Retail and Commercial Leases still protected by COVD-19 Relief Regulation
A recent decision in the Supreme Court of New South Wales has provided further insights into the operation and interpretation of the Mandatory Code of Conduct for retail and commercial tenants impacted by the COVID-19 pandemic.
- Despite the COVID-19 relief Regulation* being repealed, Landlords and tenants have continuing obligations to comply with the NSW Regulation, so long as the lease is an impacted lease.
- The NSW Regulation requires both the tenant and landlord to renegotiate rent in good faith. If the landlord has failed to do this, the landlord is perpetually barred from taking any action against the tenant to recover any shortfall in rent.
- The NSW Regulation takes into account the tenant’s capacity to pay rent during the COVID-19 pandemic. It would be entirely counter-productive for the good faith obligation to require a tenant to continue to pay full rent, until the landlord and tenant reach an agreement.
Background – Darzi v Nolde Case
Many business owners operating their businesses from leased premises are currently dealing with the impacts of COVID-19 outbreaks and lockdowns, and their ability to survive financially.
The subject of a recent case, Darzi Group Pty Ltd v Nolde Pty Ltd  NSWSC 774, was of lease disputes between a tenant and a landlord involving the operation and interpretation of the Mandatory Code and the NSW Regulation.
Darzi Group Pty Ltd (Darzi) was the tenant operating a restaurant business on the ground floor of a hotel owned by the landlord, Nolde Pty Ltd (Nolde).
Darzi and Nolde had a history of legal proceedings between them. In 2019, the NSW Court of Appeal held that the parties had entered into a retail shop lease when Darzi took possession of the premises in 2014. The lease term was for five years, with an option to renew for a further five years and three months.
This case arose when Darzi exercised its option to renew in 2019. Instead of granting this option to Darzi, Nolde served a section 133E Notice under the Conveyancing Act 1919 (NSW) to Darzi, with the effect that Darzi’s entitlement to exercise the option to renew was extinguished on the grounds of a breach of the lease.
Darzi sought an order from the Court for relief against the effects of the section 133E Notice and a declaration that it had exercised the option to renew the lease.
Nolde withdrew the first section 133E Notice and served a further section 133E Notice, for failure to pay outgoings payable under the lease.
Darzi made a cross-claim against Nolde, arguing that Nolde refused to renegotiate the rent and other terms of the lease as required by the NSW Regulation.
Renegotiation of the Lease under the NSW Regulation
Darzi provided Nolde with the following information and documents, which demonstrated Darzi was an ‘impacted lessee’, and requested renegotiation of its rent:
- JobKeeper enrolment confirmation;
- financial statements showing Darzi’s annual turnover was less than $50 million; and
- income statements from the months of April 2019 and April 2020 showing a decline in turnover.
Darzi paid the May 2020 rent in accordance with the reduction it considered was applicable under the NSW Regulation.
Nolde rejected that Darzi was an ‘impacted lessee’ under the NSW Regulation. Nolde then sent a letter stating that Darzi did not provide sufficient information about its eligibility as an ‘impacted lessee’ and requested it provide additional information, including:
- a confirmation from the ATO that Darzi qualified for the JobKeeper Scheme;
- a full copy of the financial statements for the 2018 and 2019 financial years;
- a statement of financial performance outlining the income, expenses, assets and liabilities of Darzi, audited or certified by a chartered accountant;
- a year to date statement of financial performance for the business, and a statement of financial performance for the 2019 and 2018 financial years;
- monthly turnover reports, profit and loss reports and balance sheet from 1 April 2020 to date, generated from an accounting system including all supporting sales reports;
- monthly turnover reports, profit and loss reports and balance sheet for the business for the corresponding period from 1 April 2019 to date, generated from an accounting system and relied upon to prepare Darzi’s tax returns, including all supporting sales reports; and
- any information on business interruption insurance that Darzi held.
Nolde required Darzi to pay the rent in full until Darzi provided all the information requested, and until they reached an agreement on rent relief. Nolde also served Darzi with a section 129 Notice under the Conveyancing Act 1919 (NSW), specifying that Darzi breached the lease by paying reduced rent in May 2020 without Nolde’s prior agreement, and without providing sufficient evidence that Darzi was an ‘impacted lessee’.
Darzi argued that the information requested by Nolde went far beyond what was required to comply with its obligations under the NSW Regulation.
The Court considered the conduct and attitude of both Darzi and Nolde during the rent relief renegotiation with reference to the requirements of the Mandatory Code and the NSW Regulation.
The Court found that:
- The amendment to section 88(1) to the Retail Leases Act 1994 (NSW) had the effect that the NSW Regulation continued to apply, despite its repeal, to anything occurring in relation to a lease while the tenant was an ‘impacted lessee’.
- The effect of clause 7 of the NSW Regulation was that a landlord was “perpetually barred” from taking any prescribed action to recover any shortfall in rent paid, if that landlord did not comply with its obligations to renegotiate the rent in good faith. The Court concluded that there was nothing in clause 7 that limited the duration of the prohibition on the landlord’s conduct.
- As a consequence of Nolde’s breach of its obligations to renegotiate in good faith, Nolde will never be entitled to take a prescribed action against Darzi in respect of the shortfall in payment of rent.
- It was unreasonable for Nolde to require Darzi to provide extensive financial information when the information that had been provided for the purposes of good faith renegotiations was sufficient to establish the fact that Darzi was an ‘impacted lessee’ under the NSW Regulation.
- The Court determined that, given the urgency of the situation, tenants would not necessarily be required to provide extensive financial information to landlords, particularly if that information was not readily available and had to be prepared on a bespoke basis to satisfy a landlords’ request.
- It was not correct that a tenant must continue to pay rent until such time as the renegotiation process had been completed, and the landlord had agreed to the reduced rent.
- The Court considered that Nolde’s submission was contrary to the primary objective of the Mandatory Code. The Mandatory Code assumes that a tenant’s capacity to pay rent may, in fact, be immediately affected by the COVID-19 pandemic. It would be entirely counter-productive for the good faith obligation to require the tenant to continue to pay full rent until the landlord and tenant reach an agreement.
Interestingly, the Court also made a comment that certain conduct may be regarded as unconscionable (for example, in a situation where a landlord caused substantial loss to a tenant by ignoring its obligations under the Mandatory Code, and obliging the tenant to continue to pay full rent on a protracted basis without engaging in the required good faith obligations). However, this issue will be considered by the Court only when it arises.
Landlords and tenants should consider how they conduct themselves during the process of rent relief renegotiations and ensure that they comply with their good faith obligations under the Mandatory Code and delegated legislation. If a landlord breaches these obligations, that landlord may not be entitled to recover rent or any shortfall in rent from the tenant.
Whilst this was a case decided in NSW, it may have implications for the way in which Courts deal with similar circumstances in other States and Territories.
If you are a tenant or a landlord involved in a lease dispute, we can assist you in obtaining a satisfactory and commercial resolution. We are experts in dispute resolution and would be happy to provide you with specific advice on the best course of action available.
For further information, please do not hesitate to contact us.
Craig Higginbotham and Richen Mojica
26 July 2021
* Retail and Other Commercial Lease (COVID-19) Regulation (No 1 to 3) 2020 (NSW) (NSW Regulation)