The complexities of default notices for commercial lease breaches and termination of leases

Far too often parties to commercial leases do not comply with the terms of the lease.

This is usually in respect of failure to pay rent and outgoings, but there can be many other issues: failure to provide a bank guarantee, neglecting to undertake repairs and maintenance, failing to prevent pests and vermin, or failing to trade (where there is such an obligation).

The question then becomes, what can you do about it?

Below, we explain the options for parties to exercise their rights to seek performance of the terms of a lease, or to terminate it. While applying these principles can be complex, there are general principles that parties should consider before taking the next step.

Breach / default notices

When a party breaches a commercial lease, the first step is generally to issue a default notice. A default notice is:

• primarily used to get the other party (usually a tenant) to remedy a particular breach; and/or
• used as a prerequisite to terminate a lease.

The default notice is required to identify the legal obligation under the lease, how the obligation has been breached, what the party (usually the tenant) must do to rectify it and, finally, the consequences of non-compliance with the notice (which is often the potential termination of the lease itself).

The notice is then served under the relevant notice provisions contained in the lease. Historically, notices were served by post or facsimile. These days, most notices can be served by email if allowed under more modern leases.

Notices are required as a prerequisite step prior to termination of a lease in all jurisdictions in Australia for all breaches that do not relate to the non-payment of rent. In all jurisdictions except Victoria, the length of time that must be provided to a defaulting party to remedy the breaches set out in the notice is a "reasonable time". In Victoria it is no less than 14 days (see table below).

Most jurisdictions also have a statutory exception that if a tenant has failed to pay rent, no default notice is required prior to a landlord terminating a lease (see table below). In practice, this means a landlord can re-enter and terminate a lease if the rent has only been late for one day! Of course, most landlords would not usually take such a drastic step where it is generally in their best interests to work constructively with the tenant to keep them in the premises.

It should be noted that notwithstanding the statutory exception, many leases have terms that require a certain length of notice prior to termination, even in the case of non-payment of rent. Parties should very carefully review the terms of the lease prior to any attempts to terminate the lease.

Effectiveness of a default / breach notice

For a party to rely on a breach notice to take further steps such as terminate the lease, the notice must be prepared properly and able to stand up to any legal challenge. Unlawfully terminating a lease because the default notice relied upon was invalid can result in a significant award of damages.

Accordingly, a default notice may not be effective if:

• it does not adequately identify the breaches of the lease, what needs to be done to remedy those breaches and provide the necessary time (either under the terms of the lease or the statutory timeframe);
• the breaches alleged do not provide a right to terminate the lease; or
• the notice was not properly served in accordance with the service provisions under the lease.

It is permissible for multiple breaches of a lease to be included in a default notice. Even where a defaulting party can show that some of the alleged breaches are not substantiated, this will not necessarily invalidate the notice. If at least one breach is established that gives rise to a right to terminate the lease, the notice will be valid.

One common mistake is seeking to include the legal costs of preparing the notice in the notice itself. Most leases allow for recovery of legal costs in the event of default, however it will not usually be a "breach" if those legal costs have not been paid without a prior demand.

Conduct after serving an effective notice

It is important for both landlords and tenants to understand that certain conduct after serving a valid default notice can affect a party's right to subsequently rely on that notice. For example, a landlord is unlikely to be able to rely on a default notice if:

• an invoice for further rent payment following the notice has been rendered to the tenant (this is seen as an affirmation of the lease by the landlord);
• the landlord acts in a manner that would lead the tenant to reasonably believe that the landlord has waived the breach or elected to not rely on the terms of the breach notice;
• a significant amount of time has passed between the issuing of the default notice and when the landlord seeks to rely on it; or
• the parties have agreed to a new payment arrangement (whether it has or has not been performed).

In the above circumstances, it is generally safer to issue a further default notice than rely on an old notice, which may be susceptible to challenge.

Relief against forfeiture

Relief against forfeiture is a legal remedy that may be available to a tenant whose lease has been terminated validly and they seek to recover possession of the property. Relief against forfeiture may be granted if the breach was not serious, the tenant has taken steps to remedy the breach (such as pay the outstanding rent), and the landlord has not suffered significant harm as a result of the breach.

In determining whether to grant relief against forfeiture, the Court (or Tribunal) will consider a range of factors, including the nature and gravity of the breach, the steps taken by the tenant to remedy the breach, the impact of the breach on the landlord, and the financial circumstances of the tenant (such as whether there has been a long history of defaults under the lease).

In circumstances where this remedy is potentially available to tenants, it is important for a landlord to have evidence of the historical breaches of the tenant and, where appropriate, have served formal breach notices under the lease.

Options to renew

The relevance of an effective default notice also arises when an option for a further lease term is exercisable by the tenant, particularly in the context of retail leases.

In certain circumstances (including in respect of retail leases) it provides that the only circumstances in which a tenant’s option is not exercisable are if –

• the tenant has not remedied any default about which the tenant has been given written notice; or
• the tenant has persistently defaulted under the lease throughout the lease term and the landlord has given the tenant written notice of the defaults.

In these circumstances, a tenant's entitlement to exercise an option in a lease may turn on whether the tenant has been given notice in writing of the default or defaults.

Conclusion

Default notices and the termination of commercial leases can be complex legal issues. It is important for both landlords and tenants to understand their rights and obligations under the lease agreement and Australian law. If you are a landlord or tenant facing issues related to a commercial lease, we recommend seeking legal advice from a qualified commercial lawyer. Lander & Rogers' legal experts have extensive experience in this area and can provide tailored advice to meet your specific needs.