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Tenants beware! Effect of default on entitlement to option to renew

A recent decision of the Court of Appeal has reiterated the need for a tenant to ensure compliance with the lease terms at all times, including after the tenant has exercised an option to renew, to preserve its right to the new term.

Grepo & Anor v Jam-Cal Bundaberg Pty Ltd [2015] QCA 131

In this case, the tenant leased commercial premises from the landlord for a term of three years commencing on 14 May 2010.

The lease contained a provision allowing the tenant to exercise an option to renew the lease if the tenant:

not less than six months prior to the expiration of the lease gave the landlord written notice that it wished to renew the lease; and

had at all times up to the date of expiry complied punctually with its obligations under the lease.

Despite being served with a number of notices to remedy breach in the months leading up to the expiry of the lease, the tenant gave notice to the landlord of its desire to renew the lease in accordance with the option provisions.

The lease expired in May 2013, however, the tenant remained in occupation of the premises. During its continued occupation, the tenant received two further notices to remedy breach.

In October 2013, because of the tenant’s continued failure to remedy its breaches, the landlord gave the tenant a notice to deliver up possession of the premises and commenced proceedings in the Supreme Court for recovery of possession of the premises.

At first instance, the tenant was successful in arguing that the breaches detailed in the notices to remedy breach had not occurred before the option was exercised and the landlord could therefore not deny the tenant the right to the option to renew.

The landlord appealed to the Court of Appeal. Arguments turned to the application of section 128(4) of the Property Law Act 1974.

Section 128(4) of the Property Law Act 1974

This section seeks to preserve a tenant’s right to exercise an option to renew in circumstances where the landlord alleges breaches of the lease to deny the tenant the right to the option. The section requires that the landlord serve upon the tenant a notice, within 14 days of receiving the tenant’s option notice, advising that the landlord intends to refuse any renewal on the basis of the tenant’s breaches.

The parties to this lease agreed that section 128 applied to the breaches that were alleged in the landlord’s notices to remedy breach served prior to the tenant’s exercise of its option. However, the landlord argued that section 128 did not apply to breaches which occurred after the tenant’s exercise notice.

The tenant argued that the landlord failed to give a section 128 notice and so could not rely upon the breaches stipulated in the notices to remedy breach served after the tenant exercised its option.

The tenant suggested that the exercise of the option to renew effectively occurred in two stages. The first stage is the tenant giving the written notice within the period under the lease and the second stage is the tenant ensuring that it does not breach the lease between the giving of option exercise notice and the expiry of the lease. Therefore, only after the expiry of the lease could it be determined that all pre-conditions of the option exercise had been met.

The tenant argued that no prescribed notice had been served by the landlord within 14 days of the expiry of the lease in accordance with section 128(4) and accordingly, the landlord could not rely on the subsequent breaches to refuse the exercise of the option to renew.

The Decision

The Court found that for the purposes of section 128(4), the expression “purported exercise of the option” occurred at the time the notice of exercise was given. The tenant’s right to the option, however, was subject to the condition that the tenant did not breach any of its obligations before expiry of the lease.

The Court concluded that because the breaches of the lease were after the notice of exercise was served but before the expiry of the lease, the pre-condition for the exercise of the option was not met and the landlord was therefore not required to grant a new lease.

The Court found that the landlord was not required to give the prescribed notice under section 128(4). The section only applies to breaches occurring before service of the option notice. The section refers to breaches in the past tense only and the Court rejected the argument by the tenant that the exercise of the option comprised a two-staged process of the giving of the exercise notice and the expiry of the term without breach.

What this means for landlords and tenants

Where the option clause requires a tenant to comply with all terms of a lease up to the date of the expiry, a continually defaulting tenant is in danger of losing its option if it breaches the lease after properly exercising its option to renew. The protection of section 128(4) is not afforded to the tenant in those circumstances.

For a landlord, where the tenant is in breach of the lease at the time it exercises its option to renew, the landlord must serve a “prescribed notice” on the tenant within 14 days; otherwise the tenant may have the right to rely upon section 128(4) in order to preserve its option.

Care needs to be taken by both parties at this important time in the leasing transaction in order to preserve rights under the lease and at law.

If you have any questions about how this case may impact upon you, please do not hesitate to contact our office.

"The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication."