McINTOSH v DYLCOTE PTY LTD

COUNSEL : PLAINTIFFS: MR S J BURCHETT DEFENDANTS: MR D P F OFFICER QC/MR J B COSTIGAN SOLICITORS : PLAINTIFFS: DALY BUSSOLETTI & CO DEFENDANTS: DON McDOUGALL CATCHWORDS : LANDLORD and TENANT; termination of the tenancy; power to terminate by notice in writing in case of damage or destruction of Hotel building; opinion of lessor whether reconstruction undesirable; implied terms required reasonable consideration of opinion and reasonable period of notice; provision for arbitration in case of dispute deprived disputed termination of effect pending arbitration; lessors' purported termination and re-entry were not effective and lease continued in effect. Alcatel Australia Limited v Scarcella (1998) 44 NSWLR 349. Australian Blue Metal Limited v Hughes [1963] AC 74. Crawford Fitting Co and Ors v Sydney Valve and Fittings Pty Ltd (1988) 14 NSWLR 438. CASES CITED : Hughes Brothers Pty Ltd v Trustees of the Roman Catholic Church (1993) 31 NSWLR 91. Renard Constructions Pty Ltd v Minister of Public Works (1992) 26 NSWLR 234. Tool Metal Manufacturing Co Ltd v Tungsten Electric Co Ltd [1955] 1 WLR 761. Wintergarden Theatre (London) Ltd v Millennium Productions Ltd [1948] AC 173. DECISION : SEE PARAGRAPH 31

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION BRYSON J

4881/98 WILLIAM McLEOD McINTOSH & ORS v DYLCOTE PTY LIMITED & ANOR.

1 HIS HONOUR : The Cabbage Tree Hotel, at 73 Princes Highway Fairy Meadow New South Wales, is the land in Folio Identifier 2/803531 and was leased by Dylcote Pty Limited the first defendant to Mr John Henry Ferris and others by lease registered 275736H for a term of twenty years commencing on 11 November 1991 and terminating on 10 November 2011. The lease restricts the use of the premises to a licensed hotel and bottleshop - clause 5.1. After intermediate transfer the lease was transferred to the plaintiffs by transfer 2018300 dated 26 February 1996, and they have conducted the hotel business under the lease since then. The hotel building was very extensively damaged as a result of storms, heavy rain and flooding on 17 August 1998. The litigation arises out of a Notice of Termination of the lease dated 30 November 1998 and delivered to the lessees on 1 December 1998, and attempts by the second defendant Mr Hunt, a Commercial Agent on behalf of the lessor, to eject the lessees from the hotel early on 2 December 1998. The lessees contend that the Notice of Termination was ineffective, and that they are still entitled to possession under the lease. They obtained an interim injunction and they are still in possession. There has been no attempt to put the claim to re-enter on the basis of breach of covenants of the lease. 2 The litigation turns on the effectiveness of the lessor's decision to terminate and Notice of Termination under clause 3.11 of the lease. Clause 3.11 is in these terms:- "If the whole or any part of the Building shall be destroyed or damaged by fire flood lightning storm tempest or other disabling cause so as to render the Demised Premises during the Term substantially unfit for the use and occupation of the Lessee or so as to render the rebuilding or reconstruction of the Building in its previous form impracticable or undesirable, in the opinion of the Lessor, then:- "(a) This lease may be terminated, without compensation, by either the Lessor or the Lessee, by notice in writing to the other provided always that in the latter case the Lessor shall have first failed to rebuild or reinstate the Demised Premises within a reasonable time after being requested so to do in writing by the Lessee; (b) Any such termination shall be without prejudice to the rights of either party in respect of any antecedent breach of the terms of this Lease; (c) Nothing herein contained or implied shall be deemed to impose any obligation upon the Lessor to rebuild or reinstate or make fit for use and occupation the Demised Premises; (d) Upon the happening of any such destruction or damage the total yearly rent hereby reserved and the outgoings payable by the Lessee under Clause 4 of this Lease or a proportionate part thereof according to the nature and extent of the damage sustained shall abate until the Demised Premises shall have been rebuilt or reinstated or made fit for use and occupation or until this Lease shall be terminated pursuant to the provisions of sub-clause (a) of this Clause as the case may be; AND (e) In the event of any dispute arising out of the operation of this Clause the same shall be referred to arbitration under the provisions of the laws for the time being in force in the State of New South Wales. Notwithstanding anything in this Clause expressed or implied the Lessee shall have no such right of termination and rent shall not abate if the destruction or damage was caused by the Lessee." 3 There was reference throughout argument to provisions of the lease relating to repairs and to insurance, although the Notice of Termination was not based on failure to comply with them. Part 6 - Maintenance Repair And Alterations - provides at 6.1:- "The Lessee will during the Term and otherwise so long as the Lessee may remain in possession or occupation when where and so often as need shall be maintain replace repair and keep the Demised Premises in good and substantial repair order and condition (having regard to their condition at he (sic) commencement of the Lease) damage by explosion, earthquake, aircraft, riot, civil commotion, fire, flood, lightning, storm, tempest and reasonable wear and tear, act of God and war damage only excepted unless any insurance moneys are irrecoverable through the neglect default or misconduct of the Lessee.

