Long term lease, long term relationship – some key issues facing landlords and tenants

Braham v Stephan & Anor [2015] VSC 87

A recent Victorian Supreme Court case is a timely reminder that long term leases raise a number of issues that need to be considered carefully. Braham v Stephan & Anor [2015] VSC 87, which was argued over the issue of whether the tenant had repudiated the lease, or, alternatively, whether the landlord could terminate the lease, because of an unauthorised farm shed built by the tenant, illustrates some of these issues.

Braham v Stephan & Anor
In Braham, the vendor was unable to legally subdivide land in Menzies Creek, Victoria, and so sold it to the purchasers subject to a lease-back to the vendor over the northern portion of the land for 99 years at peppercorn rental of $1. The lease included an option for the vendor to purchase the northern portion of the land for $10. After the sale, the vendor registered caveats over the land to protect his interests.

During the second year of the lease the vendor (now tenant) allowed his son to build a shed on the land without first obtaining a building permit. The relationship between the purchaser (now landlord) and vendor deteriorated due to council action against the purchaser when the vendor failed to demolish the shed as directed under council orders. The purchaser attempted to end the lease, alleging that the building of the shed was an illegal act that amounted to repudiation of the lease or, failing actual repudiation, breached an intermediate term of the lease that justified termination.

Hargrave J found that the lease was not repudiated despite the vendor erecting a shed without first obtaining a building permit. As the tenant had all but full legal ownership of the northern portion of the land, "it would be a very serious thing to find repudiation in the absence of abandonment of possession for a lengthy period of time" (Braham, [41]). There had not been such abandonment.

A similar approach was taken to the issue of whether the breach justified termination and the landlord's arguments on that point were not accepted.

Due to the underlying value of the land or the improvements made by the tenant to the land, a landlord (or its liquidator) may have a strong motivation to terminate the lease, particularly if there is no rent (or only peppercorn rent) payable for the balance of the term.

However, Braham has confirmed that if a tenant’s interest in land under a long-term lease is very close to freehold title, a court will not lightly find that the tenant has repudiated the lease.

Key points in Braham indicating that the tenant’s interest was little short of a full freehold title were the:

• length of the lease term;
• peppercorn rent payable under the lease;
• lease terms - which indicated that the sale and leaseback of the northern portion of land was only a mechanism to permit the tenant to have effective ownership of the land until subdivision and the tenant's subsequent purchase of it could take place. It was clear that the landlord only intended to purchase the southern portion of the land (not subject to the long term lease) and further, the price stated on the sale contract was for the value of the southern portion of the land only; and
• contract terms - these took account of changes in planning policy during the lease to allow for subdivision and exercise of the option to purchase the northern portion of the land.

Why a long term lease?

While there is not a precise point at which a lease can be regarded as a long term lease, the key differentiating feature of a long term lease for the purposes of this article is that the tenant is essentially treated under the lease as if it were the freehold land owner and has all the obligations associated with being a freehold land owner (for example, carrying out structural maintenance and the risk of loss or damage to improvements).

There are a number of common circumstances in which a long term lease may be granted:

• when a landlord wishes to retain ownership or a degree of control of the property while still receiving an income or other benefits from the lease over a significant period of time. Examples include government-owned assets either which cannot be sold for policy reasons or where heritage issues or current and future use of the property may be of concern;
• if the land cannot be subdivided, although the laws of most States treat a grant of a lease of part of a lot for longer than a certain period as a subdivision requiring statutory approval (subject to exceptions including typically a lease of part of a building);
• where there is some taxation benefit such as avoidance of stamp duty (although the use of longterm leases as a substitute for freehold to avoid stamp duty has been limited by legislation);
• where there is a statutory regime which precludes grant of freehold; or
• where it is intended that the land as developed by the tenant reverts to the landlord at the end of the lease term.

Issues for the landlord

Although each long term lease raises its own issues, the following are some of the issues that a landlord should consider before entering into a longer term lease.

Risks associated with property ownership
The landlord will be subject to risks associated with property ownership (as illustrated in Braham) without the benefit of the income that would be gained from freehold title (where a premium is paid and no rent or a peppercorn rent is payable during the lease term). When drafting a long term lease on behalf of a landlord you would typically seek to include clauses in the lease transferring those risks, so far as possible, to the tenant.

