Australia: Surrender and unintended consequences: What happens to a sublease when you surrender a head lease?

Surrender is a commonly accepted means of enabling the handover of premises from one tenant to another and improving the income stream from those premises. This month, we set out the legal consequences on a sublease of a surrender of the head lease and provide some tips for addressing the legal issues which arise.

The legal consequences of termination vs the legal consequences of surrender

The legal consequences of the termination of a head lease on a sublease are clear and well established. As a general rule, the termination of a head lease automatically results in the termination of the sublease. This is so because the sublease is a derivative interest which is dependent on the ongoing existence of the head lease.

There is some uncertainty whether or not a notice given under an express right to terminate the head lease is effective to terminate a sublease. The decision of the Victorian Supreme Court in Adamson v Busch [1955] supports that view as do decisions which culminated in the decision of the House of Lords in Barrett v Morgan [2000]. The English decisions are likely to be followed in Australia. However, the position awaits authoritative determination.

Intuitively, one might think that a surrender of a head lease has the same result. However this is not the case. The surrender operates as a regrant by the tenant to the head landlord subject to the subtenant's rights. Unfortunately, this does not mean that the obligations of the subtenant under the sublease are necessarily enforceable by the head landlord following the surrender of the head lease. At common law, there is no privity of estate or privity of contract between the head landlord and the subtenant following surrender, but only a notional continuance of the head lease to support the subtenant's rights (subject to any express rights of termination set out in the surrendered head lease).

Legislation such as section 122 of the Conveyancing Act 1919 (NSW) remedied this situation. It enables the head landlord to enforce the obligations of the subtenant under the sublease against the subtenant following surrender of the head lease. However, it does not give the subtenant greater rights than it has under its sublease and merely preserves as against the head landlord the rights that the subtenant could have enforced against the tenant. In Cihan v Oncu [2004], it was held that this did not entitle a subtenant to exercise an option to renew against the head landlord because there was no obligation on the tenant in the sublease to exercise the option to renew the head lease in order to preserve the subtenant's option to renew the sublease.

Formal vs implied surrenders

It is common for surrenders to be formally documented in a deed. When done this way, the deed of surrender can address the question of subordinate interests such as subleases, either by way of a warranty from the tenant that there are none, or by imposing an obligation on the tenant to procure a surrender of any subordinate interests.

On the other hand, a surrender may be implied where there is unequivocal conduct by the parties to the head lease that is inconsistent with the continuance of the tenancy. Particular care needs to be exercised when the tenant is in default under the head lease and wishes to hand back the keys to premises which are occupied by a subtenant. A surrender may be implied in those circumstances.

Different results may follow depending on how the tenant's defaulting conduct is managed. Cases such as Wood Factory Pty Ltd v Kiritos Pty Ltd (1985) demonstrate that circumstances showing an implied surrender can also show acceptance by the landlord of a tenant's repudiation of the lease. In these cases, the implied surrender operates as a termination of the head lease as well as any sublease. In the absence of repudiatory conduct, cases such as Fleeton v Fitzgerald (1999) show that a head landlord needs to follow the procedural requirements of section 129 of the Conveyancing Act 1919 (NSW) to preserve any rights of termination. Otherwise, a surrender may be implied and the head landlord will be bound to recognise the sublease (although in that case, the court also held that the subtenant had impliedly surrendered its sublease).

The effect of consent

Generally speaking, lack of consent to a sublease is irrelevant to the effect of surrender of the head lease on the sublease at law. The head landlord's remedies for a failure by the tenant to obtain the consent of the head landlord are normally found in the termination provisions of the head lease and those provisions will no longer be available to the head landlord following surrender of the head lease.

Where the head landlord formally consents to a sublease, the terms of the deed of consent will normally address the question of default and regulate the remedies available to a subtenant under section 130 of the Conveyancing Act 1919 (NSW). From a practical perspective, there is no need to address the question of surrender in the deed of consent if the sublease is in the common form of a sublease incorporating the terms of the head lease. Where the terms of the sublease are completely different or radically vary the terms of the head lease, it is prudent for the head landlord to obtain a covenant from the subtenant that the sublease will terminate on a surrender of the head lease. Otherwise, the landlord may be bound by terms that are unfavourable to it. The tenant can protect itself under the terms of the sublease against claims from the subtenant arising out of a loss of the sublease through surrender. A subtenant cannot complain about the approach of the head landlord and the tenant in these circumstances as this merely reflects the precarious nature of the subleasing market.

Key takeaways

The following lessons and pointers emerge from the cases.

1. A sublease terminates on the termination of a head lease but not on the surrender of the head lease.
2. A head landlord should tread carefully in circumstances where there has been a history of default and a tenant hands back possession of the premises. The wrong approach may deprive the head landlord of any claims in damages for loss of the head lease and leave the head landlord with an unwanted tenant.
3. In certain circumstances, a deed of consent should deal with the issue of surrender of the head lease as well as default and the consequences that flow from the surrender.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.