Business failure is an unfortunate reality that most landlords are required to deal with from time to time.  Often landlords are left in very difficult situations when a lessee’s business fails, particularly where the lessee is unable to carry out its obligations under a lease with a significant term left to run.

This raises the question: what rights are available to a landlord when a lessee has been forced to prematurely bring leasing arrangements to an end? In the recent case of Sentinel Countrywide Retail Ltd v PC Emerald (Qld) Pty Ltd [2015] QSC 348, the Queensland Supreme Court dealt with precisely this issue.

In this alert, Partner James Bottomley, Solicitor Kerrod Giles and Law Clerk Bridie Feehely examine this decision and analyse the guidance it provides for landlords facing these situations.

Background

PC Emerald (Qld) Pty Ltd (the lessee) leased a premises in a shopping centre located in Emerald, Queensland.  The lessee operated a pizza store from the premises.  The lease was for a term of seven years, commencing on 1 February 2014 and expiring on 31 January 2021.

Between 1 July 2015 and 30 October 2015, the lessee’s business began operating at a significant loss.  Further losses were also forecast for the period of November 2015 to January 2016.  In view of those projected losses, the lessee decided that the business should cease trading.

Subsequently, the lessee notified Sentinel Countrywide Retail Ltd (the landlord) of its intention to cease trading from the premises.  The landlord then served the lessee with a notice, demanding that it recommence trading from the premises, but the lessee continued to close the store operating from the premises.

The landlord then commenced proceedings to obtain a mandatory injunction that would require the lessee to recommence trading from the premises during the trading hours of the shopping centre.

Established practice

In order for a court to grant an injunction compelling a lessee to trade, “exceptional circumstances” must exist.  Injunctions will not be ordered if damages are an adequate remedy. Traditionally, courts have been reluctant to make orders compelling a party to act in a way that may not be commercially viable. The other practical consideration is that Courts do not wish to be put in a position of potentially being required to monitor the future performance of the lease contract, where the terms of an injunction requiring the lessee to trade (if granted) would usually require detailed performance conditions to be imposed by the Court.

Here, the landlord alleged that the circumstances surrounding the dispute were so exceptional that the granting of an injunction compelling the lessee to continue trading was warranted.  Conversely, the lessee argued that there were no exceptional circumstances that would permit the court to make such an order.

Issues at trial and the landlord’s contentions

At trial, the landlord claimed that damages were not an adequate remedy and that exceptional circumstances existed because:

  • the closure of the lessee’s store would have ongoing detrimental effects on the landlord that were unlikely to be quantifiable;
  • in the alternative, even if the loss sustained by the landlord could be quantified, there was a significant risk that the landlord would not be able to recover its losses from the lessee; and
  • an injunction could be drawn with sufficient specificity so as to remove the risk of further litigation occurring with respect to the lessee’s mandatory continuation of trade.

Outcome of the proceedings

Inability to quantify loss

The Queensland Supreme Court dismissed the landlord’s argument that damages were not capable of being quantified.  Justice Applegarth found that although in this instance it may be difficult to quantify damages with precision, it did not mean that damages were not an adequate remedy.

In addressing the damage sustained by the landlord, Justice Applegarth found that there was no evidence that the lessee’s business was crucial to attracting a large number of customers to the centre or that its closure would significantly impact the centre’s trade.  In drawing that conclusion, Justice Applegarth specifically pointed to uncontested evidence that 90 per cent of the trade conducted by the lessee’s business occurred at times when other shops in the centre were closed.

Suggestions by the landlord that the closing of the lessee’s business would affect the landlord’s plans to develop a “food precinct” in the centre were similarly dismissed as there was no evidence that the landlord’s plans could not continue without the lessee.

Inability to recover losses

The landlord then argued in the alternative that, even if damages could be quantified, damages were not adequate because there was a significant risk that the landlord would not be able to recover its losses should the lessee be permitted to cease trading.  The landlord’s submissions on this point rested on the fact that the lessee company was set up solely for the operation of the lessee’s business and otherwise had no substantial assets.

Justice Applegarth acknowledged that although the nature of the lessee company might prevent the landlord from recovering any damages, the risk faced by the landlord had arisen out of the landlord’s own commercial decision to lease the premises to an entity with no substantial assets.  Consequently, Justice Applegarth also found against the landlord on this point.

Orders and continuing litigation

Finally, Justice Applegarth outlined that, even if the landlord was successful in proving damages were inadequate, the granting of an injunction would only serve to create continuing litigation between the parties.

That was because, in considering the nature of the lessee’s business, an order governing the manner in which the lessee must operate its business may not be adaptable to the lessee’s commercial needs for the remaining five year term of the lease.  Any deviation by the lessee from an injunction would likely result in repeated applications by the landlord seeking strict enforcement of the original orders.

Additionally, Justice Applegarth pointed out that forcing the lessee to continue trading from the premises would be contrary to public policy because it would interfere with the legitimate commercial decision of the lessee to end a loss making venture, and further, could have the unintended effect of forcing the lessee’s directors to engage in insolvent trading.

Key points for landlords

Key points from this decision that should be considered by landlords when entering into a lease, or otherwise dealing with a lessee who has made a commercially justified decision to bring its lease arrangement to an end, include:

  • landlords should ensure that they conduct adequate due diligence of lessee companies and, where the lessee company does not have substantial assets, obtain a guarantee from a related entity or the lessee’s company directors;
  • where a lessee does not have significant assets, landlords may wish to consider negotiating shorter lease terms to reduce the potential loss that may be suffered should the lessee’s business prematurely fail;
  • where a lessee prematurely ends a lease arrangement for commercial reasons, the most accessible court ordered remedy for a landlord will likely be damages – however, in these scenarios, courts will generally only award compensatory damages; and
  • landlords should be aware that the more likely scenario where a court may potentially order the operator of a loss-making business to continue operating is where the lessee is an anchor tenant or major lessee who with its business, brings customers to the centre in question.  Proceedings against a lessee who does not fall into that category are more likely to fail.