The agreement for renting a property is one legal document that almost no-one can avoid. You may have to negotiate (if at all you know how to) or at least sign one either for personal or business use. However it’s surprising as to how few people take the opportunity to negotiate or even understand these agreements – property owners and occupiers included. Most people in India have little idea as to what to look out for in these agreements. Hence, we decided to write this comprehensive guide to negotiating and understanding legal agreements dealing with leasing, renting or leave and license arrangements for residential and commercial properties. This is a must read if you own property that you want to rent out, or even if you are staying or working from a rented premises.
While each house rent or lease agreement has its unique situations that can merit unique terms and conditions to be inserted in a contract, there are some crucial terms that should almost always be included in agreements to protect their interests and prevent future misunderstandings that could potentially lead to trouble, disputes, financial losses or litigation.
First let us see what are the most common legal relationships you may enter into while renting a house or a commercial property .
A lease is a transfer of the right to use the property in question which may be for a specified period, or even for perpetuity provided that a price is paid for the same. If the landlord does not want to create a lease in perpetuity, it would be better to specify a time period in the lease agreement. It is not possible to evict the leaseholder while the lease is in existence – unless there is a provision for terminating the lease agreement provided in the lease agreement itself.
What if a lease amounts to a tenancy?
Most Indian states have enacted tenancy laws or rent-control legislations, which place a ceiling on the rent that can be charged on leased properties, and also severely restrict the grounds on which the tenancy can be terminated. The lessee is called a ‘statutory tenant’ in such cases. Properties in premium locations in Mumbai and other cities have been leased on what is today considered to be a nominal rent – as the pace of inflation and increase in property prices was many times higher than the corresponding increase in rent permitted under tenancy law. This causes severe financial loss to the owner of these properties. While the owners have very valuable property in their ownership, they can not enjoy the value of the same as they can neither charge market rate of rent, nor can they evict the existing tenants.
Therefore, persons leasing their property must ensure that the letting of property on rent does not qualify as a tenancy under rent control legislation, and this has to be done through careful legal drafting.
Leave and License
A leave and license agreement is one of the most popular ways adopted by parties to ensure that the letting of property does not amount to a lease under tenancy related legislation. Unlike a tenancy or lease, a leave and license agreement does not create any property rights in favour of the person who occupies the house (licensee).
In case of tenancy as well as lease, the right to use the property gets transferred from the owner to the person who is renting out the place. However, no such transfer of right to use takes place in leave and license agreements. There is only a license given to the licensee for limited use of the property in a certain way. The terms of the licenses govern what are the rights of the licensee (the person who rented the house). This is the form of agreement most preferred by landlords, and 11 month leave and license agreements for residential properties have become a norm all over India. Lease agreements are common only with respect to commercial properties.
Advantage of leave and licence
Due to the difficulty of getting a tenant or a leaseholder to vacate a place, most landlords prefer to enter into a leave and license agreement for a contractually specified period after which the licensee is obligated to vacate the premises. Under a leave and licence, the amount of rent (and increases in rent in case of renewal of the agreement) can be contractually determined by parties. Further, the lessor or owner has greater freedom with respect to termination of the licence and eviction of the lessee.
It is a common practice to grant leave and license agreement only for 11 months or less to avoid being classified as tenancy. Leave and license agreements also do not attract the rent control acts that once plagued many residential property owners. If the licensee and the landlord agree to continue the arrangement and renew the agreement, they may enter into a fresh leave and license agreement for 11 months at a time.
A lease however, is for a longer duration of time, usually for 1 year or more, although there is no minimum or maximum period specified by law. A lease creates a property right in favour of the lessee (the person taking a lease over the property). Leases are more common for commercial properties as opposed to residential properties which are usually let out on basis of leave and license (lease of commercial property is discussed later).
