Dealing with a tenant’s breach of a commercial lease
Last Updated: May 5th 2020, 10:00am (ACST)
Unfortunately, many landlords will experience a tenant who defaults in their payment of rent or other obligations under a commercial lease. These landlords will find that they need to take action in order to deal with the default and to mitigate their losses.
If you are a landlord and you do not follow the legal procedure, the tenant may end up taking legal action against you. The law is very specific about how a landlord must act when it seeks to enforce its rights against a tenant and gives tenants opportunities to counterclaim where procedures are not properly followed.
It is therefore imperative that landlords follow the legal procedure when dealing with a defaulting tenant.
If you are a landlord and find yourself in a situation where you need to deal with a defaulting tenant, there are a number of procedures to take into consideration:
- Serving a notice to remedy breach
- Distraining goods in the premises
- Re-entry of premises
- Court action against a tenant
- Other remedies available to a landlord
Landlords need to also be aware of the potential application of the COVID-19 Emergency Response Act 2020 and the Mandatory Code of Conduct to their commercial lease. Both the Act and the Code restrict the exercise of a landlord’s enforcement rights against a defaulting tenant where a tenant is suffering financial hardship due to the COVID-19 pandemic.
Identifying the breach
The first step is to identify the clause of the lease that a tenant has breached.
It is often the case that a default is due to a tenant’s failure to pay rent when required under the lease. In almost all cases, a lease will contain a covenant that the tenant must pay the rent and set out when it must be paid.
Under the Real Property Act 1886 (RPA), there is an implied term that a tenant must:
“pay the rent thereby reserved at the times therein mentioned, and all rates and taxes which may be payable in respect of the demised property, during the continuance of the lease;”
Once the clause has been identified, the next step is to serve a notice on a tenant requiring it to remedy that breach.
Serving a notice to remedy breach
The next step is to serve a formal notice to remedy breach on a tenant.
This notice must be served in accordance with the lease requirements in respect of the provisions on default and service of notices. If a landlord wishes to exercise its right of re-entry, then the notice procedure must comply with section 10 of the Landlord and Tenant Act 1936 (LTA).
Section 10 of the LTA states that:
“A right of re-entry or forfeiture under any proviso or stipulation in a lease for a breach of any covenant or condition in the lease shall not be enforceable by action or otherwise, unless and until—
(a) the lessor serves on the lessee a notice specifying the particular breach complained of, and, if the breach is capable of remedy, requiring the lessee to remedy the breach, and in any case requiring the lessee to make compensation in money for the breach; and
(b) the lessee fails within a reasonable time thereafter to remedy the breach, if it is capable of remedy, and to make reasonable compensation in money to the satisfaction of the lessor for the breach.”
It is implicit in section 10 that the notice requiring a tenant to remedy the breach should also specify, if it be the case, that a landlord proposes to re-enter and take possession of the premises if the breach is not remedied.
A landlord must allow a tenant a reasonable time to remedy the breach. In most cases, 14 days will be sufficient but what is a reasonable time is determined on a case by case basis, having regard to the amount involved and to the background. Some breaches (for example to carry out any outstanding works in the premises) may require a longer period of time.
We can help in any query about the length of the notice period and preparation of the notice.
There is no prescribed form for the notice, so it must be drafted in a manner that complies with section 10 and the requirements of common law. The notice must:
- be in writing;
- identify the parties, the lease and other particulars relevant to the lease;
- specify the breach with sufficient particulars, including setting out the clause of the lease that the tenant is in breach of, the amount of unpaid rent or other monies, and the date that such monies were due;
- require the tenant to remedy the breach, if it is capable of remedy;
- require that breach to be remedied within a specified time-frame (which must be a reasonable time) and in any case, require the tenant to pay compensation for the breach;
- disclose that if the breach is not remedied within the specified time-frame, then the landlord intends to re-enter and take possession of the premises; and
- be signed and dated by the landlord or a solicitor on its behalf.
The notice must be accurate (in both substance and form) and served on the tenant in accordance with the requirements of the lease.
If these requirements are not complied with, then a subsequent re-entry by a landlord may be invalid and unlawful. A notice which does not comply with these requirements may have to be re-issued on the tenant.
Distraining goods in the premises
A landlord has a right to distrain goods in premises for outstanding rent. This right entitles a landlord (or a person lawfully authorised by the landlord) to enter the premises, seize goods on the premises and to sell them by public auction for the best price that can be obtained in order to satisfy any outstanding rent due to the landlord.
