Australia: When the end is nigh: terminating leases and agreements for breach of contract

When the end is nigh: terminating leases and agreements for breach

Breach of a lease or other agreement is a serious matter. This article examines some aspects of the right to terminate for breach, and how the relevant language in a lease or agreement should be understood.

When can you terminate?

Where a breach of contract has been established, the innocent party may have a number of options. It can claim for damages or specific performance (being an order from the Court that the defaulting party must comply with its obligations under the contract), or in some cases, it can terminate the agreement. The particular obligation breached and the extent of the breach itself will determine which remedy is available.

An innocent party's right to terminate an agreement will arise where there is a contractual provision which confers that right, or where there is a breach or repudiation triggering the right under common law. A common law right to terminate will arise in three circumstances:

1. breach of an essential term
2. repudiation of the agreement by a party
3. a sufficiently serious breach of a non-essential term.

When courts assess the obligations created by an agreement (looking at the agreement's terms and their classification), as well as the consequent seriousness of a breach, they will primarily seek to interpret the parties' intentions based on the contents of the documentation itself.

Essential terms

Essential terms are considered 'conditions' of an agreement. Any breach of an essential term gives the innocent party the right to terminate and recover loss of bargain damages, as demonstrated in the case of Shevill v Builders Licensing Board (1982) 149 CLR 620) (Shevill's case). This means that the innocent party may claim damages not just for losses suffered up to the date of termination, but also for future loss arising from the breach (subject to the duty to mitigate that loss). The test for whether a term is essential is: would a party not have entered into the agreement without the assurance of strict or substantial performance of the condition? ¹

It is worth noting that breach of an essential term entitles, but does not require, innocent parties to terminate. Depending on the circumstances, some innocent parties may elect not terminate but to seek specific performance instead.

Since Shevill's case, most landlords seek to specify in their leases which particular clauses are essential terms to avoid later dispute in this regard.

Repudiation

When a party's conduct shows that it does not intend to perform its obligations under an agreement, this may amount to a repudiation of the agreement. Determining what will actually amount to repudiation will depend on the circumstances.

In last month's alert, we considered the case of Lagouvardis v Brett and Janet Cottee Pty Limited[1995] ANZ ConvR 590. There, the landlord's failure to prevent dust from entering the tenant's workshop was considered to amount to repudiation, entitling the tenant to terminate the lease and to recover damages with no liability for rent for the remainder of the lease term.

This can be contrasted with the unreported case of Arlone Pty Ltd v Teller Properties Pty Ltd [1995] (at paragraph 30). In that case, the tenant directed its agent to withhold rental payments to the landlord until a dispute about local authority requirements had been resolved, and the landlord subsequently terminated the lease due to the rental payments being withheld. The Judge held that the landlord's termination was invalid as the tenant's actions in withholding rent for three months did not amount to repudiation of the lease. This was because it did not evidence a sufficient intention on behalf of the tenant that it would not be bound by the lease. It is important to note that there was no clause in the lease stating that payment of rent was an essential term. The lease also did not contain any clause precluding the tenant from setting off against its rental payments any money owed by the landlord to the tenant.

Non-essential terms

A sufficiently serious breach of a non-essential term which "goes to the root of the contract", or a breach which "substantially deprives the innocent party of the benefit of the contract", could entitle the innocent party to terminate the contract. ²

To more accurately define the parties' intentions as to what amounts to a serious breach, words such as 'substantial' or 'material' will typically be used in commercial agreements to refine the scope of phrases such as 'adverse effect'. For example, a clause that gives the landlord a right to subdivide the land only if this does not have an 'adverse effect' on the lessee clearly provides a restricted or limited right to subdivide. The level of restriction that is imposed, however, may depend upon the interpretation of any qualifying adjectives such as 'material', 'significant' or 'substantial'.

As issues of interpretation frequently arise in relation to non-essential terms, there is often considerable negotiation when documents are being prepared as to the particular qualifying adjectives to be used.

Where the meaning is not clear from the document itself, courts may interpret contractual terms having regard to the commercial context and purpose. Courts will ask: what meaning would a reasonable business person, imbued with all the background knowledge available to the parties, attribute to these words? This was demonstrated in the case of Schenker & Co (Aust) Pty Ltd v Maplas Equipment and Services Pty Ltd [1990] VR 834 (Schenker & Co).

The table below provides some guidance about the way in which courts have approached the interpretation of particular qualifying words:

Key takeaways

The following guidelines emerge from the cases:

• Breach of an essential term gives an innocent party the right to terminate an agreement and claim loss of bargain damages. Parties should therefore pay close attention to clauses which are specified in the lease as essential terms.
• Repudiation may only take effect when a party's failure to perform its obligations under an agreement clearly demonstrates that the party intends not to be bound by the agreement.
• The courts will, where appropriate, interpret the wording used in commercial agreements having regard to what a 'reasonable business person' would take those words to mean.
• The use of the qualifying word 'material' may import a subjective element, allowing courts to consider the affected interests of the innocent party.

Footnotes

¹Tramways Advertising Pty Limited v Luna Park (NSW) Pty Limited (1938) 38 SR (NSW) 632 at 641–2; Koompahtoo Local Aboriginal Land Council v Sanpine Pty Ltd (2007) 233 CLR 115).
²Koompahtoo Local Aboriginal Land Council v Sanpine Pty Ltd (2007) 233 CLR 115)