Checklist to ensure an effective lease deed or leave and license agreement
Following is a checklist for the essential clauses in a leave and license as well as lease agreements:
Find out who is the actual owner
It is crucial that a leave or license or lease agreement is signed only with the real owner of the house. Find out who is the owner, and even demand to see some papers establishing the name and identity of the owner. Usually in residential societies it is very easy to find out the name of an owner. You can request the owner to examine the title deeds of the property, which will mention how land was originally allotted (by a government authority, etc.) and how its ownership transferred. These documents should be requested before paying the security deposit or making any advance payment. Electricity bills or bills relating to municipal taxes can also be referred to (although they are not very reliable indicators of ownership).
It is more difficult to trace ownership of agricultural land, which may have been transferred through several private hands, through intestate succession, partitions, intra-family transfer etc. for hundreds of years.
If the person leasing the property is not the owner of the land, find out if he has the authority to lease it.
If the person entering into the contract is not the owner but someone else, you should check whether he has the authority to lease the property. Usually, a power of attorney can suffice for the purpose.
If you fail to enter into a contract with the real owner but enter into an agreement with someone who is not the real owner without due authority to enter into contracts, then the real owner may at any point evict you from the premises and you’ll have the status of a trespasser in the eyes of law.
While it may be possible to recover your costs from the person who misrepresented himself as being capable of letting out the property to you, but it will require a difficult and sometimes prolonged legal battle which is best avoided. In such cases, you may even register an FIR alleging fraud.
Also, in the agreement itself, it is desirable to insert a warranty clause on behalf of the lessor stating that he is bona fide owner of the premises and that he has the requisite unfettered rights to rent out, lease or give on license the premises in question. An indemnity clause can also be inserted in cases there is a breach of this warranty, making the owner liable to make good all the losses arising out of such breach of warranty.
Renting out mortgaged property
Sometimes, a property to be rented out will be mortgaged with a bank or some other financial institution, in which case they would retain the registered sale documents. In that case, the owner would require a no-objection certificate from the bank or the financial institution. Failing to do this would be in violation of the mortgage agreement – and in case the bank tries to recover money by selling the property it may jeopardize the rights of the occupant, which must be kept in mind and provided for in the agreement.
Term of the agreement
What is the duration of the lease? Or the license? This is very important to specify. Any mistake in this regard can be very costly for the landlord. For leave and license agreements, a term of no more than 11 months is desirable. Commercial leases are often of long duration, sometimes running into 5-6 years as well. In case of factories, cinema halls or such other properties leases can be multi-decades or even multi-century long.
In case of lease of restaurants, or any property with significant setup or installation costs should be of a longer duration – so that the lessee who would make a lot of investment in the installation and set up gets enough time to exploit his investments.
Termination clause and notice period
Most property related disputes between landlord and occupant usually take place over termination and eviction. It is, hence, very important to clearly specify in the agreement as to how and in what circumstances the agreement can be terminated. Usually provision is made for both fault based and no-fault termination. Fault based termination rights are triggered when one party breaches any terms and conditions of the agreement. No fault termination is when the parties can terminate the agreement without citing any reason.
Due to the difficulty and costs associated with finding a new premise as well as finding a new occupant, both landlords and tenants are usually not too happy to have easy no-fault termination clauses. Hence, leaving the premises is often made difficult by throwing in long notice periods and even lock in periods. This is very common in commercial property leasing.
In any case, it is a common practice to include a clause stating that either of the parties can terminate the contract, and the manner in which the termination notice shall be served and the duration of the notice period. The notice period is essentially the time other party gets to make alternative arrangements or brace for the termination before it is actually terminated. One month notice period means that the party willing to terminate the contract must notify the other party at least one month before he actually intends to terminate the contract. One month and three month notice period are most common in India although sometimes parties can insist on an even longer notice period.
Even if the owner wants to sell the property, he must respect this notice clause.
Lock in clause
Some agreements have a lock-in clause. The lock-in clause of a leave and license or lease agreement states that a tenant cannot leave the rented property or terminate the agreement for a specified period of time, during which the contract is ‘locked in’. This period is commonly referred to as a lock-in period. If the tenant leaves the rented property he/she would be required to continue to pay the rent until the lock-in period is over.
