Take care with ‘subject to’ conditions in a Commercial Lease Proposal

When a commercial lease is agreed, it is normal for the lessor and lessee to sign a Lease Proposal / Heads of Agreement which contains ‘subject to’ conditions to be satisfied before the lease becomes legally binding.

A recent decision of the Supreme Court of New South Wales has demonstrated the legal significance of the ‘subject to’ conditions in Lease Proposals. This decision will prompt commercial leasing agents, landlord and tenants to review their ‘subject to’ conditions to reduce the scope for uncertainty and legal dispute.

The decision is Realm Resources Ltd v Aurora Place Investments Pty Ltd [2019] NSWSC 379 (8 April 2019) (Darke J).

The Lease Proposal and the entry of the Lease

In June 2017, Aurora as sub-lessor and Realm as sub-lessee signed a Lease Proposal for the lease of about 300 sq metres on Level 16 of the Aurora Place building in Phillip Street Sydney.

The Lease Proposal, prepared by Aurora’s agent Jones Lang LaSalle, described the main provisions of a proposed lease. At the end, was this ‘subject to’ condition:

The terms and conditions of this proposal are subject to:

i. availability of the Premises;
ii. Lessor’s Board approval; and
iii. satisfactory legal documentation being entered into by the parties.

This offer may be withdrawn in writing by the Lessor at any time.

This offer supersedes all previous correspondence.

The standard Aurora Place Lease agreement applies.

This document is not binding on the parties other than the sections relating to Confidentiality and the Lease Deposit.

On 27 June 2017, Aurora’s solicitors issued a sublease for a 5 year term commencing on 1 September 2017. The terms of the sublease, which was a 60 page document, were negotiated between the respective solicitors.

The terms were agreed, and on 15 August 2017, Realms’ solicitors sent the sublease executed by the lessee by courier to the Aurora’s solicitors. On 23 August, Realm’s solicitors sent the certificate of currency of insurance, which was the final requirement (the bank guarantee for the security bond of $280,506 and the registration fee had been delivered previously).

The next day (on 24 August 2017), Realm had second thoughts about the sublease, and its solicitors emailed Aurora’s solicitors to request that Aurora not enter into the lease until further notice:

We are instructed to request that you do not arrange for the landlord to sign the lease at this stage, and that you hold the lease signed by the tenant in escrow pending further communication from us.

The heads of terms clearly states that the terms of the proposal are subject to satisfactory legal documentation being entered into by both parties. In these circumstances neither party is bound unless and until a formal lease has been executed by both the landlord and the tenant.

Realm did not proceed with the sublease and applied for a declaration that no binding sublease was entered into, relying on the ‘subject to’ condition. Aurora contended that the sublease was binding, and that it was entitled to recover $735,000 for unpaid rent and damages.

The ‘subject to’ condition in the Lease Proposal

The ‘subject to’ condition set out three matters to be satisfied before the lease was binding upon both parties.

The Court focused on the third matter in the ‘subject to’ condition, namely:

iii. satisfactory legal documentation being entered into by the parties.

The Court noted that it was unclear: “it is not prescriptive as to the manner in which the parties would enter into the satisfactory legal documentation, or the form the documentation may take”. It was therefore left to the Court to determine these matters.

The Court found that there was ‘satisfactory legal documentation’ because after the terms were agreed, the sublease as signed by Realm was sent to Aurora’s solicitors.

The more contentious issue was whether the sublease was ‘entered into by the parties’. The Court found that it had been entered into, for these reasons:

The sublease was intended to take effect as a deed, not as a simple contract. That is, it was binding immediately. This conclusion was strongly influenced by this clause in the sublease: “This lease is a deed, even if it is not registered”. The effect of registration at the titles office is to make a document which is not a deed, take effect as a deed.
The formal requirements for a deed had been satisfied: It was signed in accordance with s 127(1) of the Corporations Act and was therefore was a deed for the purposes of 127(3) of the Corporations Act.
The deed was delivered by Realm, which is to say, the executing party delivered the deed with ‘an intention to be bound immediately’, ‘subject only to satisfaction of the condition that Aurora bind itself’. Aurora subsequently obtained board approval and signed the sublease.

The Court noted that: “No statement was made [in the Lease Proposal or solicitors correspondence] to the effect that neither party would be bound unless and until both parties had executed the sublease. Therefore, Realm’s attempt to ‘pause’ the sublease by its email of 24 August 2017 was not effective. The Court said that even if it had been possible to withdraw from the sublease, the email was not effective to do so because it did not clearly state that the offer to lease was withdrawn.

Conclusion

In this case, the dispute arose because the lessee wanted to walk away from the sub-lease at a late stage. There was no suggestion that the ‘subject to’ condition was defective.

But the fact that the ‘subject to’ condition played a central part in the Court’s deliberations suggests that it could have been better drafted. For instance:

Instead of:

satisfactory legal documentation being entered into by the parties

Substitute:

satisfactory legal documentation, lessor’s requirements being satisfied and the lease being signed by both parties

The 'moral' is that the 'subject to' conditions need to be clearly drafted, so as to avoid legal disputes. In this case, instead of 'satisfactory documentation being entered into', it would have been clearer if it read 'documentation satisfactory to the landlord being received by the landlord'.