The relationship between a landlord and tenant is like a marriage — each party promising to love, honour and obey.

But what happens when the landlord doesn’t honour the lease? Does the tenant still have to obey (i.e. pay rent)?

The New South Wales Supreme Court recently examined this issue in Ozton Pty Ltd v Cromwell Seven Hills Pty Ltd [2016]. In this case, the Court looked at the landlord’s right to call on security in the form of a bank guarantee when the tenant stopped paying rent.

What Happened?

Ozton Pty Ltd was the tenant of five commercial premises located in Northpoint Tower, North Sydney. Ozton Pty Ltd subleased four of the five premises to other companies. Cromwell Seven Hills Pty Ltd as trustee for the Cromwell Northpoint Trust (Northpoint) owned the building.

In early 2016, Northpoint began redeveloping and renovating the building (the Redevelopment).

Ozton Pty Ltd was unhappy with the redevelopment proposal, arguing that:

  • the works would disrupt their right to quiet enjoyment; and
  • Northpoint would be using the remainder of the adjoined premises not leased to Ozton Pty Ltd in a manner that would undermine Ozton’s business.

Instead of continuing to pay rent and lodge an objection, Ozton Pty Ltd simply stopped paying rent.

Northpoint maintained that the tenants must comply with the lease and demanded the rent. They threatened that if Ozton Pty Ltd didn’t pay, they would take the rent from the bank guarantees that Northpoint held as security.

Ozton Pty Ltd commenced proceedings to obtain an interlocutory injunction to stop Northpoint from using the bank guarantees for rental arrears.

What Were the Legal Issues?

The Court considered two questions.

1. Could Ozton Pty Ltd withhold rent or claim an equitable set-off?

The lease included an express clause that prohibited any rent set-off regardless of reason. Under the lease, the landlord could also call on the bank guarantee if the tenant defaulted on rent.

2. What remedy was available to Ozton Pty Ltd?

Ozton Pty Ltd argued that Northpoint had breached the lease and that damages were not enough because the loss might be so severe that its subtenants might stop paying rent, abandon their sublease or claim damages against Ozton because of the Redevelopment.

What is an Equitable Set-Off?

Because the lease in dispute expressly stated that a rent set-off was not allowed, Ozton Pty Ltd could not rely on the common law (i.e. case decided precedents) to make the argument. Instead, Ozton argued that they had an equitable right to set-off. The circumstances must be such that it would be unjust or inequitable not to allow the set-off.

A right to set-off allows one party to apply a debt that they are owed to discharge all or part of the debt they owe. The right can be expressly written or implied into the contract. It typically arises in the context of building and construction.

What Did the Court Decide?

In this case, the Court did not allow the injunction. They decided that the leases demonstrated that the parties both intended for Northpoint to have the benefit of the rent for the term of the lease – despite any disputes that may arise along the way.

The Court went on to say that, if parties to a contract want to stop an equitable set-off argument — like Ozton Pty Ltd’s argument — the parties must include clear, express wording in their lease (or agreement). This means an expression that payment must be made ‘without set-off’ will operate to exclude an equitable right to set-off. Parties should then pay careful attention to the drafting of the lease and other types of contracts.

The Court further considered that Ozton Pty Ltd would not suffer a loss if Northpoint called on the guarantees and that damages would have been a sufficient remedy. As a result, the injunction was not required as it was not ‘urgent’.

Ozton Pty Ltd highlights how a dispute over a redevelopment can escalate if parties do not address these issues at the time they enter into the lease.

In some circumstances, enforcing a contractual term in a lease that prohibits a party from taking action to prevent loss regardless of default can seem unfair. Courts will, however, consider the likely loss, the terms of the agreement and the surrounding circumstances.