For instance, if the lock-in period is 1 year and the tenant wants to leave after 4 months, then unless he is able to negotiate something better with the landlord, he must either retain the place until the end of the year despite giving notice, or vacate the place but pay for the entire year’s rent anyway.
Lock in periods is more common in lease agreements as opposed to leave and license agreements.
The occupant should be wary of this clause, especially if he is unsure about how long he intends to occupy the property. If the landlord insists on adding this clause, the tenant can try and add a provision for it to not apply in exceptional circumstances (for example, the lock-in clause will not apply if the tenant is transferred to another city by his employer).
It is common practice to specifically prohibit sub-letting. Otherwise, the landlord would lose control over what kind of people are allowed to stay in the property. If sub-letting is not prohibited, the occupant may sub-let the property to undesirable people on whose conduct there will be no control of the landlord.
In case of properties such as restaurant, factories or any other property with major investment in installation costs, it is important to have less strict sub-letting clause. Ideally there should be no restriction on sub letting given the nature of the restaurant business, where management often changes hand frequently. In any case, the agreement should at least include a clause where upon paying a specified fee to the owner, sub-letting will be allowed.
Apart from specific obligation to pay and the amount of rent/ license fee/ lease fee, the agreement should be very clear about when the payment obligation arises. There should be no doubt as to on what date what amounts become payable. It is also justifiable to specify what will be the mode of payment – such as cheque, cash or internet transfer, and to whom the payment is to be made. Sometimes, the security deposit is adjusted against the last few months rent – which should also be specified in the agreement. The consequences in case of delay in payment, usually penal interest in the range of 12 to 18%, in case there is more than 10 days of delay, can also be specified.
Increase in rent clause
Many a time a landlord may slip in a vague rent increase clause that gives him the power to increase it any time “if market price changes”. The perception of market price can widely differ from person to person – hence it is the duty of licensees or lessee to keep such clauses out of the agreement. Some lease agreements specify that every year the rent will increase by 10% – in which case it would be a good idea to clarify whether this is a simple increment or a compound increment. In case of leave and license agreements, since such agreements are anyway only for 11 months, rent increase clauses are unusual and should be negotiated hard by occupants. The agreement should specify that unless specifically provided in the agreement, there will be no rent increase during the term of the agreement.
The landlord may insist on a guarantor clause, though this is not a common practice. In case any default is made by the occupant, the guarantor can be called on to make the losses good. This is a rarely used clause but very effective in case of disputes between landlords and occupants.
Maintenance/association charges clause
In case of an apartment or house rented in a society, there may be a fixed monthly maintenance charges or association charges by the society. The usual practise is for the landlord to pay the maintenance/ association charges, although he can transfer the same on the occupant through the agreement. The agreement should have a clause stating who is going to bear this expense. The agreement should specify who would bear all electricity, water and other utility charges if any.
Wear and tear clause
Certain features of the property are bound to deteriorate with time, for example: the paint coating etc. and the occupant should not be held responsible for such normal wear and tear. The agreement should contain a wear and tear clause stating that the occupant will return the property in the condition in which he received it, subject to normal wear and tear, as long as the same was not caused by any direct act or negligence.
Clause for furniture and fixtures
If a piece of furniture is no longer working or becomes unfit to use as a result of everyday wear and tear, then the landlord is required to replace or repair the item. The landlord cannot charge the tenant or withhold the deposit for items which are unusable due to everyday wear and tear. A specific clause should be entered into the agreement for this purpose. However, if an occupant would damage a piece of furniture or equipment through improper use or carelessness then the landlord is allowed to charge the tenant for the damage or withhold all or part of the deposit up to the amount of loss.
