Australia: Commercial leasing and consequential loss

What you need to know

• There is considerable uncertainty surrounding the extent to which consequential loss can be claimed in Australia. As a result, both landlords and tenants should carefully consider what losses they might suffer if the other party breaches their lease.
• It is important to be specific when negotiating and drafting provisions in relation to direct or consequential loss. Express covenants around the use of the leased premises can help to inform courts that certain losses may be anticipated, and it is also a good idea to include specific reference to 'loss of bargain' damages in circumstances where a tenant breaches the lease.
• Ultimately, precision drafting is key.

When a lease is breached, the innocent party may have a number of options. ¹ One such option is the right to claim damages as compensation for any loss suffered. The way in which a court may interpret terms in a lease that relate to damages can have important consequences for both parties.

In this article we look at what loss an innocent party may seek to recover where the other party breaches its obligations under a lease.

Damages and "consequential loss"

The underlying purpose of damages is to place the innocent party, so far as damages can do, in the same position as if the contract or lease had been performed. ²

Traditionally, and in line with the English authority of Hadley v Baxendale ³, courts have held that where one party breaches an agreement and the innocent party suffers loss, damages should be provided to the innocent party flowing from losses that may be classified as:

• direct loss: loss which may fairly and reasonably be considered as arising naturally, i.e. according to the usual course of things; or
• consequential loss: loss which may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract, as the probable result of the breach of it.

Accordingly, any loss suffered that could not be categorised as either direct or consequential loss was considered too remote from the breach and was not recoverable under the common law.

Consequential loss has since been the subject of considerable debate; although not necessarily being played out in the context of lease disputes. Australian courts have made it clear that in practice, a rigid approach to what forms consequential loss is inappropriate. ⁴

The Peerless Case and a shift in focus

The 2008 case of Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26 (Peerless) marked a significant change in direction to the way Australian courts interpret the meaning of the words "consequential loss" in commercial agreements. The Victorian Court of Appeal in Peerless saw the true distinction as between:

• normal loss: which is loss that every plaintiff/claimant in a like situation will suffer; and
• consequential loss: which is any loss suffered beyond the normal measure.

Peerless essentially broadened the scope of what could be considered "consequential loss" in a particular circumstance. In doing so, Peerless, and subsequent decisions in superior courts of South Australia, ⁵ Western Australia ⁶ and most recently in New South Wales, ⁷ have created uncertainty as to how courts will interpret references to consequential loss and damages generally.

Tenant considerations

Tenants have the benefit of an implied promise by the landlord to ensure the tenant enjoys 'quiet enjoyment' of the premises. ⁸ However, prudent tenants may seek to impose additional more specific obligations on their landlords, especially in relation to the tenant's particular use of the premises.

Consider the example where a pharmaceutical wholesaler seeks warehouse premises to store medical supplies that are highly sensitive to temperature. A standard commercial lease might provide that the tenant is to take the premises in their existing state and condition and that it is for the tenant to satisfy itself that those premises will be fit for the intended purpose. In addition, there might be specific provisions restricting remedies available to the tenant for failure of services (e.g. to rent abatement alone), together with detailed releases and indemnities protecting the landlord against particular losses. ⁹

However, the wholesaler (being a prudent tenant) might require provisions obliging the landlord to maintain the temperature of the premises within a certain range, as well as separate covenants regarding the structural soundness and watertight qualities of the warehouse. It would be a matter of negotiation as to the consequences that would flow if the landlord breached those obligations and the medical supplies were ruined. Whilst this might be a difficult negotiation, it would be preferable for the parties to consider this issue and provide for it in the lease (including as to responsibility for insurance), rather than leave it to a court to determine where responsibility lies, what loss would be "normal" and who should bear the loss.

Landlord considerations

An important consideration for a landlord is loss of future rental income or "loss of bargain" where a lease is terminated.

Traditionally, a landlord who terminated a lease for tenant default could only claim arrears of rent up to the date of termination and not loss of bargain damages. ¹⁰ To claim loss of bargain damages, a landlord needs to show that the tenant's breach amounts to a repudiation or fundamental breach of the lease by the tenant. Repudiation and fundamental breach are legal concepts not easily inferred by conduct or circumstances. Accordingly, most leases now contain express provisions stipulating that particular covenants are essential or fundamental terms. Further clauses will provide that repudiation or breach of an essential or fundamental term by the tenant will entitle the landlord to sue for the loss of the future benefits under the lease that the landlord would have enjoyed had the lease gone full term. As penalties are not enforceable at law, the mechanism for calculating loss of bargain damages will also generally take account of the landlord's duty to mitigate its loss by re-letting the premises and for present day valuation of the damage suffered. From a landlord's point of view, it is crucial that the lease contains these sorts of clauses which are often referred to as Shevill clauses. In seeking to enforce Shevill clauses, a landlord should also be conscious of being able to adequately prove any loss of bargain damages claimed, as courts will not place a landlord in a better position than if the lease was performed. ¹¹

Key takeaways

• There is uncertainty surrounding the extent to which consequential loss can be claimed in Australia
• Parties should carefully consider what losses might be suffered in given situations and how that risk is to be managed
• When negotiating and drafting provisions in relation to direct or consequential loss it is important to be specific
• Express covenants around the use of the premises, performance of the services or quality of the building inform courts that certain losses may be anticipated
• Landlords should include Shevill clauses in their leases
• Insurance should always be an important consideration for both landlords and tenants, and seeking to anticipate and allocate risk in the lease document should be used in conjunction with maintaining adequate insurances

Footnotes

¹ For more information on the options available to an innocent party please see, "When the end is nigh: terminating leases and agreements for breach", 30 June 2015, http://www.dibbsbarker.com/publication/When_the_end_is_nigh__terminating_leases_and_agreements_for_breach.aspx
² Robinson v Harman (1848) 1 Ex 850
³ (1854) 9 Exch 341
⁴ Alstom Ltd v Yokogawa Australia Pty Ltd and Anor (No 7) [2012] SASC 49; Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2] [2013] WASC; Macmahon Mining Services v Cobar Management [2014] NSWSC 502
⁵ Alstom Ltd v Yokogawa Australia Pty Ltd and Anor (No 7) [2012] SASC 49
⁶ Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2] [2013] WASC
⁷ Macmahon Mining Services v Cobar Management [2014] NSWSC 502
⁸ For more information on the covenant for 'quiet enjoyment' please see, "Quiet enjoyment – what does it mean?" 25 February 2015, http://www.dibbsbarker.com/publication/Quiet_enjoyment_%E2%80%93_what_does_it_mean.aspx
⁹ For more information on releases and indemnities please see, "Indemnities and releases under commercial leases" 17 December 2015, http://www.dibbsbarker.com/publication/Indemnities_and_releases_under_commercial_leases.aspx
¹⁰ Shevill v Builders Licensing Board (1982) 149 CLR 620
¹¹ For more information on evidence to prove loss please see, "After a tenant defaults: Proving loss of bargain damages", 29 May 2014, http://www.dibbsbarker.com/publication/After_a_tenant_defaults__Proving_loss_of_bargain_damages.aspx

This article is intended to provide commentary and general information. It should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this article. Authors listed may not be admitted in all states and territories