Termination for unpaid rent: profiting from lessee mistakes?
Gan v Shop 3, 228-230 Hanvaylee Parade Kensington Pty Ltd  NSWSC 1322
In this recent appeal decision from NSW Supreme Court, the lessee (a Malaysian Restaurant) claimed that the lessor’s actions in enforcing the lease, issuing breach notices and ultimately ending the lease by re-entry were contrary to an implied obligation to act in good faith and unconscionable. The Court confirmed the Tribunal’s decision that it was not a breach of good faith to enforce clear contractual rights.
Towards the end of the lessee’s first five year lease the lessee exercised an option to renew. The rent for the option term was to be determined by market review. The parties could not agree on the new rent, and so the issue was referred to a valuer. The valuer finalised the determination of the current market rent approximately 3 months after the commencement of the option lease.
In those first three months, the lessee was invoiced and paid (with delays) the rent as applicable under the expired lease.
The valuer’s determination was an increase in the rent of approximately 17%. That determination took into account a four month rent free period (essentially applying this equally over the first twelve months as an abatement).
The lessor notified the lessee of the new rent and demanded payment at the new rate. The lessee erroneously took the view that it was entitled to the four month rent free period, which would not have expired until the following month. The lessee considered that the rent it had paid for the first three months should be applied to the future rent due, and as such, the lessee considered it was ahead in rent payments, not in arrears.
The lessor sent 4 notices over the next three weeks demanding rent and explaining the error the lessee had made in relation to the rent free.
Alongside this issue of rent payments, the lessee had been seeking to sell its business. It had offered the lessor an opportunity to purchase its business, which was refused. The lessee had indicated that it was talking to potential purchasers and just needed a little more time. The lessee had told the lessor it would pay all arrears if a purchaser could be found, and even offered to pay interest on the late payments.
The lessor terminated the lease by re-entry, however when it did so, it found a note on the door stating that the restaurant was closed until further notice.
Within ten weeks, the premises were re-let (as a fitted out restaurant) at a higher rent.
The lessee commenced proceedings, arguing that the lessor was not entitled to have terminated the lease. There were many grounds for its arguments, however the Tribunal found in favour of the lessor. The lessee appealed to the full panel of the Tribunal, and then to the Supreme Court.
At the Supreme Court, among other arguments relating to the validity of the breach notices and the interpretation of the valuation, the lessee claimed that the lessor breached an implied obligation to act in good faith and had acted unconscionably by terminating the lease. The lessee claimed that by terminating the lease, taking the lessee’s fitout, and re-leasing the premises at a higher rate, the lessor had made a gain of $700,000. The lessee claimed this amount from the lessor on the basis that it was unconscionable for the lessor to profit in this way from the small mistakes of the lessee.
The lessee argued that the lessor knew that the lessee was seeking to sell its business and that the lessor misled the lessee into believing that the lessor would provide assistance, while at the same time planning to terminate the lease and re-lease the premises with the fitout at a higher rent.
The lessee was unable to provide evidence that the lessor’s actions were in breach of an obligation to act in good faith or were unconscionable. The Court found that the lessee’s argument relied on its mistaken understanding of the valuation and the rent free period. If the lessee was entitled to a four month rent free period, the termination of the lease would have been invalid. But because the termination was valid, it could not be unconscionable for the lessor to have acted in that way. The facts supported the lessor.
Further, the lessor had given the lessee numerous notices, and had explained the lessee’s mistake regarding the valuation and the rent free period. The lessee had refused to pay rent and had closed the restaurant.
The Supreme Court could not find any reason why the lessor’s actions could be considered unconscionable in these circumstances.
Matthew Rafferty, Partner