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Recovering loss of bargain damages following termination of a lease

Most commercial leases contain clauses outlining the circumstances in which:

the tenant will be in breach; and
the landlord will be entitled to terminate the lease and recover any resulting loss or damage.

Subject to certain restrictions and notice requirements¹, termination in reliance on an express contractual right will generally be valid and effective.

However, before entering into a new lease, and prior to giving effect to any proposed termination of a lease, care should be taken to ensure the landlord will be entitled to recover all of its losses from a defaulting tenant (or its guarantors).

Defining loss of bargain damages

Damages suffered by a landlord because of a tenant’s breach of a lease may include:

Unpaid rent and outgoings up to the date of termination of the lease; and/or
Loss of rent for a period following termination of the lease.The latter is referred to as ‘loss of bargain’ damages. This is because the landlord loses some or all of the commercial benefit of having entered into the lease with the tenant in the first place.

For example, following termination of an existing lease:

A premises may remain vacant for a period (sometimes years) until a new tenant can be secured; and/or
It may be necessary for the landlord to lease the premises for lower rent to secure a new tenant.

In either case, the landlord loses the commercial benefit which the performance of the lease would have conferred upon the landlord (being the payment of rent at the agreed rate for the remaining term of the lease).

In cases involving termination of a lease with a significant remaining term, loss of bargain damages will often exceed any other type of damage suffered. This is particularly so in a cooling rental market, which might lead to significant vacancy periods and reduced rent.

Right to recover loss of bargain damages

When a landlord terminates a lease pursuant to an express right in the contract, loss of bargain damages will only be recoverable if:

The terms of the lease specifically entitle the landlord to loss of bargain damages in the circumstances; or
The landlord can prove it had a common law right to terminate the lease (such that it is not necessary for the landlord to rely on an express contractual right to terminate).

When will a common law right of termination arise?

At common law, a party may terminate a contract if the other party commits:

a breach of an essential term of the lease – an essential term is one which the parties have agreed (either expressly or by necessary implication) goes to the root of the contract (in that it is of such importance that the promisee would not have entered into the contract unless assured of strict or substantial performance of the term);
a sufficiently serious breach of an intermediate term of a lease – the breach must substantially deprive the innocent party of the whole of the benefit of the contract; or
a repudiation of the lease – this requires the tenant to evince an intention no longer to be bound by the contract or to fulfil it only in a manner substantially inconsistent with the party’s obligations.

It can be difficult for a landlord to prove that a common law right of termination exists, and it can be risky to terminate on this basis alone.

The fact that a party may be entitled to terminate a lease in certain circumstances will not necessarily result in a term being considered an essential term of a lease.

Importantly, a covenant to pay rent at specified times ordinarily will not, without more, amount to an essential term of a lease.

Shevill’s case

The principles relating to loss of bargain damages were applied by the High Court of Australia in Shevill v Builders Licensing Board².

In that case:

A lease provided that if rent was unpaid for 14 days, or if the tenant was in breach of any covenants under the lease, such as becoming bankrupt or being placed into liquidation, the landlord may terminate the lease “without prejudice to any action or other remedy the lessee has or might or otherwise could have for arrears of rent or breach of covenants or for damages as a result of any such event”;
The tenant was constantly late in paying rent;
The landlord terminated and claimed as damages for breach of contract an amount equal to the rent which would have been payable for the balance term of the lease;
The court found that, despite that the landlord was entitled to terminate the lease, it had no right to recover loss of bargain damages including future rent; and
The landlord’s recoverable damages were limited to arrears of rent up until the date of termination.

Relevantly, the court stated the following:

“… it does not follow from the fact that the contract gave the respondent the right to terminate the contract that it conferred on it the further right to recover damages as compensation for the loss it will sustain as a result of the failure of the lessee to pay the rent and observe the covenants for the rest of the term”.³
“In all these circumstances the lessor is given the right to re-enter. However, it would require very clear words to bring about the result, which in some circumstances would be quite unjust, that whenever a lessor could exercise the right given by the clause to re-enter, he could also recover damages for the loss resulting from the failure of the lessee to carry out all the covenants of the lease – covenants which, in some cases, the lessee might have been both willing and able to perform had it not been for the re-entry.”⁴
“[If] one has regard to the impact on the lessor of the lessee’s failure to pay the rent when due, such a consideration yields no support for a finding of essentiality.

Although the lessee’s failure to pay the rent promptly was a serious breach of contract which the [landlord] should not have been obliged to tolerate indefinitely, it was aware that it might have difficulty in finding another tenant if it were to re-enter and terminate the lease. It was not bound to take that step.

Substantial payments in reduction of arrears of rent were made [prior to termination] … It could have sued the lessee or the guarantors for arrears of rent. Re-entry was a drastic step which the [landlord] ought to have taken not only if it desired to be relieved of an unsatisfactory tenancy but provided it had another one to take its place.

If it exercised its right of re-entry only in order to apply greater pressure on the tenant with a view to regular payments of rent in the future, it took the risk that the lessee would accept the forfeiture. That is what happened, with the result that the Board effectively terminated the lease and secured possession of premises which it could not thereafter let for a considerable time. That consequence was not the fault of the former lessee.

[The landlord] was not entitled to damages for the loss of the contract which it chose to bring to an end.”⁵

Steps for securing loss of bargain damages

To increase the prospects of recovering future rent and other loss of bargain damages following the termination of a lease, landlords should seek to ensure that the lease contains appropriate clauses specifying:

The terms of the lease which are ‘essential terms’ (clauses providing that all terms in the lease are essential are unlikely to be effective);
That in the event of termination, the landlord will be entitled to recover loss of bargain damages (including rent payable for the remaining balance of the term of the lease); and
That ‘time is of the essence’ with respect to certain time-specific obligations.

Where possible, landlords should terminate a lease on common law grounds rather than relying on an express right of termination pursuant to the terms of the lease where loss of bargain damages are sought.

Following termination, landlords remain subject to a common law duty to mitigate their losses. This usually obliges a landlord to take reasonable steps to re-let the property at market rent.

Takeaways

Matters affecting a party’s entitlement to recover damages are often given insufficient consideration at the time of negotiating the terms of a lease, and when effecting a termination of the lease.

It is all too easy for a landlord to fall into the trap of relying on a contractual right to terminate, without proper regard as to whether loss of bargain damages will be capable of being claimed. For example, this often occurs when there has been an event of insolvency or a failure to pay rent by a due date.

If loss of bargain damages are unlikely to be available, it may be in the interests of a landlord to sue for rent arrears rather than terminating the lease.

Parties should carefully consider any consequential losses that might flow from the termination of a lease and should seek appropriate advice to ensure that their interests are protected.

¹ For example, section 124 of the Property Law Act 1974 (Qld) may require a landlord to provide a notice to remedy breach prior to terminating.

² (1982) 149 CLR 620.

³ Shevill v Builders Licensing Board (1982) 149 CLR 620 at 627.

⁴ Shevill v Builders Licensing Board (1982) 149 CLR 620 at 628

⁵ Shevill v Builders Licensing Board (1982) 149 CLR 620 at 637-638

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