Farm Leases – is a handshake good enough?

No one likes paperwork, especially legal paperwork. For this reason many farm leases are agreed in the pub (at least before social distancing) between neighbours or family members, with a handshake and a ‘she’ll be right’ attitude.  Unfortunately, uncertainty and misunderstanding invariably creep in.

At the risk of being a Debbie Downer, an informal farm lease is usually unenforceable, creates unnecessary confusion, and can lead to an expensive court case when the property is sold or inherited. To top it all off, an undocumented arrangement is also likely to bring you into conflict with the Tax Man.

Advantages of a good farm lease

Why do people enter into a farm lease?

A farm lease can be of real benefit to all parties.  If you’re an older farmer seeking to fund your retirement, leasing your property can reduce production risk and working capital, while still generating income and allowing you to retain ownership of the asset.  If you’re a younger farmer, you can expand your production, gain secure access to land and focus your capital investment on machinery and livestock while you build a base. But if you enter into this arrangement without a formal document, it could all go to waste.

That said, the written document is just the end point. The really important part is the discussion that takes place before your sign. This is where you clarify the deal, and can move forward with confidence that both parties know what they are getting (and giving).

Part of the negotiation process is to avoid ending up with a ‘one-sided’ or inappropriate document, that doesn’t really reflect your deal. Think of the lease agreement as a ‘checklist’ to make sure you have everything covered.  If the right issues are addressed, both parties will know exactly what their rights and responsibilities are, and the written agreement can then be put away in a drawer.

The exit

What should you be thinking about?

It may seem odd, but your first thoughts should be about how the arrangement will end.  What events will trigger the termination of the lease agreement?  Late payment of rent or failure to pay utility bills?  The use of chemicals or products deemed to be restricted on the property?  Overstocking of paddocks?  Failure to maintain equipment or infrastructure?  Activities taking place that were not agreed to? How will you resolve disputes?  During ‘handback’ how will improvements made by the tenant be dealt with? What condition should the land be in?

The exit is when the owner will get their valuable asset back, and the tenant will be able to walk away. This is really where all the action is, and where things can go awfully wrong.

Responsibilities

Who is responsible for what?

Who should maintain internal access roads, bores, dams, irrigation and fencing?  What about weeding, spraying, fire management, disease and hazardous materials?  Who pays for the insurance and utility costs?

Rubbish removal can be a major source of disagreement as can the removal of trees and entry onto the land by third parties not known to the landowner.

Rights

What are the rights of each party?

Does the landowner have a say in the farm management plan?  Can the tenant register the lease?  What happens if the property is sold or the landowner dies?  What can the landowner do if the tenant walks away before the lease has expired?  What recourse does a tenant have if the landowner attempts to evict them?

Rent

Critical to both parties will be the calculation of a fair lease price.  Most commonly, leasing rates are based on a percentage of the usable land value.  Consequently, as land values rise so do leasing values.  The reverse applies if the market value for land falls.  However, there are other models available that may be more suited to dry land farming operations, irrigated farming and livestock production.

Negotiations about rent might also consider the eventual sale of the land to the tenant.  Will rent paid be deducted from the sale price or some other adjustment made?

Lease agreements between related entities

It is fairly common for farmland to be leased to related entities, for example, from a self-managed super fund or farm trust to the operating company.  In these cases, should the lease agreement be any less formal?  In our opinion, absolutely not.  Consider:

Superannuation Law

A formal registered lease is required by Superannuation Law.  It must be at market value.

Bankruptcy

If the farming partnership goes broke or has a claim made against it, you will need a registered lease to rank above unsecured creditors and the liquidator or bankruptcy trustee.

Succession issues

If the farm business is left to a family member and the farmland left to other family members, a formal lease agreement will ensure that the family members who get the land have an income and the family member who farms does not lose the ability to use the land or have rent increased unilaterally.

Tax

If there are any borrowings against the land or other deductions available (such as for land care or fencing), then such expenses are only deductible if the operating entity pays market rent as evidenced by a formal lease agreement rather than just book entries that may not be accepted by the ATO or may not arise in relation to an actual obligation that arose in the year in which the deductions were incurred.

How we can help

Andreyev Lawyers specialise in providing legal services to farming families.  If you need advice about the negotiation or preparation of a farm lease agreement or are involved in a dispute over a farm lease, we can help you.  Call us on 1300 654 590.

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