The procedure is governed by the LTA. Under section 125 of the RPA, it is implied in every lease that the landlord has the “power to distrain according to law”.
Distraining goods can be a powerful self-help remedy which allows a landlord to recover outstanding rent without the need for court action. It also allows the landlord to recover costs associated with the distraining of the goods, including legal, bailiff, locksmith and auctioneer costs and expenses.
There are various documents associated with distraining goods which must be displayed on the premises. We can assist with the preparation of these documents for you and your bailiff. We can also recommend bailiffs who regularly deal with distraining goods.
In an earlier publication, we discussed the procedure and the right to distrain goods for unpaid rent in commercial leases.
There are a number of important points to consider in relation to the exercise of this right:
- the right cannot be exercised after the lease has been terminated or expired;
- the right only applies to unpaid rent. It does not extend to outgoings, GST or other amounts due and payable by a tenant under a lease; and
- all goods in the premises may be distrained. There are exceptions to this, including goods belonging to a third party; clothes, tools and implements of trade, and household items to the total value of $20.00; and records of a health practitioner.
There may be serious consequences to a landlord who does not comply with the procedure set out in the LTA. For example, if a landlord distrains and sells goods when in fact no rent was due and owing, then the owner of the goods may take legal action against the landlord to recover double the value of the goods sold together with legal costs.
Once the distress is levied then the tenant is unable to use any goods in the premises or to trade from the premises. Distraining can sometimes be an effective tool to achieve a quick resolution without the need to exhaust the procedure under the LTA. If a tenant pays the outstanding rent before the sale of the goods, then landlord can withdraw the Warrant to Distrain and allow the tenant to return to the premises to continue to trade.
Re-entry of premises
A lease should contain a clause on a landlord’s right to re-enter the premises following a breach of the lease by a tenant.
Under the LTA, a landlord must comply with the requirements of section 10 before re-entering (except where the rent is in arrears for three months: see section 12(5) of the LTA). Where the lease allows for a landlord to exercise a right of re-entry following a breach of the lease, and a landlord serves a notice in accordance with the requirements of section 10 and a tenant has failed within a reasonable time to remedy the breach of covenant, it will then be lawful for the landlord to re-enter and take possession of the premises.
Occasionally a lease may not contain a clause on a landlord’s right of re-entry. Under the RPA, there is an implied term in a lease that a landlord may re-enter and take possession of the premises if there is a failure by a tenant to pay rent or a default of any covenant and that failure or default is not remedied within three months. This power to re-entry is conditional on a tenant being in default for three months. If the lease does not contain any proper clause for re-entry, then a landlord may be restricted from exercising a right of re-entry until the rent has been in arrears for three months or otherwise the default of a covenant has not been remedied within three months. The requirements of section 10 will also apply before re-entering (except in the case of rent in arrears for three months).
The most frequent means of actually re-entering are by a landlord (or a person lawfully authorised by a landlord) physically entering the premises, advising the tenant that the re-entry has occurred and serving a notice of re-entry on the tenant. Once a re-entry which effects a forfeiture has occurred, then the lease is immediately terminated.
It is critical that a landlord has complied with the provisions relating to notices and re-entry. A tenant may be entitled to relief against forfeiture under the LTA if a re-entry and purported termination by a landlord is invalid and unlawful. A landlord’s unlawful termination may be a repudiation of the lease, which a tenant may accept and elect to terminate the lease and then sue the landlord for damages.
Court action against a tenant
A landlord may take legal action against a tenant in damages to recover damages for its losses suffered due to the breach.
The provisions of the lease may allow for a landlord to recover specific damages or compensation in respect of the breach, including:
- the outstanding rent and any future loss of rent;
- the costs incurred by a landlord due to the breach, including legal fees; and
- unpaid interest on outstanding rent.
It is important to consider a landlord’s duty to mitigate its loss in relation to damages for future loss of rent in respect of the balance of the lease term. Generally this means you need to take all reasonable action to find a replacement tenant as soon as possible.
If a landlord is successful in obtaining judgment against a tenant, there are a number of Court orders that may be available to a landlord to facilitate the repayment of the debt, including a Warrant for Sale and Charging Order over a tenant’s real property (if any).
Before taking legal action against a tenant, it is strongly advised that a landlord obtains legal advice.
Other remedies available to a landlord
A landlord may have other remedies available to it depending on the terms of the lease. These include:
Director’s Personal Guarantee – If the tenant is a company and its director(s) signed a deed of guarantee as part of the lease, then a landlord may issue a notice on demand on the guarantor for payment of outstanding rent or other monies due to the landlord. The guarantor will be personally liable to pay the tenant’s debt to the landlord. A landlord may take court action against the guarantor to recover damages for its losses suffered due to the tenant’s breach.
