Tenancy Agreement – the finer points to look out for before signing an Offer Letter and placing an earnest deposit
Before entering into a tenancy agreement, parties will typically sign an offer letter while both negotiate and set out in detail the terms that will govern their landlord & tenant relationship. The purpose of the offer letter is to set out and secure each parties’ promise to enter into an agreement, through payment of earnest deposit placed by the tenant (usually 1 month of the rental sum), which is usually prepared by a property agent.
Contrary to commonly held belief, what is material to be agreed upon at the point when the offer letter is signed is not just limited to the rental sum, period of tenancy, deposit sums and option to renew; there are other terms that tenants and landlords should consider before signing the letter, given that subsequent failure to enter into a tenancy agreement due to either parties’ inability to agree on the other terms may result in the defaulting party having to forfeit its earnest deposit and/or pay liquidated damages.
What are some key points or special terms to insert into an offer letter?
- Whether the letter clearly provides for the event that either party is unable to agree on the terms of the agreement
If no agreement is reached despite negotiating in good faith, the letter should provide that no liquidated damages is payable to either party due to the failure to execute a tenancy agreement.
What amounts to ‘good faith’ is of course arguable, but generally the negotiation should not breakdown due to disagreement on ‘non-material’ terms which, in the circumstances, have negligible effect on the agreement as a whole or are of a nature that a reasonable person would not disagree.
The offer letter should also clearly address the 2 possible scenarios and their respective consequences (including clear timelines) where EITHER the tenant OR the landlord decides not to sign the tenancy agreement.
- Right to terminate tenancy early
This right may be of importance in cases such as where the tenant is a company renting the property for its expatriate employee or to an expatriate employee signing as tenant directly. Problems may arise where the employee gets transferred to another location, and there are no other employees who will be housed in the premises. As such, from the tenant’s point of view, it is important to consider whether to negotiate for a right to terminate the agreement early in such a specific event, and to indicate such intention upfront in the offer letter in simple terms. In other situations, tenants may be caught off guard when the draft tenancy agreement contains onerous wording to the effect that the tenant shall not be able to terminate the tenancy early, and in doing so the tenant will be liable for the full unexpired term. This stressful situation can be avoided by negotiating upfront for the tenant to serve early termination notice (usually 1 to 3 months) or to pay rental in lieu of insufficient notice.
- Option to renew
Even though this is normally included in the letter of offer as a ‘standard clause’, what is often overlooked is the actual wording of the clause. For example, the option to renew is often worded as “subject to mutual agreement”, which is vague and does not allow for meaningful exercise by the tenant of the renewal right, if the landlord simply fails to agree to any term (especially the renewed rental sum). Depending on how important it is for the tenant to secure its contractual right to renew, this clause should therefore be read carefully to determine whether it can be exercised meaningfully. There is also a big difference between using the words “may” and “shall” in securing the tenant’s right to renew.
- Use of premises & approvals
While it is usually the tenant’s duty to ensure it obtains the necessary licenses or approvals to use the premises for specific purposes, tenants should set out their expectations early on in terms of the purpose for which the premises will be used. This is most relevant in a commercial context to avoid the situation where the tenant discovers that the premises is unsuitable due to, for example, the restrictions that were placed on the premises by by-laws set by the management of the building, or if the local authority disallows such business activity from being conducted. A commercial tenant should consider adding suitable wording or ‘provisos’ to ensure that it can terminate the transaction and get its earnest deposit back should such approvals not be granted through no fault of the tenant.
- Grace period for landlord’s repairs
Often times, the tenancy agreement will state that the premise is handed over to the tenant on an ‘as is where is basis’. The tenant may not have sufficient opportunity during the viewing session to test each and every appliance, fixture or fitting, and signs off on the offer letter only to discover multiple problems with the property upon moving in. The duty to repair certain parts of the property will be a common point of negotiation in the tenancy agreement. Regardless of the outcome of such negotiation, a tenant will be in a better position if it can include a specific ‘grace period’ (usually 1 month) after moving into the property, where any defects or need for repairs discovered can be alerted to the landlord for the landlord to fix at its costs.
The list above is not exhaustive and depends on the parties’ needs and what they consider to be material. While terms can be negotiated after the letter of offer is signed, the above approach saves both parties’ time as they can agree upfront on the terms which they are willing to accept/require, and are able to quickly move on and search for other deals should they fail to agree at the offer stage.
This article was written by Shawn Ho (Partner) and Adryenne Lim (Senior Legal Executive). Shawn leads the corporate practice group of Donovan & Ho, and has been recognised as a Notable Practitioner, whilst the firm has been recognised as a Notable Firm for Corporate and M&A by Asialaw Profiles 2020. We are also ranked as a Recommended Firm by IFLR1000 2020.
Our corporate practice group advises on corporate acquisitions, restructuring exercises, joint venture arrangements, shareholder agreements, employee share options and franchise businesses, Malaysian start-up founders, property and tax, and can assist with venture capital funds in Seed, Series A & B funding rounds. Feel free to contact us if you have any queries.