Interpretation of Commercial Leases & Associated Documents By Roger Walter | March 2008 Area of Expertise | Commercial Disputes
Summary Two decades have passed since the last substantial High Court decision on the relief available to landlords under commercial leases. On 27 March 2008 the High Court handed down its decision in Gumland Property Holdings Pty Limited v Duffy Bros Fruit Market (Campbelltown) Pty Limited, a case that dealt with a range of issues, but particularly the availability of loss of bargain damages following termination based not on repudiation by the lessee, but on its breach of an agreed essential term, and whether a guarantor’s covenant to guarantee payment of rent by the lessee touches and concerns the land so that, despite there being no privity of contract, the covenant passes with the leasehold reversion upon the sale of the premises.
Who Does This Impact? Those involved in commercial leasing
What Action Should Be Taken? Particular care must be taken with the wording and effect of commercial leases and the documents governing related matters, such as sub-leases and variations. This is particularly so with clauses involving ‘essential terms’. The relief available on breach of these terms may cause seemingly harsh results, particularly for lessees (and their guarantors) who find themselves out of the premises in a falling market, when re-letting may prove to be difficult or impossible and cause a landlord to sue for loss of bargain damages.
On 27 March 2008 the High Court of Australia handed down its decision in Gumland Property Holdings Pty Limited v Duffy Bros Fruit Market (Campbelltown) Pty Limited. The High Court found that Gumland, a lessor (landlord) of retail commercial premises, was entitled to various sums of arrears of rent, damages and interest, following its termination of the Lease to Duffy Bros almost five years before its scheduled March 2008 expiry, and that guarantors of Duffy Bros were also liable for these amounts.
Overview The dispute between the parties as the litigation progressed to the High Court was focused primarily on whether there was an entitlement to damages and whether the guarantees survived the series of transactions that took place after the Lease commenced, which involved not only separate assignments of the Lease and a sub-lease (of part of the premises) and a sale of the freehold title in 2001, but also a 1999 Deed between the lessee, Duffy Bros, and the initial lessor, by which the lessor authorised the sub-lease and a substantial variation of the covenant to pay rent. By clause 2 of the 1999 Deed the parties ratified and affirmed the terms of the Lease, subject to the terms of the Deed, which reduced the rent payable subject to the conditions given in the Deed’s sub-clauses 10.1 and 10.2. In effect, if Duffy Bros did not commit any further breach of the terms of the Lease defined as essential in clause 7 of the Lease, or any breach of the Deed itself, it would not have to pay the full rent required by the Lease, but only arrears, the reduced rent (for a reduced portion of the premises) and the rent it received under any sub-lease.
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Interpretation of Commercial Leases & Associated Documents by Roger Walter
It was the 1999 Deed that caused the NSW Court of Appeal to fall into error and find that no entitlement to damages arose. The amounts awarded at first instance, and found to be correctly awarded by the High Court, comprised; (a) arrears of rent including rent due under the sub-lease; (b) loss of bargain damages – assessed by reference to the difference between the rent and outgoings payable under the Lease from the termination (in August 2003) to the scheduled expiry date of 29 March 2008 and the amounts received or likely to be received in that period (this came to $1,624,737 with interest); and (c) reinstatement damages - assessed by reference to the lessor’s costs in refurbishing and arranging to re-let the premises. The Court of Appeal set aside the trial judge’s orders awarding (b) and (c) on the basis that the failure to pay rent constituted a breach of the 1999 Deed alone and not a breach of the Lease itself. This was essentially an error of construction. The Court of Appeal’s error arose in circumstances in which the lessor’s obligation to pay rent under any sub-lease was different as to timing and as to amount to the corresponding term of the Lease and where the failure of Duffy Bros to pay rent under the Lease was a little technical in circumstances where it occurred only because the sub-lessee had stopped paying sums due as rent due under the sub-lease and where that rent was paid entirely for the benefit of the lessor, rather than Duffy Bros, who had by that time (2002) stopped trading from their portion of the demised premises but continued to meet their rental obligations in respect of it. The 1999 Deed came about because Duffy Bros had fallen behind in their rent and wanted to reduce their ongoing exposure to rent by giving up a portion of the premises to another tenant as well as settle an arrangement for the payment of rental arrears. Had Duffy Bros been able to avoid the complication of the sub-lease and insisted instead on new leases being drawn in 1999, the unfortunate events that followed, including the litigation itself, could have been avoided.
The Law The legal principles called upon in the High Court’s decision to grant the appeal were relatively well established and unremarkable. It was unsuccessfully argued on behalf of Duffy Bros that a landlord is not necessarily entitled to terminate and sue for loss of bargain damages even if the parties specifically agree on a term being essential and that breach of it will permit the innocent party to terminate and sue for loss of bargain damages. The agreed essential term was the “covenant to pay rent throughout the lease term at a date not later than seven (7) days after the due date for the payment of each monthly instalment of rent and any other monies payable under the terms of this Lease”. The High Court found that this term was not only expressed to be essential but that it should in any event, as a matter of construction considering the Lease as a whole, attract that characterisation. And in any event, the High Court concluded its view on this aspect by stating the law as follows: Save for any applicable statutory requirements or rules of law, there is no reason why general contractual principles do not apply to leases in this respect. Under general contractual principles, an innocent promisee can terminate the contract, and recover loss of bargain damages, where there is repudiation, or a fundamental breach, or a breach of a condition – i.e. a breach of an essential term. And under those principles it is possible by express provision in the contract to make a term a condition, even if it would not be in the absence of such a provision – not only in order to support a power to terminate the contract, which [Duffy Bros] concedes, but also to support a
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power to recover loss of bargain damages. No convincing reason was given to explain why the former outcome was sound in law but the latter was not. In terms of legal principle, the other area of interest traversed by the High Court in this decision was that concerning the ability of covenants ‘touching and concerning land’ to overcome the distinction between privity of contract and privity of estate. This distinction was called in aid of Duffy Bros in respect of the contractual term specifying the lessor’s entitlement to loss of bargain damages. In a different context it was also called in aid of the guarantors of Duffy Bros. The High Court had no difficulty finding in favour of the landlord, who had acquired the land in 2003, in both instances and in doing so it applied, and welcomed into the Australian law, the four-step test that appears in the English decision of P & A Swift Investments (A Firm) v Combined English Stores Group plc [1989] AC 632 at 642: (1) the covenant benefits only the reversioner for the time being, and if separated from the reversion ceases to be of benefit to the covenantee; (2) the covenant affects the nature, quality, mode of user or value of the land of the reversioner; (3) the covenant is not expressed to be personal (that is to say neither being given only to a specific reversioner nor in respect of the obligations only of a specific tenant); and (4) the fact that a covenant is to pay a sum of money will not prevent it from touching and concerning the land so long as the three foregoing conditions are satisfied and the covenant is connected with something to be done on, to or in relation to the land.
Implications This case is a rather forceful illustration of the fact that particular care needs to be taken with commercial leases and associated transactions, such as sub-leases, assignments, variations and guarantees. The wording and effect of the written provisions governing these transactions, particularly the clauses involving the creation of essential terms and the relief available on breach of these terms may cause seemingly harsh results, particularly for lessees (and their guarantors) who find themselves out of the premises in a falling market, when re-letting may prove to be difficult or impossible and cause a landlord to sue for loss of bargain damages.
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Interpretation of Commercial Leases & Associated Documents by Roger Walter
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