By Deren Hassan, Partner and Clementine Fryer, Associate

The recent NSW Supreme Court decision in Darzi Group Pty Ltd v Nolde Pty Ltd [2021] NSWSC 774 is important to retail and commercial landlords dealing with the continued effect of the COVID-19 leasing Regulations following its repeal. The case considers the operation of the legislative changes introduced to retail and commercial leasing due to COVID-19. The decision is especially significant to landlords as it held that clause 7 of the Retail and Other Commercial Lease (COVID-19) Regulation 2020 (No.s 1-3) (NSW) (the Regulations) has the effect that a landlord is perpetually prevented from taking prescribed action if the landlord has not complied with the obligation to renegotiate the rent and other terms of the lease in good faith. There are on-going implications to landlords and tenants alike as the Regulations and the National Cabinet Mandatory Code of Conduct SME Commercial Leasing Principles During COVID-19 (the Code) continues to have force in relation to any period a tenant is an impacted lessee.

A chequered history

The parties had a chequered history of litigation between them. In 2014, the landlord Nolde Pty Ltd (Nolde) and the tenant, Darzi Group Pty Ltd (Darzi) entered into a heads of agreement to lease premises for Darzi to operate a restaurant. A dispute arose as to whether the heads of agreement was binding and if so, whether the parties had entered into a lease with an option to renew. The NSW Court of Appeal held in Darzi Group Pty Ltd v Nolde Pty Ltd [2019] NSWCA 210 that there was a statutory lease pursuant to section 8 of the Retail Leases Act 1994 (NSW) (RLA) when Darzi entered into possession of the premises as lessee and began operating as a licensed restaurant business. Further, that a binding and enforceable agreement for the lease came into existence in 2016, after the parties agreed to the final terms of an agreement for lease which replaced the heads of agreement.

How the matter came before the Court

The current proceedings arose when Darzi exercised its option to renew in 2019. Nolde served Darzi with a section 133E Conveyancing Act 1919 (NSW) prescribed notice with the effect that Darzi’s entitlement to exercise an option was extinguished on the grounds of breaches of the lease. The notice required Darzi to seek an order for relief against the effect of the alleged breaches to prevent being precluded from its entitlement to the option. Darzi sought a declaration that it had exercised the option to renew the lease found by the Court of Appeal. Nolde ultimately withdrew its section 133E notice, executed the lease and served a second section 133E notice for failure to pay outgoings. As part of its response, Darzi alleged that Nolde had refused to comply with its obligations to renegotiate the rent and other terms of the lease as required by the Regulations.

Rent renegotiations

Darzi provided Nolde with a statement that it is an “impacted lessee” according to the Regulations and requested a renegotiation of its rent. Nolde received JobKeeper enrolment confirmation and financial statements prepared by Darzi’s accountants for the year ending 30 June 2019. Nolde denied Darzi was suffering financial stress and entitled to a rent reduction and said that Darzi did not provide sufficient information to determine whether it is an “impacted lessee”. While Darzi provided confirmation of Jobkeeper enrolment, Nolde requested evidence from the ATO that Darzi qualified for the scheme, including all necessary supporting information.

Darzi partially paid Nolde the rent it considered was payable for May and June 2020 proportionate to its reduction in turnover consistent with Principle No 3 of the Code.  Darzi’s turnover then recovered to the extent that Darzi ceased to qualify as an impacted lessee and it has since paid Nolde the full amount due for rent under the lease. Therefore, the dispute about the shortfall in rent payments and the operation of the Regulations is for a period of only two months. Nolde alleged that Darzi had “unilaterally decided to reduce the rent it is willing to pay” [83]. Nolde then “took the extreme course” [138] of serving Darzi with a section 129 Conveyancing Act 1919 (NSW) notice specifying that in breach of the lease, Darzi had unilaterally decreased the payments of rent to Nolde as set out in the lease without providing sufficient evidence that Darzi was an “impacted lessee”. Nolde gave an undertaking that it would not take any prescribed action under the section 129 notice and would allow Darzi to remain in possession of the premises pending the outcome of the proceedings.

The parties let the dispute concerning the disputed rent payable rest there, and there was no further effort to comply with the Regulations. That may have been in part because Nolde’s response in serving the section 129 notice entrenched the dispute, and also because Darzi’s financial circumstances had improved and Darzi had been paying the full rent.

The proceedings were before Justice Robb who decided Sneakerboy[1], the earliest case to consider the Regulations. In determining the dispute between the parties concerning the underpayment of rent, His Honour considered the legislative and administrative measures put in place to deal with the impact of the COVID-19 pandemic on the ability of business owners who operated their businesses from leased premises to survive the effect of the pandemic financially.

