What is the effect of an offer to lease?

It is common for parties to a commercial lease to enter into a letter of offer before entering into the formal lease or, in circumstances where the premises are yet to be constructed, an agreement for lease.

What is the role and effect of a letter of offer of lease?

Can a letter of offer of lease operate after an agreement for lease or lease has come into effect?

Recently the Victorian Court of Appeal in Masters Home Improvement Australia Pty Ltd and Woolworths v North East Solution Pty Ltd¹ considered, amongst other things, whether the terms of the letter of offer continued to apply to the contractual arrangements between the parties even though the parties had subsequently entered into a formal agreement for lease with the lease annexed.

Background

On 2 June 2009 Woolworths Limited (Woolworths), entered into a Letter of Offer (LOO) with the Maxi Food Group (Maxi) pursuant to which Maxi agreed to acquire a development site in Strathdale, Victoria (Strathdale Site) and construct a store on it to be leased by Woolworths.

The LOO was a binding agreement that recorded the intention of the parties, subject to certain conditions being met, to construct and lease a Masters store at the Strathdale Site and to enter into a formal agreement for lease based on Woolworths’ standard form agreement (AFL).

Importantly clause 13 of the LOO provided for:

• Woolworths to issue a design brief for construction of the Masters store; and
• If the costs of constructing the Master’s store as per the design brief differed in cost to the construction of other major trade supply/restricted retail premises (which the parties understood to mean a Bunnings store), the difference in cost would be paid by Woolworths as a lump sum payment.

On 24 February 2010, North East Solution Pty Ltd (NES) (a corporate entity within Maxi), Woolworths and and Masters Home Improvement Australia Pty Ltd (Masters), entered into the AFL.

The AFL provided under clause 2.2 that:

• NES must construct, at its cost, the Masters store in accordance with the plans and specifications set out in the AFL (Landlord’s Works);
• NES must work out the costs for the Landlord’s Works (Landlord’s Works Costs), if any contribution was required by Masters (Masters’ Contribution) and the payment terms for Masters' Contribution;
• the parties must, acting reasonably and in good faith, attempt to resolve any differences they may have in relation to the estimated Landlord’s Works Costs, Masters’ Contribution and the payment terms; and
• if the parties could not agree if any contribution was required by Masters, the amount of that contribution and the payment terms, within the timeframe and parameters stipulated in the AFL, either party could terminate the AFL.

Between March and April 2010 the parties negotiated in respect of:

• the amount of the Landlord’s Works Costs;
• the amount of Masters’ Contribution; and
• the payment terms for Masters’ Contribution.

Ultimately the parties were unable to reach agreement and, in May 2010, after the time limit for negotiations under clause 2.2 had expired, the parties terminated the AFL.

NES commenced proceedings in May 2012 alleging that Woolworths and Masters had breached clause 2.2 of the AFL in that:

• there was no genuine disagreement between the parties in relation to the calculation of the Landlord’s Works Costs and Masters’ Contribution; and
• if there was a dispute, Woolworths/Masters had breached its obligation under clause 2.2 of the AFL to act reasonably and in good faith in its attempts to resolve any differences in relation to the estimated Landlord’s Works Costs and Masters' Contribution before exercising its right to terminate the AFL.

The judge at first instance upheld the claims by NES and, importantly, accepted NES’ submissions that paragraph 13 of the LOO was an important part of the factual matrix relevant to the construction of the effect of clause 2.2 of the AFL. 

As a result the judge held that:

• in so far as the provisions of the LOO had not been abrogated or varied by the provisions of the AFL, the terms of the LOO continued to apply; and
• that Masters was required to make the Masters' Contribution payment by way of a lump sum, the term having been incorporated by inference or implication from clause 13 of the LOO.

Appeal

Woolworths appealed the decision at first instance.  Central to Woolworths’ submissions was the construction of clause 2.2 of the AFL.

Woolworths’ submissions in respect of the proper construction of clause 2.2 fell into two broad categories, namely that:

• the judge at first instance wrongly treated the LOO and the AFL as cumulative; and
• terms in the LOO that were inconsistent with the AFL could not be incorporated or implied in the AFL.

Proper construction of the AFL

In their submissions, Woolworths argued that the AFL and the LOO should be treated as separate documents, because:

• the AFL was a formal, detailed, negotiated agreement between sophisticated commercial parties with the assistance of lawyers;
• the lease attached to the AFL contained an entire agreement clause and the AFL and lease comprised the one agreement;
• it was clear on the face of the terms of the AFL that the parties intended it to be a comprehensive statement of their agreement from the time it was executed;
• the parties that were signatories to the AFL (NES, Masters and Woolworths) were different to those of the LOO (Woolworths and Maxi); and
• the AFL never made reference to the LOO.

Woolworths drew the Court’s attention to the fact that the process outlined in the corresponding clauses of the AFL and LOO setting out how the parties would determine the amount and method of payment of Masters’ Contribution contrasted significantly in the two documents and that the relevant clauses in the LOO were superseded by the provisions in the AFL.

The Court of Appeal agreed with Woolworths’ submissions and held that the starting point of interpreting the AFL was the AFL itself.

The Court of Appeal held that there was a degree of ambiguity in clause 2.2 of the AFL and, therefore, it was permissible to consider the surrounding circumstances, including the LOO, in construing clause 2.2 of the AFL. 

However, by the time the AFL was entered into, the terms of the transaction had progressed and, given that the AFL was a formal agreement negotiated and entered into by sophisticated commercial parties, the process sketched out in the LOO for determining the amount to be paid by Masters had been superseded.

Accordingly, the AFL should be read independently of any provision in the LOO and, on its proper construction, the AFL did not impose an obligation on Masters to pay the Masters’ Contribution by way of a lump sum, nor was the obligation an inferred or implied term of the AFL.

Lavan comment

Generally, an AFL or a lease will override a LOO.  Therefore, the parties need to make sure that the AFL or the lease correctly reflects the agreement between the parties. 

Parties should give proper consideration to the scope of the “entire agreement” clause in the AFL or the lease.  If appropriate, that clause should also include the LOO as part of the agreement between the parties.  If a LOO is not included within such a clause, it will be harder for a party to argue that the AFL or lease does not reflect the terms of the LOO.

If a party wants to challenge the terms of an AFL or lease on the basis that those documents do not reflect the agreement between the parties, reference may be had to the LOO.  However, this is not an easy exercise and can be time consuming and expensive.

This means that the parties must be certain that the terms of the AFL and the lease reflect the parties’ agreement.  To the extent that the AFL or the lease differ from the LOO, the parties should be clear that they agree to this difference before the AFL or the lease is signed.  Once the AFL or the lease is signed, it is not an easy task to procure any variation or rectification of the terms of those documents.