Retail Lease Renewal Options and Lease Repudiation: Critical “Essential” Terms in Pozetu (PTY) LTD V Alexander James (Pty) LYD (2016)

Alexander James (Pty) Ltd entered into a five-year lease for a retail premise in Queen Street, Woollahra, in the Eastern suburbs of Sydney.  To protect continuity of tenure at the end of the lease, they agreed a lease option with the landlord Pozetu (Pty) Ltd. 

Such options give the tenant a right to renew before the lease ends and provides some comfort that the business can have a further lease if they wish to continue at the location and some certainty as to the terms on which they can continue.

The rent on renewal of the lease was agreed in the form of a “ratchet” and the option in the first lease, in Clause 4.2, said that the rent from the commencement of the new lease term was to be the greater of:

a)     105% of the rent in the last year of the previous term

b)     Current Market Rent

Having agreed these important terms, an option to renew with a market rent review, what could possibly go wrong?

What did go wrong took over seven years of protracted litigation. It was eventually resolved by a judgment of the New South Wales Court of Appeal in Pozetu (Pty) Ltd v Alexander James (Pty) Ltd (2016) emphasising the importance of taking advice from experienced commercial property lawyers before entering a retail lease.

Key Facts

The landlord and tenant had entered into a five-year lease for a retail store in Woollahra.  The lease included an option to renew for a further five years.  As the initial lease drew to an end the tenant exercised their option to renew.  However, as no agreement had been made over the rent, the tenant continued to pay the same rent they were paying in the final year of the initial term on a month to month basis. About six months into the option term, the tenant decided to give notice to the landlord, Pozetu (Pty) Ltd, that they would be leaving the premises and terminating the lease.  The landlord sought damages for repudiation of the lease on the part of the tenant and the loss of rent for the five years of the new lease term.

Key Issues

In New South Wales, commercial leases for retail premises are governed by the Retail Leases Act 1994.  The NSW Court of Appeal considered whether the option lease between landlord and tenant was legally valid under the Act.  As outlined, Clause 4.2 of the option lease stated that the rent was to be determined through two methods of which the higher amount produced would determine the rent payable.

Section 18(3)(c) of the Retail Leases Act 1994 states that such a provision is void if it “provides for the 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”.

Because of this, the Court held that the market rent review clause was rendered void by the 1994 Act.  Moreover, as rent is an essential term of a lease, there was no lease binding the parties after the initial lease had terminated and the option to renew was unenforceable.

Where a party’s conduct shows that it does not intend to perform its obligations, this may amount to repudiation of the agreement but this was not the case.  The tenant had the right to leave the premises provided they gave one months’ notice to the landlord.

What does it mean?

The NSW Court of Appeal, in overturning a decision of the NSW Civil & Administrative Tribunal (NCAT), held that the rent review clause under an option lease was void.  Where an essential term (in this case how the rent was to be determined) is deemed invalid, the entire lease is rendered unenforceable.  Consequently, the tenant could give notice and the landlord was not entitled to damages for “lost” rent.

There are clearly a number of implications for a business entering into a retail lease, or considering litigation, either as lessor/landlord or as tenant/lessee.

The case provides an example of the importance of the parties paying close attention to those clauses which are specified in the lease as essential terms.  It is vital to ensure that the essential terms, such as rent, are agreed upon by both parties. In order to avoid a situation such as this arising, most landlords will wish to specify in their leases which particular clauses are essential terms.

It is clearly important to ensure clauses in the lease do not contravene the Retail Lease Act.

Specifically, retail shop rent reviews must not contain a ratchet mechanism i.e. the rent determination clause cannot give the landlord the right to choose from a range of methods which would give them the highest financial return when it comes to a rent review.  It is possible to designate a fixed amount or perhaps an increase by a fixed percentage but the relevant clause cannot provide for the higher of two or more methods as the way of setting the rent on renewal.

When it comes to considering litigation, this can be expensive and time consuming so time spent getting it right up-front can be time and money well spent.  This is amply demonstrated by this case which is an example of “excess litigation”. The dispute took over seven years to resolution by the Court of Appeal having first been heard and then appealed in the NSW Civil & Administrative Tribunal (NCAT), a forum which is meant to resolve disputes relatively quickly and cheaply.

Contact Szabo & Associates, Solicitors in Surry Hills, Sydney

The experienced lawyers at Szabo & Associates, Solicitors can provide assistance with all aspects of retail and commercial leases in whatever capacity.  It is important to seek legal advice from an experienced commercial property lawyer before entering a lease. Contact us on 02 9281 5088 or fill in our online contact form.