To reduce the landlord’s risks, a long term lease might include terms to the effect that the tenant should reimburse the landlord for costs of the type of that a landlord usually bears under a lease for a shorter term. Such costs can include the cost of structural repairs to the building, necessary expenditure of a capital nature, repairing and replacing inherent defects and statutory charges for providing services or facilities such as kerbs and gutters outside the property. This is the essence of what is known as a "triple net lease"; the tenant is made responsible for all costs and liabilities as if it owned the freehold.

Changes in law
Due to the length of the lease term, landlords should bear in mind that there may be changes to the law and government policies over the term that adversely affect the landlord or the tenant. In granting a long term lease the landlord is particularly exposed to risks arising from changes to taxation laws, as was seen with the introduction of the GST. Ultimately the Commonwealth government specifically introduced transitional laws due to the widespread problem of many leases not dealing with this important change in law. However, remedial legislation may not always be enacted or put the landlord in the same position it was previously in.

There is also a risk that a change of law may bring about frustration of a lease.

Illegal and dangerous structures or activities on the land
As was the case in Braham, orders and notices issued by a council or other authority are generally issued on the landlord as owner of the land. In Braham the council successfully brought legal action against the landlord for the illegal shed constructed by the tenant, which put the landlord to the cost and expense of litigation. The lease can provide that the tenant must arrange for the relevant authorities to serve such orders or notices on it (as well as the landlord), that the tenant must comply with such notices as if it were the owner of the land and if necessary, take or defend legal action with the landlord’s consent but at its own expense. The landlord can be given the right to remedy any such default. However, there remains some residual risk for the landlord.

As the owner of the land, a landlord can also be liable for risks associated with contamination, death, injury or property damage to third party property which occur on the land. Although the landlord would usually protect itself by including indemnities in the lease and ensuring insurance was appropriately addressed and maintained, there will, again, still be residual risk for the landlord.

Control of the property
It is unrealistic for a landlord to expect that the same tenant will be in place during the term of a long-term lease and, if it is, that its ownership will be unchanged.

Some thought therefore needs to be given to the scope of any restriction on assignment and other dealings. There are also statutory constraints that are applicable (for instance under New South Wales and Queensland legislation).

Issues for the tenant

There are also important issues for the tenant to consider which include:

If the landlord is a company, a liquidator may disclaim the lease
Generally, where a lease generates income there is no incentive for the liquidator of a landlord to disclaim the lease. The position is very different when the lease no longer generates income for the landlord

Willmott Growers Group Inc v Willmott Forests Limited (Receivers and Managers Appointed) (In Liquidation) [2013] HCA 51 has confirmed that the disclaimer of a lease by the liquidator of a landlord company brings the rights and obligations of both parties under the lease to an end. The result of this case is that a tenant's security of tenure is now linked to the solvency of the landlord.

When acting for a tenant proposing to enter into a long term lease, we recommend advising of the risks associated with the landlord’s potential insolvency.

Obtaining landlord's consent and other actions required by the landlord
Depending on the lease terms and the rental (if any) payable to the landlord, the landlord may have little incentive to provide consent to applications made by the tenant, for instance for a development approval.

In order to avoid these difficulties, if the tenant intends to develop the land or is aware of other issues that may require landlord's consent it may be appropriate to draft a clause that contractually requires the landlord to promptly give consent or take the relevant action. For example, in Braham the tenant wanted to easily obtain consent to subdivide the land as it was ultimately intended to be the owner of the land. The below clause was included in the transaction documents:

"When requested by the Lessee, immediately sign all documents, give all consents and approval and do all things necessary to allow the Parent Land to be subdivided". (Braham, [7])

The tenant was also expressly permitted to assign or transfer the lease, or assign or transfer his interest in the land without the consent of the landlord. In addition the landlord agreed that it would sign all documents and do all things necessary to give effect to the tenant mortgaging or charging his interest in the lease or the land or parting with possession or giving effective control of the land by the grant of a franchise, licence or concession.

Lessons to learn

We have, in this article, touched on only some of the important issues that arise under long-term leases. The Braham case is a reminder that long-term leases raise issues that need careful consideration.

This article first appeared in the Australian Property Law Bulletin [May 2015, Vol.30, No. 4]