Justice Croft’s last retail leasing appeal – RFC v Verraty Pty Ltd [2019] VSC 597

My friend, colleague and fellow blogger Robert Hay QC recently wrote a post here about the Supreme Court decision in Richmond Football Club Ltd v Verraty Pty Ltd [2019] VSC 597.

The decision is significant for a number of reasons.

First, the decision is the last decision about retail leasing from his Honour Justice Croft, who recently retired from the Victorian Supreme Court after close to 10 years of service to the State of Victoria.

To describe his Honour’s contribution to retail and commercial leasing over his years of service to the Court, and in his capacity as a barrister and author, as unparalleled would be an understatement.

As the leading retail leasing barrister when at the Bar, the leading author in the country on retail and commercial leases and the Justice of the Supreme Court sitting on almost all leasing cases over the last 10 years, Croft J has been, in a very real sense, the first and last word on leasing law in Victoria.

Some of his Honour’s career highlights include:

• appointment to the Victorian Supreme Court in 2009, during which time his Honour sat on virtually all appeals from VCAT retail leasing cases;
• authorship of Commercial Tenancy Law (4^th ed, 2018) and its earlier editions in 2009, 1997 and 1990;
• ongoing authorship of the leasing loose-leaf service Retail Leases Victoria (Butterworths);
• practice at the Victorian Bar as an advocate and arbitrator in retail and commercial leasing matters and appointment as senior counsel in 2000; and
• Secretary for Law (ie head of Attorney-General’s Department) and solicitor for the Northern Territory, 1986-88.

On behalf of the Victorian retail and commercial leasing community, I would like to extend both thanks and congratulations to his Honour for his years of service to the leasing community.

Justice Croft has taken chambers in Dawson Chambers and is continuing to act as a commercial arbitrator.

Secondly, the decision is important for practitioners in this areas and warrants detailed discussion.

RFC and its landlord at the Wantirna Club, Verraty Pty Ltd, have a long history of litigation.

The litigation considered by this post considers the operation of sub-s 11(2) of the RLA 2003.  Section 11 states that:

11        Application generally

(1)       This Act applies to a retail premises lease that is—

(a)       entered into after the commencement of this section; or

(b)       renewed after the commencement of this section, whether the lease was entered into before or after that commencement.

(2)       Except as provided by Part 10 (Dispute Resolution), this Act only applies to a lease of premises if the premises are retail premises (as defined in section 4) at the time the lease is entered into or renewed.

There are other sections of the RLA 2003 that are relevant to the litigation, particularly s 1, which states that (emphasis added):

1          Main purpose

The main purpose of this Act is to replace the scheme in the Retail Tenancies Reform Act 1998 with a new scheme to enhance—

(a)       the certainty and fairness of retail leasing arrangements between landlords and tenants; and

(b)       the mechanisms available to resolve disputes concerning leases of retail premises.

RFC had entered a lease in 1998 for a term of 10 years with an option for a further term of 10 years.  In 2004 the parties purported to vary the lease by extending it to a term of 20 years commencing 7 May 1998.  It was a term of that lease that the tenant was required to pay as an outgoing land tax payable by the landlord.

In Richmond Football Club Limited v Verraty Pty Ltd [2011] VCAT 2104, the first litigation between these parties, Senior Member Riegler at VCAT held that the purported variation operated as a surrender and re-grant by operation of law and that, as a result, a new lease was entered into in 2004.  As that lease was regulated by the RLA 2003, the obligation to pay land tax was rendered void by operation of s 50 of the RLA 2003 and the landlord was obliged to refund a substantial sum of land tax paid by the RFC.

The RLA 2003 applies to leases of ‘retail premises’ as defined in the Act.  However, sub-s (2) of the RLA 2003 states that:

(2)       However, retail premises does not include the following premises:

(a)       premises in respect of which the occupancy costs (as defined in subsection (3)) under the lease concerned is more than the amount prescribed by the regulations for the purposes of this paragraph;

…

(3)       In subsection (2)(a), occupancy costs means—

(a)       the rent payable under the lease, not being rent (or any part of rent) that is to be determined by reference to the turnover of a business; and

(b)       the outgoings, as estimated by the landlord, to which the tenant is liable to contribute under the lease; and

Note

Section 46 requires the landlord to give the tenant a written estimate of the outgoings to which the tenant is liable to contribute.

