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What you need to know
- Many retail leases include a covenant to trade, which requires the tenant to open the premises for trade during specified hours.
- Landlords need to be aware of the complexities that can arise when seeking to enforce a covenant to trade and what might be required to support an argument in favour of compelling the tenant to re-open, if it has ceased trading. Landlords may also find difficulties in enforcing a 'non-trade charge' if it amounts to a penalty.
- Tenants need to give consideration to the surrounding circumstances and the potential effect on other parties with an interest in the success of the retail centre, before taking any decision to cease trading.
Commercial and industrial leases will include various obligations governing the tenant's use and occupation of the leased premises. Depending upon the nature of the premises, the landlord may not be overly concerned about whether the tenant is trading from the premises, or even whether the premises are actually occupied. Provided the tenant is paying rent and not causing any damage to the property or otherwise being a nuisance, a landlord may be indifferent about whether or not its tenant is actually using the premises.
However, in a retail context, a landlord may be very interested in whether or not the tenant is trading. A landlord operating a retail centre is likely to prefer to have all tenants open and trading during specified hours, to ensure that customers frequent the centre and make the best use of the retail offering. "This is for obvious reasons, including the appearance of the centre, the fact that a fully-tenanted centre attracts more customers and that a partially empty centre is less appealing to customers and to prospective and current tenants."1 A retail centre that is trading well will be attractive to other potential tenants, with the long term result that the landlord is able to ensure occupancy levels, increase rents over time and maintain the capital value of its investment. An empty shop (where no obvious refurbishment is taking place) can lead to a 'domino effect' where the retail centre starts to lose its attraction to customers, more shops close and both rental income and capital value suffer.
In addition, many retail landlords require the recovery of a 'turnover rent' from tenants. This means that once a tenant's revenue from the relevant location reaches a certain threshold level, the landlord is entitled to a percentage of the tenant's turnover above that threshold. Again, continued trading during agreed hours is more likely to result in the tenant reaching the turnover threshold (triggering additional rental for the landlord), than if the tenant is not trading for extended periods of time.
It is mainly for these reasons that many landlords include in their retail leases a 'covenant to trade', being an obligation on the tenant to open the premises and trade during minimum specified hours. Some interesting questions may then arise as to what remedy the landlord has if the tenant is not trading during those minimum hours. Often, ceasing to trade may be a consequence of some other issue (such as damage to the premises which renders trade impossible or ineffective, or an associated default such as the tenant vacating without authority and ceasing to pay rent). In those situations the parties may be less concerned about the covenant to trade and more concerned about the associated issues of default, liability and cross-claims.
But what happens when a retail tenant simply stops trading, but continues to honour the other requirements of the lease including the payment of rent? This may occur in a number of situations including where the tenant is:
- looking to assign the lease and is seeking a suitable assignee
- undertaking some prolonged period of stock-taking
- temporarily ceasing to trade for personal health or family reasons.
The general rule against enforcing a 'covenant to trade'
This issue was recently explored in Sentinel Countrywide Retail Ltd v PC Emerald (Qld) Pty Ltd 2 (Sentinel) where a tenant closed its pizza shop franchise because the business was operating at a loss. Having closed, the tenant was attempting to negotiate a surrender with the landlord, but continued to pay rent in the interim. The Court summarised a general rule that "Courts never grant mandatory injunctions requiring persons to carry on business". The Court generally needs to see some exceptional circumstances in order to enforce a covenant to trade.
The landlord in the Sentinel case was ultimately unable to convince the Court that exceptional circumstances existed. The landlord failed to show that damages were not an adequate remedy for any loss suffered as a result of the closure of the pizza shop.
The Court made two interesting comments on the financial capacity of the tenant. The first was that forcing the pizza shop to continue to trade may very well have pushed the tenant into extreme financial difficulty, or even insolvency. It may be very difficult for landlords to pursue an urgent order for a tenant to recommence trading if the result would be contrary to public policy (by driving the directors of that business to a point where they may be engaging in insolvent trading).
Secondly, the Court did not accept the landlord's argument that, because the tenant was a $2 company without any substantial assets, there was a risk that the landlord might be unable to recover any damages it suffered from the tenant ceasing to trade. The Court pointed out that the risk of not being able to recover damages (because the tenant did not have the substance to pay any judgment against it) was a risk the landlord assumed when it took the benefits and burdens of a lease entered into with a $2 company.
How can a landlord demonstrate 'exceptional circumstances'?
There is some authority to suggest that the 'exceptional circumstances' threshold may be met if the tenant that has ceased to trade is one of the anchor tenants within a centre. That is, where the particular business is integral to the centre's success, it may have an unacceptably detrimental effect on the landlord and other tenants if it were allowed to continue a breach of its covenant to trade.