The COVID-19 regime

The Code is not the direct legal source of the regulatory regime to deal with the consequences of the COVID-19 pandemic on the operation of businesses from leased premises. The COVID-19 Emergency Measures Act 2020 (NSW) amended the RLA by inserting a new section 87. That section authorises the making of regulations to govern the recovery of premises by a landlord, prohibiting the termination of the lease by a landlord and regulating the exercise or enforcement of other rights of a landlord. The RLA did not expressly deal with what, if anything, the continuing effect would be of the COVID-19 regime and Regulations once it was repealed. That situation was addressed by the COVID-19 Recovery Act 2021 (NSW) which came into force on 25 March 2021. Relevantly, clause 1.25 of Schedule 1 inserted section 88(1) into the RLA. This section states “The Retail and Other Commercial Leases (COVID-19 Regulation (No 3) 2020 continues to apply, despite the repeal of that regulation, to anything occurring in relation to a lease while the lease was an impacted lease within the meaning of that regulation.” The inclusion of this provision means that despite its repeal, the Regulations continue in effect in relation to any period in which a tenant is an impacted lessee. The Court considered these provisions in determining that Darzi was not prevented from seeking rent relief after the Regulations were repealed.

The decision

Justice Robb found that Darzi is in fact an “impacted lessee” for the relevant months it sought to renegotiate the rent. Nolde had not been acting reasonably by not accepting the ATO’s acknowledgement that Darzi qualified for JobKeeper and in insisting that Darzi provide all necessary supporting information to show that it has qualified for the scheme and continues to qualify for the scheme. His Honour said at [78]:  “A reasonable lessor acting in good faith would have accepted that, if the ATO was satisfied that Darzi qualified for the scheme to the extent that the ATO would acknowledge that fact, then the ATO’s acknowledgement was adequate proof”.

The evidence was clear that Darzi’s turnover in the 2018-2019 financial year was less than $50 million. Accordingly, Nolde was obliged to renegotiate the rent in good faith. That renegotiation was required to take place having regard to the economic impacts of the COVID-19 pandemic and the leasing principles set out in the Code. The Court held that Nolde did not as a matter of fact, comply with its obligation under clause 7 of the Regulations to renegotiate the lease in relation to the rent payable following the request by Darzi.

His Honour determined that the effect of clause 7 of the Regulations is that a landlord is “perpetually barred” from taking any prescribed action if a landlord does “not comply with its obligation to renegotiate the rent in good faith” [125].  This is because while clause 6 of the Regulations operates as a prohibition against a landlord from taking any prescribed action against the tenant during the prescribed period, there is nothing in clause 7 which limits the duration of the prohibition on the landlord’s conduct under clause 7(1) of the Regulations. “Consequently, as matters stand at present, Nolde will never be entitled to take a prescribed action against Darzi in respect of the short payments in rent…” [139].

Justice Robb found [at 131] that the payment by Darzi of the reduced rent, calculated according to Darzi’s understanding of the intent of the Code, was not done on the basis of a final and absolute statement of position by Darzi as to the future amount of rent that it would pay. Properly understood, it was an interim arrangement made in the expectation that Darzi would continue to be an impacted lessee and in the belief that Nolde would swiftly comply with its obligation to conduct with Darzi a good faith renegotiation of the rent. It was implied in Darzi’s conduct that it was an open possibility that the renegotiation could lead to an agreement for the payment of a greater amount of reduced rent than Darzi had paid, in which event a balance would become payable to Nolde.

The Court rejected Nolde’s submission that until the parties had agreed to a renegotiated rent, Darzi was required to continue to make payment of the full amount of the rent. His Honour considered this situation was contrary to the primary objective of the COVID-19 regime, in preserving leases and the businesses of lessees from the immediate cash flow impacts of the COVID-19 pandemic. The COVID-19 regime assumes that the financial capacity of impacted lessees to pay rent may in fact be immediately affected by the COVID-19 pandemic. “It would be entirely counter-productive for the good faith obligation to require lessees to continue to pay the full rent until agreement to the contrary was reached” [128].

Conclusion

It is critical that landlords consider the manner in which they conduct themselves in renegotiating the rent and other lease terms for any impacted lessee, especially if the negotiations are on-going or the parties cannot reach agreement. Despite the repeal of the Regulations, it continues to have effect in relation to any period a tenant is an impacted lessee. The impact of the COVID-19 pandemic continues as lockdowns respond to outbreaks while current vaccination rates are low and the uptake unknown. For Nolde, the result of the decision is that it is forever unable to take any prescribed action against Darzi to recover the rent shortfall because Nolde failed to discharge its obligation to renegotiate the rent in accordance with clause 7 of the Regulations. The position may be different in cases where landlords comply with clause 7 of the Regulations in good faith, but the parties to the impacted lease are unable to reach an agreement.

[1] Sneakerboy Retail Pty Ltd trading as Sneakerboy v Georges Properties Pty Ltd [2020] NSWSC 996