Director guarantees in
commercial property leases
What damages are recoverable?
What financial exposure does a director undertake by
providing a personal guarantee the performance of a
commercial property lease?
The Supreme Court of NSW has ruled upon the question of
the director’s liability to the landlord pursuant to a
personal guarantee given in a commercial property lease in
the decision of Padstow Corporation Pty Ltd v Fleming
(No 3) [2013] NSWSC 24, handed down on 30 January
2013.
Justice Gzell has provided a detailed analysis of what
damages are recoverable by a landlord against a director
under a personal guarantee.
The director guarantees in
the lease
The landlord, Padstow Corporation Pty Ltd, was the
trustee of a private investment syndicate. The tenant was a
private company, Hamola Crochet Pty Ltd. The director
guarantees were given by Tom Fleming Snr and Tom Fleming
Jnr.
The lease commenced on 1 September 2004, at an initial
rent of $42,500 + GST per month, with annual CPI increases.
The term was 8 years.
The director guarantees in the lease were –
Clause 13.2 The guarantor guarantees ... all the
tenant’s obligations (including any obligation to pay rent,
outgoings or damages) under this lease ...
Clause 13.5 If the tenant is insolvent and this lease ...
is disclaimed ... The landlord can recover damages for
losses over the entire period of this lease ... but must do
every reasonable thing to mitigate those losses ...
In the principal judgment (no 2) [2011] NSWSC 1572, the
court upheld the validity of the personal guarantee given by
Tom Fleming Snr and Tom Fleming Jnr.
The guarantee was not limited in any way. But the lease
did provide that the guarantors could discharge their
personal surety by the lodgement of a security bond
equivalent to 3 months rental.
The commercial background was that the lease was entered
into as part of a property sale and leaseback arrangement.
Instead of applying the net proceeds of sale as working
capital in the business, and to pay the security bond, the
directors paid the net proceeds of sale to Tom Fleming Snr
as part of a retirement strategy. The failure to lodge a
security bond proved to be costly for Tom Fleming Snr and
Jnr because they remained financially exposed under their
director guarantees.
The tenant defaults
On 22 January 2008, liquidators were appointed to the
tenant.
Shortly afterwards the bank appointed receivers under its
debenture charge.
Over the next two months the liquidators finalised the
work in progress and the receivers sold the stock, plant &
equipment. The liquidators paid the rent during that period.
Once the premises were cleared out, the liquidators
disclaimed the lease.
On 22 April 2008, the landlord entered into possession.
The damages recoverable against the guarantors
In Padstow, because the director’s guarantee was
unlimited, the court examined the full extent of the
damages recoverable.
The Court ruled that the landlord’s claim for rent and
outgoings due pre-liquidation were recoverable.
Post-liquidation, the landlord’s claim was for damages.
The Court examined the landlord’s claim for damages under
these heads –
- Pre-liquidation damages – general – The court
ruled that legal costs incurred in obtaining legal
advice as a result of non-payment of rent were
recoverable. The sum was $3,855.05.
- Post-liquidation damages – general – The
court ruled as recoverable - legal costs incurred for
advice on the early termination of the lease; a leasing
fee invoiced for securing a tenant; electricity and
rubbish removal charges. The court rejected a quotation
for a marketing campaign for a tenant because it was not
an invoice. The cost of repairs and maintenance and fire
safety / security expenses were accepted by the tenant.
The total was $89,696.78.
- Post-liquidation damages for loss of bargain–
The court awarded damages calculated as the rent due
from 22 April 2008 (when the landlord took possession)
until 26 February 2010 (when the sale of the property
was completed). There was no dispute that the landlord
had mitigated their loss by re-renting the property,
although the rent was less than in the former lease.
- Post-liquidation damages for capital loss on sale
The landlord claimed both loss of rent from
the date of sale (26 February 2010) until the date the
lease was due to end (30 September 2012), and
also loss in capital value on sale. The court ruled that
to claim both would be double-dipping. The court ruled
that as the property had been sold, the landlord was to
be awarded only the diminution in the capital value of
its asset on sale, a sum of $90,000, and not to the loss
of rent for the remainder of the lease, a sum in excess
of $400,000.
- GST on the damages – The landlord claimed GST
on the damages awarded.
The court noted – The Commissioner of Taxation
accepts that an award of damages by a court and its
payment is not a taxable supply by the court; and
made reference to the ATO’s GST Ruling – GSTR 2001/4
paragraph 60 [a court in giving judgment, does not
make a supply for GST purposes] The landlord invited
the court to go behind the judgment, and submitted that
the apportionment of the damages according to the heads
of damage provides a sufficient nexus between the
amount awarded and a supply for GST to be payable;
and made reference to paragraph 116 of the ATO’s GST
Ruling [Where a court order ... dissects and itemises
the payment into the heads of claim relating to the
individual supplies and / or item of damages] then
GST may be payable on those supplies.
The court rejected that submission in strong terms –
In my view, that is wrong. An award of damages made by a
court is payable solely in consequence of the court’s
order, not in consequence of the underlying dispute.
Refer paragraphs 33, 34 & 35 of the judgment.
- Interest – The court awarded interest on the
default rate of 12 % pa in accordance with the rate
payable under the lease, rather than the court interest
rate which was lower.
Conclusions
The quantum of damages recoverable by a landlord for
breach of a lease is assessable under a number of heads -
legal fees, marketing and advertising fees, loss of rent to
date of sale and diminution of capital value at sale. The
damages are to be calculated without GST if they are part of
a court money order.
Legal advisors acting for a tenant need to take
particular care when providing an explanation to directors
who have agreed to give personal guarantees to secure the
obligations of a corporate tenant. The explanation must
involve the quantum of damages recoverable by a landlord for
breach of a lease. Legal advisors should take special care
to advise that the director guarantees given should be
capped, or able to be discharged if a security bond of equal
value to the capped amount is lodged.
Legal advisors acting for a landlord which is considering
the sale of the property with a lease which has ended by
re-entry need to take particular care. They should advise
the landlord that if the property is sold, their claim might
be limited to loss in capital value on sale of the property,
as opposed to retaining the property and claiming loss of
bargain until the lease was due to end.
This article was first published by Cordato Partners in
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2013 Sydney
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