Exercise of an option - a cautionary tale for Landlords

Ko v CKAS Enterprises Pty Ltd [2018] NSWSC 1876, highlights that failure to strictly adhere to the provisions of the lease, which set out how an option to renew the lease must be exercised, will be fatal to the valid exercise of the option.

The case also acts as a cautionary tale to Landlords. Landlords must be careful not to engage in casual discussions with Tenants regarding the exercise of options. All communications in relation to the exercise or non-exercise of an option should be exchanged formally, in writing and in strict compliance with the provisions of the lease in relation to the exercise of the option.

If the evidence in this case had shown that a casual agreement had been made between the parties that the option had been exercised within the period for the exercise of the option, this case may have been decided in a different manner.

Background

The lease in question was dated 13 September 2010, for a term of five years commencing on 13 September 2010 and terminating on 12 September 2015 (the Lease) and it was registered under the Real Property Act 1900 (NSW) (the Real Property Act). It contained one option to renew the Lease, for a further term of five years.

The Tenant claimed the matter of the exercise of the option had been discussed with the previous owner, the then lessor (Lessor), in or about May or June 2015, that the Tenant and the Lessor had verbally agreed that the option was going to be exercised and that the Lessor had confirmed to the Tenant at that time:

That the Tenant need not do anything formally to exercise the option under the Lease.

That the Lessor’s solicitor would contact the Tenant,

Together define as Oral Agreement.

Later, when no such contact from the Lessor’s solicitor had been forthcoming, the Tenant’s representative sent a letter to the Lessor dated 11 September 2015 which outlined the Tenant’s position, namely, that the Tenant had verbally exercised the option in or about May or June 2015, that the Lessor had verbally agreed to the exercise of the option and requesting that the Lessor prepare the necessary documents.

The property the subject of the lease was sold to CKAS Enterprises Pty Ltd (Landlord) on 13 May 2016. The Landlord bought the property subject to any existing tenancies but the contract for sale did not note the nature of those tenancies (that is, whether the premises were occupied pursuant to a validly exercised option to renew the lease or whether the tenant was holding over under the lease).

When the Landlord issued a notice in June 2016, purporting to more than double the rent for the property, the Tenant refused to pay the increased rent. This ultimately led to the Landlord issuing a termination notice to the Tenant in July 2016.

In the period from the purported rent increase to the attempted termination of the lease, the Landlord communicated with the Tenant in a manner the judge described as “curious”, often communicating with the Tenant in terms consistent with the Landlord proceeding on an assumption that there had been a renewal of the term of the Lease. Of note, the Tenant notified the Landlord in July 2016 that it was applying for a certificate to permit outdoor dining at the premises. The Landlord signed its consent to this application in August 2016. The Tenant proceeded to make this application, at its cost. The permit was granted in October 2016.

The matter of whether the option in the Lease had been validly exercised became the subject of the present litigation when the Tenant commenced proceedings in August 2016 claiming orders that the Landlord be restrained from terminating or forfeiting the Lease.

Relevant provisions of the Lease

Clause 4.4 of the Lease provided that the Lessee could exercise the option only if the Lessee served on the Lessors a notice of exercise of option not earlier than the first day stated in item 12D in the Schedule and not later than the last day stated in item 12E in the Schedule. Item 12D stated that the first day that the option for renewal could be exercised was six months prior to expiry of the Lease. Item 12E stated that the last day that the option for renewal could be exercised was three months prior to the expiry of the Lease.

Clause 12.4 of Annexure B provided that, if the Lessors allowed the Lessee to continue to occupy the Demised Premises after the end of the term of the Lease, other than under a new lease, then the Lessee would become a monthly tenant and must go on paying the same rent and other money in the same way that the Lessee had to under the Lease just before the term ended. Subject to irrelevant exceptions, such monthly tenancy was to be on the same terms as the Lease. Under clause 12.4.3, the Lessors or the Lessee was entitled to end the monthly tenancy by giving one month’s written notice at any time.

Arguments made by the Tenant

The Tenant asserted that the option was exercised by the letter of 11 September 2015.

In the alternative, the Tenant argued that by reason of the Oral Agreement, the Lessor accepted that the option had been exercised or alternatively that the Lessor was estopped from departing from a common understanding or an agreed assumption that the Tenant had validly exercised the option or that the Lessor had waived the requirement for strict compliance with the terms of the Lease.

The Tenant lastly argued that pursuant to the conduct of the Landlord following the sale, the Landlord was estopped from denying the existence of a renewed term of five years.

Arguments made by the Lessor and the Landlord

The Lessor gave evidence refuting that the Oral Agreement ever took place.

The Landlord sought to rely on the indefeasibility provisions of the Real Property Act as the option to renew had not been registered on the certificate of title.

Judge’s ruling

With regard to the arguments made against the Lessor, the judge held that:

It was possible that the conversation that the Tenant alleged led to the Oral Agreement had taken place but that it was likely that it had occurred after the time for formal exercise of the option had elapsed. On that basis, the Lessor was not estopped from denying that the option had been validly exercised.

As the option had not been validly exercised, the Lease had expired by the effluxion of time.

With regard to the arguments made against the Landlord, the judge held although the Tenant had no unregistered interest in the premises (since the option to renew had not been validly exercised) the conduct of the Landlord and the Tenant from June 2016 was explicable only on the basis of a common assumption that the Tenant had an entitlement to occupy the premises under a substantial leasehold term and not merely under the holding over provisions of the Lease. On the basis of that assumption, the Tenant incurred expense in applying the for permit certificate. The Landlord was estopped from exercising its rights to terminate the monthly tenancy unless it first paid to the Tenant reasonable compensation for the costs incurred in obtaining the complying development certificate (as that certificate would be a benefit to the Landlord).