Reviewing an Office Lease: Termination, Restoration and Deposit Deductions to Check Before Relocating

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

When a company starts considering an office relocation or expansion, two different schedules are usually running at once. One is the desired move date, worked back from signing the lease for the new office and arranging the interior fit-out. The other is the termination notice period set out in the lease for the current office. Unless the two are managed together on a single schedule, the company may find that it cannot terminate in time for the desired move date, or that the deadline to vacate the current office approaches before a new office has been secured.

Reading an office lease with the same assumptions as a residential lease can lead to unexpected pitfalls, because the legal mechanisms that strongly protect tenants are more limited than for residential leases. It is important to check the termination notice, restoration and the settlement terms for the security deposit or guarantee deposit carefully, in line with what the contract actually says.

The Binding Force of Business Lease Terms

Article 2 of the Consumer Contract Act defines a "consumer" as an individual (except where the individual becomes a party to a contract as a business or for the purposes of a business) and a "business operator" as a corporation or an individual who becomes a party for the purposes of a business. An office lease taken by a corporation is a transaction between business operators, so it is not a consumer contract to which the Act applies.

For this reason, the argument often used in residential leases, that a special clause unfavorable to the tenant is void under Article 10 of the Consumer Contract Act, basically does not work for office leases. Even if the contract contains special clauses unfavorable to the tenant, as a rule they are readily given effect as written.

Ending an Ordinary Lease and a Fixed-Term Lease

Office leases broadly fall into two types: ordinary building leases and fixed-term building leases. The distinction has a major bearing on whether the lease is renewed and on how the lease can be expected to end.

Under an ordinary building lease, Article 26 of the Act on Land and Building Leases provides that if neither party gives notice of non-renewal between one year and six months before the term expires, the lease is deemed renewed on the same terms as before (except that it has no fixed term). In addition, the landlord may refuse renewal or give notice of termination only if there is just cause under Article 28 of the Act (taking into account each party's need to use the building, the history of the lease, how the building has been used, its current condition, any offer of a relocation payment and similar factors). It is difficult for the landlord to end the lease unilaterally for its own convenience, so this type makes it easier for the tenant to remain in the premises.

A fixed-term building lease, by contrast, is a system under which the parties may agree that the lease will not be renewed, but under Article 38(1) of the Act only if the contract is made in writing, such as by a notarial deed (under Article 38(2), this includes an electronic record of the contract's contents). Article 38(3) requires the landlord, in advance, to give the tenant a document stating that the lease will not be renewed and will end when the term expires, and to explain this. If the landlord fails to give this advance explanation, the provision that the lease will not be renewed is void under Article 38(5), so whether the tenant received the document and the explanation is also something the tenant should confirm. A fixed-term lease ends, as a rule, when the term expires, and if the tenant wants to keep using the premises, the parties must agree to enter into a new lease. Because the landlord has no obligation to agree to a new lease, whether the current office is under one type or the other determines whether the company can choose to stay on when the lease ends.

Notice Periods and Penalties for Early Termination

When a company relocates or terminates partway through the lease term, it must follow the early termination provisions in the contract, regardless of whether the lease is an ordinary lease or a fixed-term lease. Article 38(7) of the Act on Land and Building Leases allows a tenant under a fixed-term residential lease with a floor area of less than 200 square meters to terminate early where there are unavoidable circumstances such as a job transfer, medical treatment or caring for a relative, but this applies only to residential use and does not apply to business offices. Whether an office lease can be terminated early, and on what conditions, depends entirely on what the contract says.

When reviewing the contract, we read specifically the length of the notice period (such as three or six months), the obligation to pay rent during the notice period, how the penalty is calculated for immediate termination, and the method of giving notice (whether it must be in writing, and whether notice takes effect on arrival or on dispatch). For example, under a lease with a six-month notice period, the company cannot vacate on its desired schedule unless it gives notice at least six months before the desired move date. Even if notice is given after that point, the termination itself is accepted, but it is common for the contract to provide that an amount equal to the rent through the end of the notice period may be claimed as a penalty. Even before the relocation plan is fully settled, the company needs to identify the notice deadline early.

The Scope of Restoration and Skeleton Restoration Clauses

The "Guidelines on Disputes over Restoration to Original Condition" published by the Ministry of Land, Infrastructure, Transport and Tourism are guidelines that assume private rental housing at around market rent, and they do not cover business building leases. When vacating an office, the guidelines' standards for who bears normal wear and tear and deterioration over time cannot simply be applied.

Business office leases often include a skeleton restoration clause, which requires the tenant to remove the equipment and interior installed at move-in and return the premises to bare concrete, and a clause requiring the tenant to bear the cost of repairing wear and tear from normal use and deterioration over time. Because transactions between business operators are considered to be negotiated on an equal footing, such clauses tend to be found valid. Where there is a skeleton restoration clause or a clause making the tenant bear normal wear and tear, it is wise to obtain an estimate of the construction costs early and budget for them as part of the relocation costs. At the same time, check whether the tenant is required to use a contractor designated by the landlord.

Deposit Deduction Clauses, Repayment of Free Rent and Subletting Restrictions

In office leases, in addition to a security deposit, money is often deposited under the name of a "guarantee deposit." A clause may provide that a fixed amount or a fixed percentage of this guarantee deposit is deducted and not returned, which is what is known as a deposit deduction. For residential leases, there is a framework under which a deduction may be void under Article 10 of the Consumer Contract Act if the amount is excessive, but this does not apply to office leases contracted by corporations. Assuming that a deduction clause is valid as a rule, identify the deduction rate, when it is applied (at signing or on surrender of the premises) and the repayment date in concrete figures.

It is also necessary to look at free rent (a period during which rent is waived), which is set to keep initial costs down. Some contracts include a clause requiring the tenant to repay the waived rent or pay a penalty if it terminates early within a short period, and this can become an unexpected expense in a sudden relocation. It is important to understand the repayment criteria (how much must be repaid if the lease is terminated within how many years) in advance.

Further, if the company plans to share part of the floor with a group company or business partner, or to open part of the office to outsiders as a coworking space, it may breach the clause prohibiting unauthorized subletting. Leases customarily require the landlord's prior written consent for an assignment of the lease or a sublease. When expanding by renting an additional floor in the same building, the starting date for the termination notice period can differ depending on whether the additional floor is under a separate contract or a memorandum, so also check whether partial termination (reducing floor space) is possible and how the rent is apportioned.

Working Back from the Termination Notice Deadline

When proceeding with a relocation, first confirm the termination notice period for the current office, estimate the time needed for the new office lease, the interior fit-out and moving in furniture, and set a target date for completing the move. The date reached by counting back the notice period from that target date is the final deadline for giving notice of termination. Under contracts with long notice periods such as six months, nine months or even a year, if the company waits until it has selected a new property or completed internal approvals before working back from the target date, it will not be able to move at the time it wants.

For the basic perspective on early termination and contract cancellation, see this article, and for how to manage deadlines and renewal procedures after signing, see this article.