High Court brings certainty for commercial leases

PricewaterhouseCoopers Legal has been successful in obtaining judgment in the High Court for its client, Gumland Property Holdings Pty Limited (Gumland).

In a unanimous decision, the High Court held that Gumland was entitled to judgment against Duffy Bros and others, for an amount of approximately $2.5m (including interest) plus costs. The High Court Judgment covered a number of issues including:

(a) breach of an essential term

(b) availability of loss of bargain damages, and

(c) liability of guarantors.

Importantly, the decision of the High Court provides greater commercial certainty to purchasers of a property who do not take an assignment of a lease but relies on rights under section 117 of the Conveyancing Act 1919 (NSW).

The facts

Transit Management Pty Ltd (Transit) owned a shopping centre. Transit granted a lease over one of the shops in the centre to Duffy Bros (Lease). The term of the Lease was 15 years commencing in March 1993. In March 1994, several individuals gave guarantees with Transit in respect of Duffy Bros obligations under the Lease (the Guarantees).

By 1999 Duffy Bros was experiencing difficult trading conditions, and had fallen into arrears with rent and outgoings. In March 1999 Transit and Duffy Bros entered into a deed providing for:

• Duffy Bros to sub-lease part of the Leased Premises, and
• a reduction in the rent payable by Duffy Bros subject to Duffy Bros not committing any further breaches.

In December 1999, Duffy Bros sub-leased part of the Leased Premises. In September 2001 Transit agreed to transfer the shopping centre to Gumland.

In 2002 the sub-lessee decided unilaterally to pay only half the rent payable.

Gumland notified Duffy Bros that the short fall in rent was a breach of the Lease and in August 2003 Gumland terminated the Lease.

Originating proceedings

Gumland sued Duffy Bros for:

• the arrears of rent up to the termination of the Lease
• the cost of reletting the Leased Premises after Termination, and
• the loss of bargain damages being the rent shortfall for the period from the date of termination of the Lease until the Lease expired.

The Trial Judge gave judgment for Gumland against Duffy Bros. However, the Trial Judge dismissed the proceedings against the Guarantors.

Court of Appeal

Gumland appealed and the NSW Court of Appeal gave judgment to Gumland against Duffy Bros and the Guarantors for arrears of rent. However, the NSW Court of Appeal held that Gumland was not entitled to loss of bargain damages or reinstatement damages.

High Court decision

In a unanimous judgment of the High Court, their Honours held that Gumland was entitled to judgment against Duffy Bros and the Guarantors for the amount of about approximately $2.5 million including loss of bargain damages and reinstatement damages (including interest).

The High Court Judgement covered a number of issues including:

Breach of an essential term

The High Court determined that:

• Duffy Bros was the Lessee and liable under the Lease for, the Leased Premises. It was consistent with the Deed that once the Leased Premises was sub-leased, Duffy Bros should continue to pay the rent and outgoings.
• In a commercial lease the court must give effect to the obligations which the parties have accepted in writing. The term to pay the rent was not only expressed as essential but on a true construction of the Lease the term would be characterised as essential.
• Practically, if it was open to parties to agree that a particular term is essential and to agree on the consequences of breach it would avoid arguments about whether the term in question was or was not essential independently of the parties' agreement and the consequences of breach.

The High Court had to determine whether a purchaser of a property can sue for Loss of Bargain Damages from a Lessee where the purchaser did not take an assignment of the Lease.

The Court held that:

• In determining the right to loss of bargain damages the High Court applied the tests for “touching and concerning the land” set out in the House of Lords in P & A Swift Investments (A Firm) v Combined English Stores Group plc [1989] AC 632 at 642 where Lord Aylmerton said that the relevant matters for consideration were:
  
  “(1) the covenant benefits only the reversioner for 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);
  (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.”
  
  
• The Lease satisfied the tests in Swift’s Case and that Gumland had right to sue for rent if it was not paid, and that it was an essential term of the Lease that Gumland had a right to terminate the Lease and sue for loss of bargain damages. Pursuant to the law the benefit of these rights were annexed and incident to, and liable to go with, the reversionary estate pursuant to s117 of the Conveyancing Act.
  
  
• The need for a lessor to recover loss of bargain damages from a lessee only arises when the commercial market is falling. If the market is static or rising, the lessor can re-enter against the defaulting lessee, recover arrears of rent, and promptly install a new tenant at the same or a higher rent.
  
  
• A lessor should not bear the risks of a falling market rather than their defaulting lessee, particularly where the parties explicitly placed that risk on the lessee. The law should not create the result of placing the risks of a falling market on a lessor, and of depriving them of the opportunity by agreement to allocate the risk otherwise.
  
  
• If the law did create this result it would have the effect of cutting down party autonomy, increasing the chance of disputes and reducing certainty.

The High Court had to determine whether a guarantor’s covenant ran with the Demised Land.

The High Court determined that:

• In determining whether a guarantor’s covenant ran with the Demised Land the High Court applied the tests for “touching and concerning the land” as Stated in Swift’s Case.
  
  
• Where the covenant of a guarantor to guarantee payment of rent by a lessee touched and concerned the land, it ran with the land, and could be enforced by a transferee of the reversion.
  
  
• The covenants in the Guarantees cannot be regarded as collateral obligations not affecting land.
  
  
• Once it is concluded that the tests are satisfied, the question of whether the benefit of the guarantee covenant is limited to arrears of rent or extends to loss of bargain damages depends on the language of the Guarantees. In this case the scope of the Guarantees extended to loss of bargain damages.

The decision of the High Court provides greater commercial certainty to purchasers of a property who do not take an assignment of a lease but relies on rights under section 117 of the Conveyancing Act 1919 (NSW).

For further information, please contact your usual PricewaterhouseCoopers adviser or:

Michael Daniel, Partner PricewaterhouseCoopers Legal Corporate and Commercial Tel +61 2 8266 6618