These fixtures (such as furniture and electrical appliances) in the premises must be listed, counted and the details of the same should be added as an annexure to the agreement. The occupant should be required to ensure in the agreement that these remain in working condition and undamaged throughout his possession of the property. The wear and tear clause must apply to these items as well.
Clause on associated facilities and amenities
Many properties come along with facilities like parking space, use of swimming pool, club or gym etc which the owner is entitled to along with the property. However, these rights do not transfer to the licensee or the lessee unless a clause is inserted into the agreement specifying that such incidental amenities and associated facilities will be accessible by the occupant.
Security deposit clause
The essential purpose of the security deposit is for the convenience of rectifying arrears in rent, damage to property, unpaid electricity or phone bills and other miscellaneous costs that remain unpaid by the occupant. The amount is often in multiple of the monthly rent (for example the security deposit can be amount equivalent to 6 months’ rent). The security deposit is refundable, less the cost of any damage on repossession the landlord and is normally interest free.
A proper clause should be inserted in the agreement stating that the security deposit will be refunded to the tenant on repossession of the property by the landlord. The agreement should clearly state whether this deposit is interest free. There should also be a clause in the leave and license or lease agreement addressing the consequences of failure in part of the landlord to return the security deposit in timely manner. The agreement should provide that a certain interest will be charged on the security if it is held back beyond the date on which it is supposed to be returned to the occupant under the contract.
This clause can also state that a penal amount will be charged on the security deposit for every day of delay by the occupant to leave the premises after the term of the lease or the leave and license is over.
The security deposit clause should also specify as to what kind of penalty can be charged by the landlord in what circumstances against the security deposit maintained with him.
Repair works during occupancy
The agreement should specify who would be responsible for what kind of repairs. Small repair work without significant financial burden should be covered by the occupant, but the cost of significant repair works which are necessary to keep the premises in liveable or usable condition should be negotiated upon and allocated for in the agreement. If not specified, this often leads to disputes between parties. If nothing is specified, then occupant may be obliged to carry out even major repairs to keep a house in liveable condition. The agreement should specify if the occupant is under an obligation to report any damage to the property to the landlord and how much time may lapse before such reporting.
Clause for tax liability
Tax liabilities may arise out of renting out a property, especially in case of commercial properties. It is desirable that the parties should allocate responsibility for payment of service taxes, property and municipal tax and water tax in the agreement. Further, note that in certain cases tax is to be deducted at source (TDS) on rent payments. This reduces the actual amount of payment received by the lessor. In order to prevent confusion in future, it is safer to specify whether TDS can be deducted from the rent amount (thereby reducing the rent amount) or whether the amount specified as rent is the amount left after deduction of TDS (in which case, the rent payment must be grossed up, known as a tax gross up).
If nothing is specified, tax liability would usually fall on the landlord. Even without mentioning as such, occupant may be able to deduct TDS anyway.
Dispute resolution clause
This clause refers to the court which will have authority to resolve the dispute, in case there arises any dispute between the landlord and the tenant. Normally, it is the court which has jurisdiction over the city in which the property is located, or the court which has jurisdiction in the city where the landlord resides. A clause to submit the dispute to arbitration through this clause is possible, and in most cases will be very desirable, especially agreements involving significant money.
General nuisance clause
General nuisance clause is to prevent the occupant from carrying out, or permitting others to carry out, undesirable acts that might cause nuisance to the landlord or the neighbours. Landlords often prefer to make this a trigger for termination without notice – although this is almost certain to be disputed and not very practical in reality.
General points of concern regarding leasing or renting of any nature
Apart from the above mentioned clauses the tenants and landlords should be aware of other basic and peculiar details of their legal relationship imposed by law. For instance, a tenant should be aware of the fact that the landlord’s permission is required before initiating any major changes to the property.
The occupant should be wary of clauses allowing for automatic increase in rent, arbitrary amendments to the existing terms of the agreement by the landlord, and any provision that permits the landlord to enter the property at any time.
With inputs from Ila Vyas, New Law College, BVDU, Pune.