What financial exposure does a director undertake by providing a personal guarantee the performance of a commercial property lease?

The Supreme Court of NSW has ruled upon the question of the director’s liability to the landlord pursuant to a personal guarantee given in a commercial property lease in the decision of Padstow Corporation Pty Ltd v Fleming (No 3) [2013] NSWSC 24, handed down on 30 January 2013.

Justice Gzell has provided a detailed analysis of what damages are recoverable by a landlord against a director under a personal guarantee. 

The director guarantees in the lease

The landlord, Padstow Corporation Pty Ltd, was the trustee of a private investment syndicate.  The tenant was a private company, Hamola Crochet Pty Ltd. The director guarantees were given by Tom Fleming Snr and Tom Fleming Jnr.

The lease commenced on 1 September 2004, at an initial rent of $42,500 + GST per month, with annual CPI increases. The term was 8 years.

The director guarantees in the lease were –

Clause 13.2 The guarantor guarantees ... all the tenant’s obligations (including any obligation to pay rent, outgoings or damages) under this lease ...

Clause 13.5 If the tenant is insolvent and this lease ... is disclaimed ... The landlord can recover damages for losses over the entire period of this lease ... but must do every reasonable thing to mitigate those losses ...

In the principal judgment (no 2) [2011] NSWSC 1572, the court upheld the validity of the personal guarantee given by Tom Fleming Snr and Tom Fleming Jnr.

The guarantee was not limited in any way. But the lease did provide that the guarantors could discharge their personal surety by the lodgement of a security bond equivalent to 3 months rental.

The commercial background was that the lease was entered into as part of a property sale and leaseback arrangement. Instead of applying the net proceeds of sale as working capital in the business, and to pay the security bond, the directors paid the net proceeds of sale to Tom Fleming Snr as part of a retirement strategy. The failure to lodge a security bond proved to be costly for Tom Fleming Snr and Jnr because they remained financially exposed under their director guarantees.

The tenant defaults

On 22 January 2008, liquidators were appointed to the tenant.

Shortly afterwards the bank appointed receivers under its debenture charge.

Over the next two months the liquidators finalised the work in progress and the receivers sold the stock, plant & equipment. The liquidators paid the rent during that period. Once the premises were cleared out, the liquidators disclaimed the lease.

On 22 April 2008, the landlord entered into possession. 

The damages recoverable against the guarantors

In Padstow, because the director’s guarantee was unlimited, the court examined the full extent of the damages recoverable.

The Court ruled that the landlord’s claim for rent and outgoings due pre-liquidation were recoverable. Post-liquidation, the landlord’s claim was for damages.

The Court examined the landlord’s claim for damages under these heads –

  1. Pre-liquidation damages – general – The court ruled that legal costs incurred in obtaining legal advice as a result of non-payment of rent were recoverable. The sum was $3,855.05.
  2. Post-liquidation damages – general – The court ruled as recoverable - legal costs incurred for advice on the early termination of the lease; a leasing fee invoiced for securing a tenant; electricity and rubbish removal charges. The court rejected a quotation for a marketing campaign for a tenant because it was not an invoice. The cost of repairs and maintenance and fire safety / security expenses were accepted by the tenant. The total was $89,696.78.
  3. Post-liquidation damages for loss of bargain– The court awarded damages calculated as the rent due from 22 April 2008 (when the landlord took possession) until 26 February 2010 (when the sale of the property was completed). There was no dispute that the landlord had mitigated their loss by re-renting the property, although the rent was less than in the former lease.
  4. Post-liquidation damages for capital loss on sale The landlord claimed both loss of rent from the date of sale (26 February 2010) until the date the lease was due to end (30 September 2012), and also loss in capital value on sale. The court ruled that to claim both would be double-dipping. The court ruled that as the property had been sold, the landlord was to be awarded only the diminution in the capital value of its asset on sale, a sum of $90,000, and not to the loss of rent for the remainder of the lease, a sum in excess of $400,000.
  5. GST on the damages – The landlord claimed GST on the damages awarded. The court noted – The Commissioner of Taxation accepts that an award of damages by a court and its payment is not a taxable supply by the court; and made reference to the ATO’s GST Ruling – GSTR 2001/4 paragraph 60 [a court in giving judgment, does not make a supply for GST purposes]. 

The landlord invited the court to go behind the judgment, and submitted that the apportionment of the damages according to the heads of damage provides a sufficient nexus between the amount awarded and a supply for GST to be payable; and made reference to paragraph 116 of the ATO’s GST Ruling [Where a court order ... dissects and itemises the payment into the heads of claim relating to the individual supplies and / or item of damages] then GST may be payable on those supplies.

The court rejected that submission in strong terms – In my view, that is wrong. An award of damages made by a court is payable solely in consequence of the court’s order, not in consequence of the underlying dispute. Refer paragraphs 33, 34 & 35 of the judgment.

  1. Interest – The court awarded interest on the default rate of 12 % pa in accordance with the rate payable under the lease, rather than the court interest rate which was lower.

Conclusions

The quantum of damages recoverable by a landlord for breach of a lease is assessable under a number of heads - legal fees, marketing and advertising fees, loss of rent to date of sale and diminution of capital value at sale. The damages are to be calculated without GST if they are part of a court money order.

Legal advisors acting for a tenant need to take particular care when providing an explanation to directors who have agreed to give personal guarantees to secure the obligations of a corporate tenant. The explanation must involve the quantum of damages recoverable by a landlord for breach of a lease. Legal advisors should take special care to advise that the director guarantees given should be capped, or able to be discharged if a security bond of equal value to the capped amount is lodged.

Legal advisors acting for a landlord which is considering the sale of the property with a lease which has ended by re-entry need to take particular care. They should advise the landlord that if the property is sold, their claim might be limited to loss in capital value on sale of the property, as opposed to retaining the property and claiming loss of bargain until the lease was due to end.