Landlord Deemed to have Repudiated Lease for not replacing Air-Conditioning

A dispute between a commercial tenant and its landlord over the air-conditioning (AC) performance in the leased premises has resulted in the tenant abandoning its lease, and the landlord, in attempting to enforce its rights under the lease, being held to have repudiated the lease by the Victorian Civil and Administrative Tribunal (Tribunal). Given the frequent tensions that arise between landlords and tenants over this repeatedly temperamental item of plant in buildings, the Victorian decision sounds a warning to all landlords of commercial property.

The decision made in October 2018 was in the case of S 3 Sth Melb Pty Ltd v Red Pepper Property Group Pty Ltd. The facts of the case were of particular interest as they involved a series of agreements in relation to the AC made between the parties, the details of which were sequentially altered and revised verbally prior to the final lease documentation being executed. This will feel as familiar territory for those involved in commercial leasing. Minor details are often not compensated for in the initial agreement, or are subject to change due to other circumstances. What tends to remain consistent however through the negotiating process is the fundamental commercial agreement which stipulates who has responsibility or liability.

The fundamental agreement was a key consideration in this case as well. The AC special condition in the lease ended up being fairly typical. It made the tenant responsible for maintenance and servicing of the AC, however, the landlord was responsible for capital repairs. This is a very common arrangement in self-contained premises where the AC services a single tenant. The AC in this premises unit was old and, despite being refurbished by the landlord at the start of the lease, it performed so poorly that the tenant who was operating a fitness centre eventually lost customers to other competitors. The dispute between the parties dragged on for over 12 months with frequent periods of non-communication. As expected, the tenant relied on the provision of the lease that required the landlord to address repairs of a capital nature whilst the landlord in return argued that the problem fell within the tenant’s maintenance obligations. The Tribunal considered various arguments as to specific repairs and whether they constituted a tenant or landlord responsibility, but ultimately the Tribunal focused on what it deemed a fundamental term of the lease.

Although the parties eventually agreed to continue with the old (refurbished) AC system, the original agreement, as actually drafted in the Lease, was that the landlord had agreed to install AC to service the premises. This agreement was consistent from the outset and was also documented in a Heads of Agreement, which the Tribunal recognised to be a fundamental agreement between the parties. Therefore by failing to carry out repairs (even disputed repairs) or failing to replace the AC, the landlord was, in the opinion of the Tribunal, actually failing in its contractual duty to provide an AC system which could service the premises and this responsibility was given priority over any failure to maintain by the tenant. It was that failure of a fundamental term of the lease that constituted a repudiation by the landlord. The result was that the tenant could legally walk away from the lease.

What does all this mean? Even though this was a Victorian decision, the reasoning given by that Tribunal could have implications in the ACT where similar cases are examined. Landlords and agents acting on behalf of landlords will need to exercise caution on how commercial agreements between the parties are represented between parties. Needless to say, standard conditions drafted in leases should not be taken for granted as to their effect and care should be taken to record the specifics of the agreement between the parties. Of equal importance is the conduct of the parties in dealing with any disputes. In most cases a tenant will be of the view that AC is a fundamental component of its ability to conduct its business in a leased premises. Similarly a landlord will expect that the AC will function adequately forever if the tenant maintains it as agreed. The potential for disagreement when a problem occurs is high. Landlords should therefore be explicit as to the extent of their commitment towards AC plant from the outset. Upgrading, replacing or repairing the AC should be treated as a specific consideration with care to identify that the cost of such commitment has been contemplated in the final commercial terms of the lease agreement. Otherwise, the risk should be clearly earmarked as resting with the tenant to accept the AC (or any other specific item or service) in the condition as at the commencement of the lease.

Further, given the outcome of this case, it would be prudent to obtain legal advice immediately once a dispute arises. The circumstances of each case will always be different and sometimes the drafting in the lease will not always be accommodating. Seeking advice from an experienced lawyer could influence the strategy on how a party approaches and responds to a dispute. It is reasonable to imagine that the landlord in this case envisaged positive prospects of success or a worst case scenario where the AC had to be replaced at its cost. The likelihood of the Tribunal making a finding of repudiation against the landlord for failure to replace the AC system in its entirety and the subsequent loss of the value of the lease probably did not enter into the equation and was undoubtedly unexpected. Therefore, to reduce the risk of the unexpected it may be wiser for affected parties to contact their legal advisers before committing to a course of action.

Update: On appeal, the Supreme Court of Victoria overturned the Tribunal’s decision.

The Landlord in this case has been successful in appealing the earlier decision of the Tribunal.  The Supreme Court of Victoria has held that the Tribunal wrongly construed the Landlords obligations under the Lease, specifically the obligation to install an AC unit to service the Premises.  Further, the Supreme Court ruled that the doctrine of repudiation has been misapplied by the Tribunal.

The Supreme Court’s reasoning again focused on the facts and the drafting in the Lease, highlighting some important points:

  1. The Landlords obligation to install AC to service the Premises was held not to be a continuing obligation.
  1. The Landlords repair obligation (capital repairs) was held not to be an essential term of the Lease.

The drafting and the manner in which the obligations were expressed were relevant in the Supreme Court’s reasoning.

Importantly, the Supreme Court’s decision commented on the application of the principles of repudiation, emphasising that a Contract cannot be terminated by a party not willing or able to perform its own obligations under the Contract.  In this case, the Tenant was also in breach for failing to enter into the requisite maintenance contract for the AC.

If you would like to know more about your obligations and responsibilities as a landlord, please get in touch with George Kordis or reach out to our Real Estate Team.