Your lease of premises is approaching the end of its term and includes a make good provision. The tenant has indicated it is carrying out the required works and will be completed in time to provide vacant possession by the termination date. On the termination date you receive a letter in the post containing keys to the premises which you promptly inspect only to discover the place is a mess and there are considerable works either badly done or not done at all. It’s all good – you hold a bank guarantee that you will draw on to satisfy your expenses…or at least that’s what you WOULD do if it weren’t for the Court of Appeal’s decision in Lucas Stuart Pty Limited -v- Hemmes Hermitage Pty Limited and a badly drafted lease!
Be Sure of your Terms
The terms of a lease can make or break a landlord’s entitlement to call on a guarantee, particularly for make good works that need to be rectified after the lease has been determined.
Particular care should be taken to consider the terms that relate to events which lead to the lease’s termination and circumstances in which the bank guarantee is returnable. For example, you might be surprised to find clauses in a lease which provide that:
the termination date is the date on which the tenant abandons the premises, and
on termination of the lease the landlord is to return to the tenant all bank guarantees.
These two terms clearly contradict a landlord’s right to hold on to a guarantee after the tenant has left the premises, regardless of any contractual right to call on the guarantee to satisfy any breach (such as make good works that were not carried out).
Not always by Default
Even if your lease does safely ensure your right to hold onto a bank guarantee to secure against a default after termination of the lease, it doesn’t mean that you can decide that you are going to draw on it.
The New South Wales Court of Appeal decision of Lucas Stuart Pty Limited -v- Hemmes Hermitage Pty Limited related to a claim under a building contract by a developer to draw on security bonds to satisfy costs of rectifying a contractor’s defective works. In this case, the contractor provided performance bonds to the developer in respect of building works. In the event that “the contractor has not materially complied with its obligations” the contract required the developer to issue a notice specifying the breach, what action was required to be done to rectify the matter and a “reasonable” time in which to do so. The developer issued a notice in respect of certain defective works and subsequently sought to call on the security bonds. The contractor sought an injunction to prevent the developer from calling on the bonds.
In order to obtain such an injunction the contractor needed to satisfy the Court of three elements. Firstly, that there was a serious issue to be tried. Secondly, that damages were an insufficient remedy, and finally that on the balance of convenience it was appropriate to provide the relief sought. In Lucas Stuart a notice of dispute could only be issued if there had been a breach of "material obligations". The contractor argued that the defects in the works did not constitute a material breach of its obligations. Accordingly the argument follows that the notice is defective and can not be relied on to call on the security bonds.
The Court said that whether or not the defects constituted a material breach was a "serious issue to be tried" and would require consideration in light of the whole of the contractor's obligations. Hence it granted the injunction preventing calling on the bonds until it was determined whether the defects constituted a breach of a material obligation. Until this issue could be explored by the Court the validity of the notice and ability to rely on it to draw on the security was restrained.
In the context of leasing the question arises if the bank guarantee clause allows the guarantee to be called only if there is an act of "default" or a "breach". Who determines if there has been a default or breach? It is a valid argument for the tenant to go to the Court if there is a dispute about how "satisfactory" a make-good was and say "we dispute that the make good was unsatisfactory" - it would be open to the Court to restrain the landlord until it decided whether the make-good was satisfactory or not. Pending resolution of that issue the landlord’s entitlement to the security would reasonably be restrained.
As a precautionary measure landlords should ensure that any lease entered into contains clear unconditional terms that the question of whether or not a breach or default has occurred is in the absolute discretion of the landlord. It would also be prudent to ensure that the ability to draw on a security is not dependent on an event such as a “material” breach which could be the subject of legal argument.
Landlords will also want to ensure that bank guarantees either contain no expiry date or at least extend well beyond the term of the lease, and that there is no obligation for the landlord to return the bank guarantee until the tenant has complied with all its obligations under the lease.
DibbsBarker is presenting a seminar on managing tenant default on 13 September 2011. As well as addressing the points noted above, the seminar will deal with the legal and commercial aspects of issuing default notices and taking termination action. To register for this event, please click here.
If you have any questions regarding this alert or leasing in general, please feel free to contact the DibbsBarker Leasing Team Leader:
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