The statutory threshold for the occupancy cost exclusion is $1M.

In the subsequent, unrelated case of William Buck (Vic) Pty Ltd v Motta Holdings Pty Ltd [2018] VCAT 15, Senior Member Riegler at VCAT held that:

54. In my view, s 11(2) of the RLA prevents fluctuation to prevent late entry into the Act. Therefore, if the premises are not retail premises at the time the lease is entered into (because the occupancy costs exceed $1 million), then the premises cannot become retail premises later (if the occupancy costs fall below $1 million).
55. However, I do not consider that the reverse scenario applies. In particular, I am of the opinion that a plain reading of the provision does not prevent late exit from the Act.  As submitted by the Landlord, to construe the provision so as to disallow late exit from the Act would require the word ‘only’ to be positioned differently within the provision, as follows:

…  this Act applies to a lease of premises only if the premises are retail premises at the time the lease was entered into renewed.

56. If the provision was expressed in that manner, then it would make no difference that the disqualifying characteristic subsequently arose, such as the occupancy costs increasing to over $1 million during the term of the lease because the characterisation of the lease is made at the time the lease is entered into.
57. Therefore, if leased premises do not fall within the definition of retail premises at the time that the parties entered into the lease (or its renewal), the premises cannot become retail premises later (for example if the occupancy costs reduced to under $1 million during the term of the lease). However, that does not prevent the reverse scenario.  For example, if the occupancy costs were under $1 million at the time the parties entered into the lease, then the premises fall within the definition of retail premises.  However, if the occupancy costs subsequently increased to over $1 million during the term of the lease, then the premises would no longer fall within the definition of retail premises.

At some stage since the first decision involving RFC and its landlord, the total occupancy costs for the Wantirna Club exceeded the statutory threshold of $1M and the landlord claimed that the RLA 2003 no longer applied to RFC’s lease.

Also, RFC exercised an option for a new term that commenced in 2018.  The rent for the new term was to be determined by market rent review.  The option clause in the lease stated that (emphasis added):

16.2     Terms and Conditions of Renewed Lease

The renewed Lease granted pursuant to Clause 16.1 hereof shall be subject to the same covenants, conditions, agreements, stipulations and providers contained in this Lease save and except that:

(a)       the Annual Rent reserved by and payable for the first year of the renewed Lease shall be the Annual Rental determined in accordance with the provisions of Clause 15.1(b) of this Lease and, where appropriate, the provisions of Clause 15 shall be incorporated in full into any such renewed Lease and for the purposes of Item 13 of the Schedule hereto as incorporated into any such renewed Lease the term “lease year” shall mean each consecutive twelve (12) month period during the term created by such renewed Lease with the first such period commencing on the commencement date of such renewed Lease; and

(b)       such new renewed Lease shall omit from Item 11 of the Schedule to that lease the first further term (if any) of this covenant for renewal.

However, the market rent review clause in the lease deed contained a ratchet clause, preventing the rent from going down at a market review. Ratchet clauses are rendered void by operation of s 35(3) of the RLA 2003.  Consequently, there was also a question over whether the rent review for the new term would be regulated by the RLA 2003 or just by the lease deed.

Consequently, the landlord issued proceedings seeking:

• the payment of land tax for the period after the total occupancy costs exceeded $1M; and
• a declaration that the RLA 2003 did not apply to the rent review for the further term.

At the trial before VCAT, Senior Member Forde (discussed here) held that:

• sub-s 11(2) of the RLA 2003 permits a lease to ‘jump out of’ the Act;
• the landlord was required to give an estimate of outgoings in its disclosure statement and annually under s 46 of the RLA 2003 until the RLA 2003 ceased applying to that lease;
• once the total occupancy costs exceeded $1M as estimated by the landlord, the RLA 2003 stopped applying to the lease; and
• once the RLA 2003 stopped applying to the lease, those covenants rendered void by the operation of that Act ceased to be void and land tax became payable.

