of the renovation and furnishing fixtures when the term of lease expires or the contract is terminated early. If there is room for negotiation, it would be better that the definition of “fixture” is specified in the contract.

To ensure that its claim stands, the lessee should properly keep the written documents of the lessor’s consent to the renovation and reconstruction plans. Also, the lessee should properly keep the evidence of its operational input into the leased property during the term of lease, such as the renovation construction contract, purchase and installation contract of facilities and equipment, and corresponding documents of financial expenses.

Zhou Le is an associate and Wang Yuan is a paralegal at Tiantai Law Firm.

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