Bank Guarantee – If a bank guarantee has been provided by a tenant to a landlord pursuant to the terms of the lease then in the event of a breach by the tenant, the landlord may present it to the bank to recover its losses due to the tenant’s breach. A lease should make provision for a replacement bank guarantee or a ‘top up’ any amount that the landlord has used.
Charge – A landlord may be entitled to have an equitable charge over any real property of a tenant or a guarantor as security for payment of the rent and other monies owing under the lease. This charge may be secured by way of a caveat over any interest in land owned by a tenant or guarantor in relation to the charge granted.
A landlord may also be entitled to register a security interest on the Personal Property Securities Register (PPSR). A PPSR security interest will attach to personal property owned by the tenant. This will allow a landlord to charge the personal property as security for payment of the rent and other monies owing under the lease.
The Personal Property Securities Act 2009 entitles a landlord to seize goods (collateral) if a tenant is in default under the lease. Section 123(1) states: “A secured party may seize collateral, by any method permitted by law, if the debtor is in default under the security agreement.”
A PPSR charging clause can be included in the lease in respect of a tenant’s personal property or in a deed of guarantee in respect of a guarantor’s personal property.
Lease clauses – A well-drawn lease should contain provisions dealing with defaults and a landlord’s rights in the event of a tenant’s default. These provisions should be detailed and comprehensive for the landlord’s protection. A lease should include clauses setting out:
- events of default by a tenant, including non-payment of rent;
- a landlord’s remedies in respect of an event of default, including a right of re-entry and termination;
- a right for the landlord to charge interest at a default rate on any outstanding rent or other monies due;
- a tenant’s obligation to pay or reimburse a landlord for its costs and fees arising from any re-entry, termination, or the recovery of any outstanding money; and
- a tenant’s obligation to compensate a landlord in damages for any breach, re-entry or early termination or repudiation by a tenant, including damages for future loss of rent.
May 2020 Update – COVID-19 pandemic
Landlords need to take into consideration the application of the COVID-19 Emergency Response Act 2020 (Act) and the Mandatory Code of Conduct (Code).
The Act which came into effect on 8 April 2020 will apply for the period commencing on 30 March 2020 and ending on the day fixed by the Minister by notice in the Government Gazette. Under the Act, where a tenant is suffering financial hardship (i.e. the tenant is eligible for, or receiving, a JobKeeper payment in respect of the business) as a result of the COVID-19 pandemic, a landlord cannot take any prescribed action (e.g. evicting a tenant, exercising a right of re-entry, terminating the lease, distraining goods, suing for damages, requiring performance by a guarantor or any other remedy available to a landlord against a tenant) against the tenant on the grounds of a breach of lease, including a failure to pay rent. Further, any act or omission by a tenant in response to the COVID-19 pandemic will be taken not to amount to a breach of lease or constitute grounds for termination of the lease or the taking of any prescribed action by the landlord against the tenant.
If a landlord defaults in complying with the Act, a tenant may apply to the Small Business Commissioner and/or the Magistrates Court for appropriate relief against the landlord.
Similarly the Code which came into effect on 7 April 2020 prohibits a landlord from terminating a commercial lease due to non-payment of rent during the COVID-19 pandemic period or reasonable subsequent recovery period. The Code sets out a number of principles to guide landlords and tenants in entering into amended leasing arrangements during the COVID-19 pandemic. Where the parties cannot reach agreement on the leasing arrangements, either the landlord or tenant may refer the matter to the Small Business Commissioner and/or the Magistrates Court for appropriate relief. It should be noted that the Code has not been enacted as binding law in South Australia and we will continue to monitor any developments in this regard.
It is important that a landlord follows the correct procedure when dealing with a defaulting tenant. A landlord will need to ensure that all procedures carried out by it or on its behalf comply with all legal requirements. An improper procedure may cause a tenant to dispute the validity of the procedure and take legal action against the landlord.
Johnston Withers Lawyers: Experience You Can Trust
Our commercial property lawyers have extensive experience in acting for landlords in all aspects of commercial leases, including recovering debts from a tenant. If you need assistance with recovering a debt from a tenant or resolving any lease dispute, please contact Andrew Mitchard.
The content of this article is intended to provide a general guide to the subject matter. It is not legal advice. Specialist advice should be sought about your specific circumstances.
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