Cracks in cement lead to cracks in contract: getting your lease terms right

It is tempting when entering a lease to use standard, general clauses for basic obligations under the lease. The recent decision of Morabito v Kingston Industries [2023] NSWSC 1020 has demonstrated why this might not be the best strategy, as it underscores the importance of effective and clear drafting of key provisions in an industrial lease. It also reinforces the importance of the parties taking reasonable steps to mitigate any losses stemming from purported breaches of contract.

A lease ends, a dispute begins

This dispute concerned a lease over an industrial warehouse and carpark. Mrs Morabito, the plaintiff (Landlord), leased the premises to the defendant, Kingston Industries Pty Ltd (Tenant) in 2010. The term of the lease expired in or around July 2017 and the Tenant continued to occupy the premises on holding over terms until December 2017 when it vacated the premises.

The Landlord undertook an end of lease inspection and subsequently asserted that the Tenant's use of the premises had caused damage to the floor of the warehouse and to the concrete slab in the carpark. The Landlord claimed that, because of this, the Tenant had breached the permitted use, it had not complied with its make-good obligations and in turn, the Landlord could not re-lease the premises for 17 months due to the damage at the premises.

In dismissing all of the Landlord's claims, the NSW Supreme Court explored three key issues for industrial leases:

• Permitted use: The permitted use was "Plant Hire / Distribution". The lease contained standard terms including that the Tenant will not mark or damage the premises and will not allow the floor of the premises to be broken, strained or damaged by overloading. The Court also considered whether extrinsic material was admissible to help define the permitted use.
• Make good: The make good obligations were general in nature and required the Tenant to make good any damage caused to the premises. However, the lease noted that the make good obligations did not extend to any repair required because of fair wear and tear, the Landlord’s negligence or extending to anything beyond the control of the Tenant.
• Lost rent: The Landlord claimed for lost rent but failed to mitigate its damages by repairing the warehouse floor and concrete slab for 17 months.

Permitted use

The Tenant's business involved the hire and distribution of machinery such as excavation and earth moving equipment (some weighing over 22 tonnes). Notably, the Tenant had, for the duration of the lease (including all agreed variations), remained in this business and had stored and distributed heavy plant in and from the premises.

The Landlord argued that the Tenant was permitted to move machinery, including machinery up to 25 tonnes, to and from and around the premises by truck, but could not move that equipment directly on the concrete without using protective matting, steel plates or timbers. The Landlord made the argument by reference to what a "reasonable businessperson would understand the term plant hire and distribution to mean". The submission was that a reasonable businessperson would not understand the permitted use to include the unprotected trafficking of heavy earthmoving machinery. The Landlord further submitted that the unprotected movement of machinery went against industry standard and relied on the guide to industrial floors and pavements – design, construction and specification (commonly known as CCAAT 48) in support of this submission.

The Court turned its mind on whether extrinsic evidence such as the CCAAT48 guidelines could be relied upon in construing a lease. The Court considered some judgements that provided commentary to the effect that there may be instances whereby some provisions in a registered lease may require extrinsic evidence in their determination. However, the Court ultimately held that there was no ambiguity in the construction of the permitted use in the lease and therefore there was no need to rely on any extrinsic material to help construe those provisions in the lease.

Make good

The dispute regarding the Tenant's make good obligations largely hinged on the exceptions to said obligations. Importantly, the Court accepted the Tenant's submissions that the Tenant's obligation to reinstate the warehouse floor to its condition at the commencement of the lease was subject to the other clauses in the lease (ie. the permitted use provisions). Therefore, the make good obligations were excluded from damage caused by not only fair wear and tear, damage due to the Landlord’s negligence or for a reason beyond the Tenant's control (as expressly provided in the lease) but also by using the floor for the permitted use. The Landlord did not make a submission contrary to this conclusion, leaving the issue to be determined as factual only and concerning whether the damage to the concrete on balance was caused by the Tenant's lack of care or misuse, rather than occurring in a different way that would not amount to a breach of the lease.

In turn, the parties submitted various engineering statements and independent reports to determine the integrity of the concrete slabs at the commencement of the lease, to establish whether the damage was caused by the Tenant's use of the premises or by some other manufacturing defect. The Court ultimately held that the warehouse floor and concrete slab contained construction deficiencies that were beyond the Tenant's control and therefore not forming part of the Tenant's make good obligations.

Lost rent

Due to the conclusions made by the Court regarding the permitted use and make good obligations, it was largely irrelevant for the Court to consider the argument of lost rent . However, for completeness, it considered the Landlord's failure to repair the concrete and its attempts to re-let the premises (despite not repairing the concrete slab) in determining potential damages for loss of rent.

Multiple prospective tenants expressed an interest to lease the premises after the Tenant had vacated. The Landlord rejected all offers to lease the premises to these prospective tenants. In one case, a prospective tenant was willing for the floor to be "left as is". In another, the floor was not discussed, but the Landlord rejected the applicant because, "due to the make good of the property" it "would not feel comfortable with having the tenant in occupation while major works are being carried out".

The Landlord submitted that it was reasonable for it to keep the premises vacant while continuing negotiations with the Tenant from December 2017 until October 2018 in the hope that the Tenant would replace the concrete. The Court rejected this, noting that the Landlord could have rectified the concrete (which would have taken no longer than six weeks) and leased the premises in early 2018. The Court ultimately held that the Landlord failed to take up offers from viable tenants for 17 months without good reason and therefore did not mitigate its loss.