On appeal, Croft J overturned the decision on three grounds.

First (at [38] to [62] of the Court’s reasons), Croft J held that sub-s 11(2) of the RLA 2003 does not contemplate a late departure from the RLA 2003, it merely fixes the date for determining its application as the date when the lease was entered into.

Moreover, allowing a late exit from the RLA 2003 is inconsistent with the express statutory purpose of enhancing certainty in retail leasing arrangements between landlords and tenants (see sub-s 4(1)(a) of the RLA 2003, set out above).

Consequently, the Court held that:

• the RLA 2003 does not allow a late-exit and the sole date for determining whether the Act applies is the date that the lease was entered into;  and
• as a result, the tenant was not liable for land tax.

Secondly (at paras [63] to [68] of the Court’s reasons), partly as a result of the first finding, there is no requirement under s 4 of the RLA 2003 to provide an estimate of outgoings every year in order to determine the total occupancy costs.

Section 46 of the RLA 2003 requires the provision of annual estimate of outgoings.  The Court held that this requirement is separate to the occupancy costs exclusion in s 4(2) and (3) of the RLA 2003, despite the presence of the note under sub-s 4(3) of the RLA 2003 that refers to s 46.

Although not strictly relevant to the decision, it is worth noting that Croft J also made the following remarks about the operation of s 46 of the RLA 2003:

67. … I do agree with the view expressed by the Tribunal as to the effect of non-compliance with the requirements of s 46(3)(b), as follows:

52.   I accept Verraty’s [the Landlord’s] submission that it is irrelevant that the notice was not given within the time prescribed by s46(3)(b). The only penalty for not giving notice by that time is that the liability to contribute to outgoings does not arise.  I reject Verraty’s submission that even when the estimate is given late, the tenant remains liable to pay outgoings that relate to the period before the estimate is given.  Such an interpretation makes the consequence of a landlord not giving a notice meaningless.[1]

Thirdly (at paras [69] to [80] of the Court’s reasons), Croft J considered the impact of the avoiding provisions of the RLA 2003 on the 2018 lease.

After considering the text of clause 16.2 of the lease deed (the text of which is set out above), the Court held that:

77. On the basis of provisions such as clause 16.2 of the 2004 Lease and having regard to the provisions of s 27 of the RLA, in particular s 27(1)(c)—a provision which will operate as soon as the application of the Act to the lease as a “retail premises lease” occurs by reason of the operation of s 11(2)—the position would appear to be that the provisions of the lease being renewed for the purpose of a provision such as clause 16.2 would be the lease is effectively revised by the implication of the various provisions of the Act which apply the formula discussed—“a retail premises lease is taken to provide as set out in this section”. This would, in the present circumstances, and having regard to the provisions of clause 16.2 of the 2004 Lease and s 94 of the Act, include the provisions of s 37 of that legislation.
78. There would not, however, appear to be any difficulty with the parties directing their minds to this possibility when the lease was first entered into if they contemplated the possibility of the RLA not applying at the time of renewal and, consequently, providing express terms to the effect that the provisions contained in any renewed term are to be those contained in the original lease unaffected by the operation of the RLA. There would be no problem with the application of s 94 of the RLA on this basis because, on renewal—the other point of time at which the operation of s 11(2) becomes relevant—the renewal is not a “retail premises lease” and therefore there is nothing to attract the operation of s 94 of the Act.

It follows, then, that because of the particular terms of the option clause:

• those parts of the 2004 lease that were rendered void by operation of the RLA 2003 were not carried over into the 2018 lease;  and
• it appears that those covenants implied into the 2004 lease by operation of the RLA 2003 would also be implied into the 2018 lease (for example, the repair and maintenance obligations of s 52 and compensation provisions in s 54 of the RLA 2003).

However, that only arose because of the particular option clause considered in that case.  While similar clauses are extremely common in the Victoria, there is nothing stopping the parties from drafting an option clause that avoids that consequence.

It is unclear at this stage if there will be a further appeal.  At the time of writing this paper, the landlord is still within time to file an appeal.