This is illustrated by the case of Diagnostic X-Ray Services Pty Ltd v Jewel Food Stores Pty Ltd 3 (Diagnostic). In this case, the tenant operated a supermarket and petrol station as part of a suburban shopping centre. The tenant subleased its supermarket business and, on the basis that the petrol station was not financially viable on its own, took steps to close that business. Although the tenant was seeking to sublease or assign the petrol station business, it had rejected offers it considered financially unattractive. For a variety of reasons, the Court was willing to grant injunctive relief to require the petrol station business to be carried on.
It was relevant that when the tenant took the lease of the supermarket and the petrol station, it was apparent that the petrol station was not a viable business on its own. The tenant alone decided to separate the supermarket business and the Court considered that the subsequent decision to shut down the petrol station business "was simply a management decision to restructure the operations" of the tenant. In addition, the tenant had not taken reasonable steps to seek to assign the petrol station lease to allow it to keep trading.
The Diagnostic case appears to be a relatively unique exception to the general rule. Courts will usually favour damages as a remedy under a contractual undertaking (such as a lease), rather than a mandatory injunction to require a business to carry on. Aside from the public policy considerations of not forcing businesses to trade towards the brink of insolvency, granting an injunction to require trading means the Court adopts the onerous task of monitoring and enforcing the injunction.
As a general summary, if a tenant ceases trading from leased premises in breach of an express covenant to remain open for business during specified hours, a landlord would ordinarily need to give the usual notice of default with a view to terminating the lease and/or claiming damages. However, if there are unique or exceptional circumstances which mean that damages may not adequately compensate the landlord, a Court may be prepared to grant injunctive relief and to require the tenant to keep trading.
Could a tenant face penalties for not trading?
For some landlords, the aspiration to have all tenants operative and trading is so significant that they may seek to include a clause in the lease which imposes an additional charge for any period of time when the tenant should be open for trade but is not. Although landlords would consider this 'motivation' for tenants to keep the doors open, tenants may view this as a 'penalty' (i.e. a punishment for failing to do something). Landlords should be cautious when including such clauses in leases and attempting to enforce them, as there is a long history of case law which nullifies contractual remedies that amount to a penalty.
If the 'non-trade charge' is an arbitrary figure (not related in any way to the damages the landlord may reasonably foresee from any breach of the covenant to trade), it may be difficult to see that provision as anything more than a penalty. Any clause of this type would need to be drafted as being agreed by the parties as a genuine pre-estimate of the damage likely to be suffered by the landlord arising from the tenant's default, and the landlord would need to be able to justify the methodology behind its calculations. An alternative approach (being 'carrot' rather than a 'stick') might be to provide rewards by way of incentives to the tenant for good performance. Many landlords, recognising the importance of keeping shops open, will take a commercial rather than legal approach and explore ways to assist a tenant to continue trading through what might only be temporary difficulties.
Key takeaways for landlords
- Whilst many landlords will prefer to include a covenant to trade in retail leases to ensure the continued operation of the retail centre as a whole, they should be aware that such covenants are notoriously difficult to enforce.
- Wherever possible (and where provided for in the lease) landlords should regularly collect tenants' detailed turnover information and sales/revenue figures to support any case to enforce a covenant to trade, or to at least assist in quantifying a damages claim.
- Landlords should also carefully consider any tenant requests to assign a lease or effect a sublease, and assist tenants during that process, being mindful that a less experienced assignee or sublessee may still be preferable to an insolvent tenant and closed shop.
- Any lease provision which imposes an additional 'non-trade charge' if the tenant fails to comply with its covenant to trade may be a penalty and therefore unenforceable.
Key takeaways for tenants
- If the lease includes a covenant to trade, tenants should be prepared to honour that covenant, even if it becomes financially disadvantageous.
- A decision to breach any lease covenant (including closing the premises permanently or periodically) is significant. No such decision should be taken without carefully considering the likely consequences, including the risk of the lease being terminated and/or liability arising for damages.
- Whilst a landlord may not be successful in securing an injunction to enforce a covenant to trade, that will not prevent a landlord from making a damages claim for any losses suffered as a result of the breach of the covenant to trade.
- If a tenant forms the view that it cannot continue to trade (for whatever reason), it may be in the tenant's best interests to approach its landlord on a 'without prejudice' basis to explore the options available, before ceasing to trade. Some landlords may be more sympathetic and pragmatic than tenants might otherwise think.
1 Applegarth J in Sentinel Countrywide Retail Ltd v PC Emerald (Qld) Pty Ltd  QSC 348.
2  QSC 348.
3 (2001) 4 VR 632.
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