Australia: Rectification to the rescue – when can landlords and tenants have an error in a lease corrected?

Services: Real Estate & Construction
Industry Focus: Real Estate & Construction

What you need to know

  • When a lease or other contractual document contains an error, the parties may be able to rely on the doctrine of rectification to seek a court order for that error to be fixed. Where a party seeks rectification based on unconscionability, it will need to satisfy a range of factors which include proving that the other party knew of the error and failed to raise it.
  • In other cases, an error in a lease or other contractual document may be corrected where a term is so wrong that it is 'commercially absurd'.
  • Despite the availability of these options to assist parties in correcting an error in a signed lease, the far better option is for those parties to ensure care is taken in the drafting and negotiation of the agreement to avoid the inclusion of errors in the first place.

The silly season is upon us and with that comes a greater emphasis on just 'getting the deal done' before year's end. While remedies are available to contractual parties where mistakes have been made in finalising deal documentation, they can be costly to resolve. Proper care therefore needs to be taken to ensure that final documents truly reflect what was agreed between the parties.

On that note, what can landlords and tenants do if they uncover a term in a lease that one of them thinks wasn't what was agreed or intended?

It is a commonly held belief that once a lease has been executed nothing can be done to correct what one party regards as an error. Although the courts are hesitant to alter any commercial agreement that has been negotiated and agreed between two parties, there are still options available.

One such option is to seek an order for rectification.

Recap on rectification

The doctrine of rectification has developed to provide equitable relief to address the unconscionability of a party deliberately benefitting from another's mistake. For a claim to be successful, a claimant must demonstrate that:

  1. at the time of execution, it believed the lease included or excluded a particular term
  2. the other party knew the term had been included or excluded, and also knew that the inclusion or exclusion was due to the claimant's own mistake
  3. despite the other party being aware of the mistake, it failed to notify the claimant
  4. the party will benefit from the claimant's mistake.

When might rectification be ordered?

Casquash Pty Ltd v NSW Squash Ltd (No 2)1clearly demonstrates the type of situation in which rectification will be granted.

In that case a lease had been agreed and executed by the parties but, due to minor technicalities, there were difficulties with its registration. The tenant then re-drafted the lease, with the landlord believing that the only amendments were to address the registry's requirements. Instead, the tenant made material changes to the outgoings item in the reference schedule, resulting in liability falling on the landlord to pay for outgoings. This amendment reversed the position agreed with the landlord, that the tenant would be liable for outgoings. For efficiency's sake, the landlord executed the second lease, subject to review against the original.

On review of the second lease, the landlord noticed what they categorised as typographical errors and advised that it was acceptable for them to simply amend by hand and initial the changes. The landlord testified to initialling the changes, leading them to believe that the errors had been corrected. However, the version of the lease that the tenant subsequently registered did not contain the corrections. Instead, the tenant had deliberately lodged the earlier lease that the landlord had executed prior to their review. Justice Pembroke stated that the tenant's "conduct was not merely sharp, it was dishonest"2 and ordered the lease to be rectified.

This case clearly demonstrates that the key is proving the other party has engaged in sharp practice. Many claims have failed because the party seeking rectification has been unable to provide such proof.

When might rectification be refused?

In the case of Terceiro and Anor v First Mitmac Pty Ltd3 the landlord failed in its attempt to obtain an order for rectification despite the lease containing an alleged mistake. For three years, the landlord increased the rent by 7.5% on an annual basis. The tenant then complained that this was not consistent with the rental review clause, which stipulated increases would be proportionate to CPI. The landlord sought to validate the increases through rectifying the rent review clause, arguing that it was the parties' intention for the rent to increase by CPI or by 7.5%, whichever was the greater.

The tenant adduced evidence that while the initial draft lease referred to the fixed increase, during negotiations the tenant had requested rent reviews be limited to CPI and an alternative rental review clause was proposed. The updated clause was eventually included in the lease. The court held that there was no justification to suggest the tenant had deliberately misled the landlord, and rectification was therefore not possible in these circumstances.

Commercial absurdity

It may not be necessary to show sharp practice in circumstances where, upon the proper construction of a term, the result is so absurd that it could not have been intended by the parties and must have arisen from a common mistake.

For example, in Westpac Banking Corp v Tanzone Pty Ltd4 the rental review clause stipulated that rent would be increased pursuant to the following formula. The new rent would be equal to:

R x x/y , where:
R = the amount of rent payable immediately prior to the review date
x = CPI for the quarter last preceding the review date
y = CPI for the quarter last preceding the commencement date

The literal interpretation of the rental review clause would allow the landlord to exponentially increase the rent as the term unfolded. This is because by comparing the current CPI to the CPI at the commencement of the lease, the landlord would be benefitting from the increase that had already been taken into account at the previous review date.

For the first four rent reviews, the landlord increased the rent through comparing the current CPI with the CPI increase over the previous two year period rather than what the rental review clause stipulated.

By the fifth rent review date, the property had been sold and the new landlord sought to increase the rent by the formula provided in the clause, rather than by the method the previous landlord had used. This resulted in the rent being increased from $131,506 to $221,558, an increase of 68.5%. The tenant, unsurprisingly, refused to accept this increase and every subsequent increase.

After the seventh rent review date, the landlord sought a declaration from the court that their interpretation of the term was correct. By this point rent had increased to $741,669, which seems absurd even in today's property market. The tenant argued that:

  • it was never the parties' intention to create this outcome
  • the formula's failure to specify that the rent would increase by reference to the previous two year period, instead of by reference to the commencement date, was clearly an accidental omission.

In reaching its decision, the court highlighted that the true absurdity appeared if the formula was applied to each rent review period. By 1999 the rent would have increased from the initial $69,404.25 to over $39 million and it was "unlikely that any person in business would have taken such a chance."5 Orders were therefore made in the tenant's favour.

'Unreasonableness' not enough

It is important to note that a term must be more than merely unreasonable for a party to attract the protection of the courts. For instance, in Miwa Pty Ltd v Siantan Properties Pte Ltd6 the lease:

  • obliged the landlord to pay the tenant a lump sum of $45,000 in relation to fitout
  • contained an option to renew, which did not explicitly remove the $45,000 payment requirement.

On renewal, the tenant asked the landlord to pay a further $45,000. The landlord argued that the option to renew clause's failure to omit the payment requirement created an absurdity. The court found against the landlord, noting that "the courts have no mandate to rewrite agreements, so as to depart from the language used by the parties, merely to give a provision an operation which, as it appears to the court, might make more commercial sense."7

Key takeaway

With those end of year deadlines fast approaching, it's imperative not to rush through the negotiation and documentation of important agreements. Parties should keep in mind that, although the sound of popping champagne bottles may be as liberating as it is enticing, the cost of taking too little care with finalising a deal can bring about unintended long term effects from which the courts will only save you in limited circumstances.

Footnotes

1[2012] NSWSC 522

2 Note 1 at [35]

3 (1997) 8 BPR 15,733

4 [2000] NSWCA 25

5 Note 4 at [28]

6 Miwa Pty Ltd v Siantan Properties Pte Ltd [2011] NSWCA 297

7 Note 6 at [18]

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

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