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Essential Terms must be agreed in a Retail Lease

A recent NSW Court of Appeal case confirmed a failure of the Market Review clause resulted in an Option Lease not coming into existence – and hence, the tenant did not repudiate it. The case is interesting in how the Retail Leases Act moderates market review clauses, and also is a good reminder about the need for clear agreement between the parties on all the essential terms – an agreement to agree is not enforceable.

In the case, Pozetu Pty Ltd v Alexander James Pty Ltd [2016] NSW 205, the lease of a retail premises in Queen Street Woollahra contained an option to renew with a market review. The lessee (Alexander James Pty Ltd) exercised that option and the initial lease expired. The parties didn’t come to an agreement about the rent, and the lessee continued paying the same rent it was paying in the final year of the initial term. About 6 months into the option term, the lessee gave notice to the lessor that it would leave the premises and terminate the lease.

The lessor commenced proceedings claiming that the lessee repudiated the option lease, and claimed damages of approximately $400,000. The Lessor won the case in the Tribunal, however this was overturned by the Tribunal Appeal Panel. The NSW Court of Appeal confirmed the Tribunal Appeal Panel’s decision. The option was validly exercised, and would usually be binding. However – there was no option lease because there was no mechanism to determine the rent. (We note that the Court of Appeal did not agree with all the Tribunal Appeal Panel’s reasoning.)

The problem with the option lease was the market rent review clause. Clause 4.2 of the initial lease provided that the rent at the commencement of the option lease was:

“The greater of:

(a)        Current Market Rent; and

(b)        105% of the rent in the last year of the previous term.”

This conflicts with section 18(3)(c) of the Retail Leases Act 1994 (NSW), which provides that “a provision in a retail shop lease is void to the extent that it … provides for base rent to change on a particular occasion in accordance with whichever of 2 or more methods of calculating the change would result in the higher or highest rent.”

This section of the Retail Leases Act rendered the whole market review clause void. Without the market review clause, there was no mechanism to determine the rent for the option lease.

Rent is one of the essential terms of a lease. If there is no agreement as to the essential terms, then there is no lease. The consequence was that there was no enforceable option lease and the lessee was entitled to terminate its occupation on one months’ notice.

“If the parties to a purported renewal of a lease have not agreed on the rental payable under the lease or on a mechanism for ascertaining the rental, no new lease comes into existence either at law or in equity.” (at para 46 per Sackville AJA)

The expression “essential terms” in this case has a different meaning to how that expression is used in relation to breach of lease cases. Here, ‘essential terms’ means the minimum matters that must be clear and agreed for there to be a lease. These would usually be the parties, the premises, the commencement and expiry date, and the rent. For a lease to exist, there must be agreement as to these essential terms, or there must be an agreed mechanism describing how they are to be ascertained (eg – rent determined by market review; or commencement date to be one day after the end of the fitout period).

If any of the essential terms are not agreed (or able to be determined by an agreed mechanism), then there is no lease.

It is not acceptable for the mechanism to be “as agreed by the parties acting reasonably”. This would be called an ‘agreement to agree.

Market rent reviews commonly allow for the parties to have a fixed period of negotiation, however, if they are unable to agree, then the rent is to be determined by a valuer. In practice, this would often amount to agreement between the parties, but the contingency of ‘determined by valuer’ keeps this method out of the agreement to agree category.

The same reasoning applies to other non-essential terms of a lease. With non-essential terms, the consequence is not that the lease does not exist, but rather that the particular obligation does not exist. For example, a tenant’s obligation to refurbish the premises to a scope to be agreed by the parties means that the refurbishment obligation is not enforceable – the tenant will not have to undertake a refurbishment. Or a landlord’s obligation to permit the tenant to place signs in a centre in locations to be agreed is also not enforceable – the landlord need never allow any signage.

This case also reminds us to be careful of including clauses that contravene the Retail Leases Act  – if those clauses are rendered void, what remains?

Matthew Rafferty, Partner

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