Australia: Make good, 'fixtures' and the impact of the PPSA
Landlord and Tenant alert

Make good obligations in leases often bring up questions of whether various items brought onto leased premises by tenants are fixtures or chattels. This article looks at the question of fixtures and whether the Personal Property Securities Act 2009 (Cth) (PPSA) has any impact on the issue.

Background

The current trend for most commercial and retail leases is to specify a "back to base building" make good covenant which requires a tenant to remove all fitout and equipment, regardless of whether it has been installed by the tenant or the landlord. The premises are then essentially returned to an empty shell, ready for the next occupant to come in and install its own fitout.

Not being in the business of "de-construction" or "project management", some tenants elect to negotiate a make good payout with their landlord to absolve themselves of the make good obligations under the lease. The tenant will then simply remove its loose equipment and vacate the premises on the lease expiry date. However, the default position will usually be that the tenant is obliged to make good the premises prior to lease expiry.

A variation on the default position may arise where the landlord does not actually want the tenant to completely remove the fitout. For premises such as restaurants, food outlets, bars, medical centres, gyms and purpose-built industrial facilities, there may be specialised fitout which is substantial and suited to a particular use of the premises. The premises may not be lettable for any other type of business without substantial reconfiguration or capital works. In those instances, the landlord's preference may well be for the tenant to leave part, or all of the fitout in the premises.

In the case of a standard office fitout, the cost of removal may potentially exceed any value in re-using or on-selling the fitout. In these circumstances, landlords would tend towards requiring a full make good. However, in the case of a restaurant fitout for example, there is a secondary market for large equipment such as fridges, cool-rooms, ovens, fryers and the like. Here the tenant may prefer to carry out a full make good with the intention of removing and selling or re-using those valuable items. As such, there may be competing interests between the tenant who wants to remove the fitout and the landlord who would prefer that it remain on site on lease expiry.

Where a lease is not clear as to who owns certain items of fitout or the parties are in dispute about the interpretation of the make good covenant, the question may arise as to whether a particular part of the fitout constitutes a chattel or a fixture.

The law of fixtures

The law of fixtures has a long history, with the common law setting down criteria as far back as the 1872 English case of Holland v Hodgson which dealt with looms being fixed to the floor of a mill. Mercifully this article is not intended to be a dissertation on the case law in the area. Nor does it aim to provide a simple answer to the question of 'what is a fixture?' The answer to that question will necessarily depend on the specifics of each individual situation.

You might then be asking, why does classification as a fixture matter? The reason is that the case law has established a principle that anything which is properly categorised as a fixture is part of the land and therefore owned by the owner of the land, regardless of who may have originally owned the item and affixed it to the property. By installing an item of fitout in such a way that it becomes "part of the land", a tenant may change the status of the object from a chattel to a fixture and thereby (unintentionally) convert ownership of that item to the landlord.

To summarise (very briefly!) the extended case law and leaving aside the distinction between 'landlord's fixtures' and 'tenant's fixtures', on the question of whether something is a fixture, the Court generally considers:

1. the intention of the parties in affixing the item to the land, and
2. the degree of annexation.

Now you may be imagining some dated office partitions or rickety warehouse racking and questioning why they would ever give rise to any substantial dispute. Well, in some circumstances, significant amounts can be involved. For example, the modern day version of the loom issue in Holland v Hodgson arose recently in the case of In the matter of Cancer Care Institute of Australia Pty Limited (administrator appointed) [2013] NSWSC 37 (Cancer Care case). There the Court was asked to address the fixtures question in relation to two cancer treatment linear accelerators that had been installed in a medical centre premises. They had a value of almost $9,000,000. A significant loss would be suffered by the tenant (or equipment financier) if the equipment had been installed with the intention, and sufficient annexation, so as to become part of the land.

PPSA considerations

The PPSA has the potential to impact this particular area of leasing and, in an article last year (click here to view), we wrote about some points to consider. That legislation affects anything that is personal property and certainly has the potential to impact a tenant's fitout. However, the PPSA does not apply to an interest in a fixture. So, is the PPSA relevant to the fixtures issue or not?

There are two points to note:

1. Discrepancy in definitions

2. There may be a discrepancy between the definition of "fixture" at general law and the definition laid down in the PPSA. This may lead to complications in the application of the PPSA exemption relating to "an interest in a fixture". We will need to wait for some case law for guidance on the issue and whether the new legislative regime has any impact on a century and a half of case law. At this point, both landlords and tenants should consider the position carefully in relation to any fitout and, at the time new leases are being negotiated, turn their minds to the question of ownership of the fitout and what needs to be done to protect their relevant interest (both in the lease document itself, but also by lodging any registrations necessary under the PPSA).

2. Security interest over equipment

3. The Cancer Care case provides some guidance. In determining that the cancer treatment linear accelerators were not fixtures, the Court considered it relevant that the accelerators were financed and subject to a purchase money security interest. The Court said that the fact that the parties had proceeded on the basis that the tenant was able to give an effective security interest over the equipment was inconsistent with any objective intention of the tenant that the equipment would become part of the premises (as a fixture) and, as such, become the property of the landlord.

   The fact that the particular fitout was financed was relevant. It was not determinative of the items being categorised as tenant's property (i.e. not fixtures), but it was one of the factors considered by the Court as supporting that result. This may raise some concerns for landlords who are themselves financing fitout or approving certain fitout on the basis that it will remain in the premises after the tenant leaves.

Landlords should carefully consider whether there are any PPSA security interests relating to that equipment. This is important because, firstly, if the landlord is also acting in the capacity of financier, a failure to register may result in another prior registered security holder defeating the landlord's interest. Secondly, another party's registration of a security interest may be indicative that the equipment is not intended to be a fixture.

Although it did not necessarily break any new ground, the Cancer Care case is a thorough and useful examination of the general law of fixtures, even though it did not directly address the potential discrepancy between the case law and the definition of 'fixture' in the PPSA. It acts as another prompt to both landlords and tenants to turn their minds to the impact of the PPSA and assess whether their standard leasing practices need to be reviewed.

Key considerations

For landlords: If any part of a tenant's fitout is being financed or contributed to by you as a landlord, where that particular fitout constitutes chattels (or if there is any doubt as to whether the fitout will actually become a fixture), you should consider the impact of the PPSA and seek advice as to whether you need to lodge a financing statement to protect an interest in the relevant fitout. Remember, simply because you are acting as a landlord does not mean that you are not also acting as a financier under the terms of the PPSA. If that is the case, the Court will apply the rules of the PPSA in relation to priority claims and, potentially, in relation to the interpretation of what constitutes a fixture.

For tenants: If you as a tenant are attaching or affixing items of fitout to premises in any significant way, but do not intend those items to become fixtures, you should address this issue with the landlord at the lease negotiation stage or, at least, prior to installation. It is always a good idea to include a specific acknowledgement as to ownership, either in the lease documentation or by other agreement.

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.