There are a number of take-home points for practitioners.

First, keep an eye out for news of an appeal in the next few weeks.  News of any appeal will be posted here.

In the meantime, the present state of the law is that:

• the RLA 2003 does not permit a ‘late exit’ during the lease term; and
• the usual form of option clause in Victoria means that the RLA 2003 will affect lease covenants into a renewed term.

Secondly, when drafting, reviewing or settling a lease for your client:

• check whether the option clause takes the usual form (set the example above); and
• consider whether your client should seek a variation to the form of the clause to avoid inadvertently affecting the lease terms on renewal if the RLA 2003 ceases to apply.  As a general rule, the effects of the RLA 2003 favour the tenant, so tenants will want the benefit of the Act to continue and landlords will not, but practitioners will need to consider their clients’ individual circumstances.

Thirdly, consider the operation of the RLA 2003 when an existing option is exercised.  In particular, if the option clause takes the usual form (see above), then:

• it might be possible to re-negotiate the bargain so that the parties agree that the new term operates as if the RLA 2003 did not apply to the previous lease deed. However, a well-informed tenant would require a substantial concession from the landlord before agreeing to that amendment;
• the effect of the RLA 2003 should be considered with respect to the new rent agreed or determined by a valuer for the new term. The RLA 2003 can affect a number of terms that are relevant to the mechanics of the rent review, including:
  1. a ratchet clause will be rendered void;  and
  2. a market rent review will be regulated primarily by s 37 of the RLA 2003;  and

• the landlord will be liable in the new term for repair and maintenance under s 52 of the RLA 2003 and the tenant is not liable for the landlord’s land tax as an outgoings, both of which would tend to drive the rent up.

Other provisions of the RLA 2003 may also affect individual clients.

Fourthly, tenants may have exercised an option in the usual form (see above).  However, because the lease otherwise falls outside the operation of the RLA 2003, the parties may be proceeding on the assumption that the tenant is liable for the landlord’s land tax as an outgoing or for repair and maintenance costs otherwise regulated by s 52 of the RLA 2003.  If so:

• tenants should consider a claim against their landlord for amounts paid by mistake; and
• rent may have been determined by a valuer, or agreed between the parties, on the mistaken apprehension that the landlord could recover land tax as an outgoing or that the tenant was responsible for repair and maintenance in the renewed term. Practitioners should consider whether a determination of the rent or any agreement based on that assumption are vitiated by mistake and can be re-opened.

Fifthly, there is a question over what happens when an option is exercised and the rent is then reviewed, to take the occupancy cost either over or under the statutory threshold.

This issue is yet to be litigated.  However, sub-s 11(2) of the RLA 2003 means that the parties must look only to the date the lease was ‘entered into or renewed’ to determine the application of that Act.

Section 11(1) states that:

(1)       In this Act, the renewal of a retail premises lease means the renewal of the lease—

(a)       under an option granted under the lease for a further term; or

(b)       under an agreement to renew the lease on substantially the same terms and conditions, except as to rent, for a further term entered into by all of the parties to the lease.

Subject to the amendments to the RLA 2003 tabled in Parliament yesterday, in Victoria it is almost universal practice that:

• an option is exercised;
• a rent review to market follows after the exercise of the option; and
• the tenant pays the rent payable at the end of the old lease term until the review to market is completed.

It seems to follow, then, that:

• if the total occupancy costs payable at the end of the old lease term is over $1M, then the total occupancy costs payable when the option is exercised is also over $1M and the RLA 2003 does not apply and there cannot be a late entry into the Act if the rent review reduces the rent;  and
• on the other hand, if the total occupancy costs in the last year of the old term are under $1M but the subsequent rent review means that the occupancy costs exceed $1M, then the lease cannot have a ‘late exit’ and the RLA 2003 continues to apply.

However, further litigation may be required to provide certainty on this question.  In particular, there may be contrary arguments about whether the rent paid prior to the market review was ever properly ‘payable under‘ the renewed lease in the required sense.

[1]           Phillips v Abel [2019] VCAT 1031.