Recently, the High Court handed down judgment in the case of Gnych & Anor. v Polish Club Limited [2015] HCA 23, addressing the contentious question: can a landlord be bound by a lease that has not been reduced to writing and that breaches legislation? Although seemingly counter-intuitive, the answer in this instance was a resounding “yes".

In this alert, Partner James Bottomley, Associate Justin Raiteri and Law Graduate Kerrod Giles discuss the reasons behind this decision and highlight the timely reminders provided in this judgment for landlords dealing with potential lessees. 

Background

The Polish Club Limited (the lessor) operated a licensed, two-storey building in the suburb of Ashfield, Sydney.  In August 2011, Jacek and Sylwia Gynch (the lessees) contacted the lessor with an offer to open a restaurant on the first floor of the building.

The lessor and lessees agreed in principle that the lessees would be granted a lease over part of the first floor (the Premises). It was also agreed that the lessees would have non-exclusive use of an adjoining hall area for overflow customers of the restaurant.

However, the lease negotiations were never finalised - no lease term was agreed upon, nor was any written agreement signed. Nevertheless, the lessees commenced operating the restaurant on 31 March 2012. Relations between the lessor and the lessees then gradually deteriorated and on 7 July 2013, the lessor gave the lessee notice that they were terminating the arrangement.

Proceedings

The lessees commenced proceedings in the Supreme Court of New South Wales, arguing that they had a leasehold interest in the Premises despite the failure of the parties to finalise a lease agreement.

The lessees maintained that they had a leasehold interest because the lessees had occupied the Premises for one year and had also elected to extend their possession of the Premises to a total of five years in accordance with section 16(1) of the Retail Leases Act 1994 (NSW) (RL Act).

Although the lessor opposed the lessees’ claim on a number of grounds, the lessor’s primary argument was that the lessees’ right to a leasehold interest was invalidated because any leasing arrangement was in breach of section 92(1)(d) of the Liquor Act 2007 (NSW) (Liquor Act). The lessor argued that the breach arose out of the lessor’s neglect in failing to obtain the approval of the Liquor and Gaming Authority (the Authority) for the lease.

Principal Decision

In the principal decision of Gynch v Polish Club Ltd (2013) 17 BPR 32, later upheld by the High Court, the New South Wales Supreme Court dismissed the argument that the lessee’s leasehold interest was invalidated by any breach of the Liquor Act.

In addressing the pivotal issue of illegality, the Court swiftly clarified that the lessees’ right to use the adjoining room could not be invalidated by illegality because it was a non-exclusive licence, noting that under clause 92(1)(d) of the Liquor Act, approval from the Authority is only required where a right is granted by way of a lease.[1]

The Court then reasoned that although the Liquor Act had been breached in respect of the Premises, the lessees’ claim was simply that an exclusive right to use the Premises had arisen out of the parties’ conduct. The Court found that this claim did not depend on the existence or absence of any illegality. Conversely, the Court identified that the lessor was attempting to defeat the lessee’s claim to a leasehold interest in the Premises by relying on an illegality that had arisen out the lessor’s own conduct.[2] Accordingly, the Court held that the lessor could not try and reclaim possession of the Premises from the lessee by relying on its own illegal conduct.

On Appeal

The lessor then appealed to the New South Wales Court of Appeal. On appeal, the Court accepted that a lease under general law had been created. This was because the parties had agreed on rent for the Premises and a term of exclusive occupation had been created by operation of the RL Act.[3]

However, the Court found that enforcing a lease that breached the Liquor Act would defeat the purpose and policy of that legislation.[4] Accordingly, the Court of Appeal overturned the principal decision.

Judgment

The lessees were then granted special leave to appeal to the High Court. The High Court confirmed the Court of Appeal’s finding that a lease had come into existence under general law in relation to the Premises even though there was no concluded agreement between the parties.[5]

In addressing the issue of illegality, the High Court upheld the principal decision, concluding that any breach of section 92(1)(d) would not operate to automatically invalidate the lease because:

  • invalidating the lease would allow the lessor to take advantage of its own wrongdoing without furthering the objectives of the Liquor Act;[6] and
  • whether the lease was to be cancelled should be a matter purely for the Authority - automatically terminating the lease would have the effect of both pre-empting the Authority’s decision, and circumventing the Authority’s disciplinary discretion, in circumstances where the lessor has acted in breach of the Liquor Act by allowing the lease of the Premises to come into existence.[7]

Key Points for Landlords

Key considerations for landlords to take into account when negotiating with prospective lessees are:

  1. incomplete negotiations may create enforceable leasehold interests for lessees. Particular caution should be exercised when permitting a lessee to occupy premises before any agreement is reduced to writing in relation to the lessee’s occupancy;
  2. illegality may not necessarily form a basis for the invalidation of a lease – that will depend on the particular legislation that has been breached and its purpose; and
  3. all states and territories, other than Queensland, require that the term of a retail lease is at least 5 years. Western Australia, New South Wales and the Australian Capital Territory specifically provide lessees with statutory options to extend retail leases to a term of 5 years, where such a lease does not initially provide for a 5 year term. The operation of those statutory options may convert a periodic tenancy into an enforceable lease for a substantial term.