Can a tenant of a commercial lease refuse to pay rent if the landlord is in breach?

A commercial lease is a contract between a landlord and a business for the purpose of renting a property owned by the landlord. Many businesses choose to enter a commercial lease from where they can operate their business rather than buying because there is not the same requirement for capital to invest. As with any contract, a commercial lease comes with a range of responsibilities on the part of both parties.

Although a landlord tends to have fewer obligations than the tenant in a commercial lease, they do have significant ones including providing specific services and not interfering with their tenant’s occupancy rights.

If a landlord fails to meet their obligations correctly it may influence the ‘enjoyment’ of the tenant’s commercial premises. It could affect the success of a business or cause problems for staff, customers and any sub-tenants. A commercial tenant can take action if the landlord breaches the lease obligations but does that go as far as a tenant breaching its obligations by withholding rent?

What are commercial tenant’s obligations to their landlord?

A commercial tenant is expected to comply with the terms of their lease agreement with their landlord. If they fail to do so the landlord may have the right to terminate the lease and seek damages. Key obligations of a tenant include the following:

(i)Payment of rent is the primary obligation of the tenant in a commercial leasing arrangement. It can represent a significant cost to the tenant’s business. The level of rent is specified in the lease agreement but will usually set out the possibility of reviewing the amount periodically. The review methodology can reference the Consumer Price Index, a fixed percentage increase or the rent is varied according to an assessment of the property’s changed market value.

(ii) As well as the rent a landlord will normally require a form of security from the prospective tenant in order to help protect their position in the event of default such as not paying rent or other failure to meet their obligations. In NSW the value requested will typically equivalent to 3 to 6 months rent. This might be in the form of a bank guarantee or could be a deposit arrangement.

(iii) Other obligations can include responsibility for outgoings such as utilities, legal fees of the landlord. In addition, a tenant is usually responsible for repairs and maintenance to the leased premises other than structural repairs.

Can a tenant withhold rent if the landlord is in breach of the lease?

This issue was considered by the NSW Supreme Court in the case of Ozton Pty Ltd v Cromwell Hills Pty Ltd (2016).

In this case the landlord was Cromwell Seven Hills Pty Ltd as trustee for the Cromwell Northpoint Trust who owned the building. Ozton Pty Ltd was the tenant of five commercial premises in Northpoint Tower located in North Sydney. Four of these premises were then sub-leased to other businesses.

In 2016 Cromwell commenced a redevelopment program for the building which the tenant was concerned about as it the work required would interfere with their ‘quiet enjoyment’ of the premises and potentially undermine their business. Ozton, rather than lodging an objection while continuing to pay rent, stopped paying.

In response, the landlord threatened that if the tenant did not meet its obligations by paying rent they would call on the bank guarantee that they held as security for the monies owed. Ozton in turn commenced proceedings to obtain an injunction to prevent the use of the bank guarantees to collect rent arrears. It argued that the landlord had breached the lease and damages would not be sufficient because of the risk of the sub-tenants themselves refusing to pay rent or claim damages against Ozton.

The key issues that the Court had to consider were whether Ozton could withhold rent, what remedies could be available to Ozton and whether equitable set-off might apply in the circumstances.

What is legal v equitable set-off in commercial contracts?

When two parties have monetary debts against each other, a right may arise to ‘set-off’ the debts against each other. Parties can agree a contractual right of set-off by including a provision in their contract. They can also agree to exclude set-off rights from a contract.

In the absence of a contractual right there may be an equitable right to set-off though not always easy to establish in practice. To do so, requires establishment of a formal close connection between the claim and cross-claim and a functional requirement that means it would be unjust to enforce the claim without taking the cross-claim into account.

 In this case, the lease expressly stated that a rent set-off was not allowable. Ozton could not rely on a legal right but argued that they had a right of equitable set-off in that it was unjust or inequitable not to allow a set-off.

What did the Court decide?

The Court decided not to allow the injunction or set-off. The leases demonstrated that both parties intended that Cromwell should have the benefit of the rent for the term of the lease notwithstanding any disputes that might arise. The Court further considered that Ozton would not suffer a loss if Cromwell called on the guarantee and that damages would be a sufficient remedy.

What does it mean?

A tenant in a commercial building must carefully consider and negotiate the terms of their lease. In understanding their rights and obligations they will then be in a better position to ensure that the commercial premises are suitable for their business.

The illustrated case demonstrates how a dispute can escalate if parties do not address these issues at the time they enter the lease.

If the dispute reaches Court, considerations will be the likely loss, the terms of the agreement and the surrounding circumstances.

As part of their decision, the Court also had made it clear that if parties to a contract want to prevent an equitable set-off argument they must include express wording in the agreement stating ‘without set-off’.

Contact our Commercial Lease Solicitors based in Sydney, NSW

At Szabo & Associates Solicitors we have many years of experience advising on all manner of property law matters including disputes. If you need assistance in drafting or reviewing your lease, or if you are in dispute, please call us on 02 9281 5088 or complete the online contact form.