This covenant shall not impose on the Lessee any obligation in respect of any structural maintenance replacement or repair except when the same is rendered necessary by any act neglect default or omission on the part of the Lessee or by the Lessee's use or occupancy of the Demised Premises. The Lessee acknowledges that the Demised Premises were in good and substantial repair order and condition at the commencement of the Term." 4 There are elaborate provisions relating to insurance under which the lessees are obliged to have insurance against a number of risks, and the insurance is to be for the protection of the lessor, who has some controls over the insurance and also rights to information. Clause 8.1 (c) is part of those provisions, and provides:- "The Lessee will insure and keep insured at all times the Demised Premises against loss or damage by fire, storm, tempest, flood and such other risks as the Lessor shall require in the names of the Lessee and the Lessor for the full insurable value of the Demised Premises (and if required by the Lessor in the Demised Premises full reinstatement value) such insurance to be with an insurance office approved by the Lessor AND the Lessee will hand the policy or policies evidencing such insurance and all receipts for premiums paid and other usual evidence of insurance to the Lessor upon the issue thereof and the Lessee will pay all premiums in respect of all such policy or policies and renewals thereof as and when same fall due and the Lessee shall not permit or make any exclusions endorsements or alterations to such policy or policies unless first approved in writing by the Lessor." The lessees had various insurances over their business. The lessees had Storm and Tempest insurance in effect on 17 August 1998 but did not then or at the time of the hearing have insurance against Flood. 5 The lessees continued the kinds of insurance which their predecessor lessees had had. Exhibit E is a certificate issued by Citylink Insurance Brokers recording terms of their insurance with Lloyds Insurers; the insurance was in various classes including "Fire and Extraneous Perils excluding flood" but there was no insurance for the class "Flood". The lessees did not propose for insurance under the class "Flood". The Fire and Extraneous Perils insurance extends among other things to loss, destruction or damage of the building as a result of events of storm tempest or rainwater, excluding flood; but "flood" has a defined meaning. Some things which would ordinarily be called "flood" are not excluded and in particular "inundation by…run-off surface water from surrounding areas" is not excluded, while flood caused by a sudden rise of Cabbage Tree Creek is probably excluded. 6 The question whether the lessees failed to comply with the covenant relating to flood insurance is not directly in issue and cannot be decided in this case, and the same is true of the question whether that failure has actually caused loss. The availability of insurance and the question whether damage to the hotel was covered by the insurance against Storm and Tempest depend on detailed facts relating to the source of the water which flooded the hotel. Those facts have not been examined in the evidence, and are still under claim to the insurers, and the answer to the question whether there is entitlement to indemnity is not obvious or easy. The terms of the lease give the impression that the lessees should have done more, but the lessor has not claimed possession on the footing of a breach of that covenant and it is not necessary to decide whether there was a breach, or whether any breach caused loss. The absence of Flood insurance was referred to a number of times in the hearing but I do not think that it is of direct importance, except that events would probably have gone differently if there had been Flood insurance. The lessor was entitled to know, and did know before 17 August 1998, particulars of the insurance which the lessees had obtained; but in my opinion that does not alter the lessees' obligation under the covenant. 7 A number of times during the hearing observations were made and questions were framed by lessees' counsel which assumed or asserted that under the lease the lessor was obliged to maintain the structure of the hotel. In my opinion the lease does not create any such obligation. The exception to clause 6.1 establishes that the lessee is not under any obligation in respect of structural repair and creates no implication that the lessor is under an obligation in respect of structural repair. In my opinion the effect of Part 6 is that either the lessor or the lessee may carry out structural repair as thought fit but neither is obliged to do so. 8 The terms of clause 3.11 present several difficulties for understanding it. One difficulty is to understand what matters are to be established by the opinion of the lessor. The first passage of clause 3.11 is open to the reading that some or all of the circumstances in which termination or abatement of rent or other action under sub-paragraphs (a) to (e) is to happen are to be established only if the lessor forms an opinion on them. On the widest reading the lessor's opinion may be necessary to establish whether the building is destroyed or damaged, whether it is destroyed or damaged by a disabling cause, whether the demised premises have been rendered substantially unfit for use and occupation of the lessee, whether destruction or damage has rendered rebuilding or reconstruction of the building in its previous form impracticable, and whether the destruction or damage has rendered rebuilding of the building in its previous form undesirable. The arrangement of ideas and expressions in the opening part of clause 3.11 and the punctuation are not of any real use in determining whether the opinion is to be the means of establishing all of these things or only the last of them, that is the question whether rebuilding or reconstruction is undesirable. 9 It is very unlikely that it was intended that all of these things were to have some effect only if established in the opinion of the lessor, because the later sub-clauses confer rights on the lessee and it is very unlikely that those rights were only to exist and be available against the lessor if the lessor had first formed and expressed an opinion which the lessee could act on; that would make it unlikely that the lessee would ever get any practical benefit. All the factual tests in the opening passage are capable of being established objectively - destroyed, damaged, disabling cause, substantially unfit, impracticable, except the last - undesirable, which unlike the others is a matter for opinion. My view is that the matter which is to be determined according to the opinion of the lessor is only the matter mentioned immediately before the opinion was introduced, that is the question whether destruction or damage rendered rebuilding or reconstruction undesirable. 10 The tests mentioned in the opening part of clause 3.11 can be satisfied in a widely different range of circumstances. For example a part of the building might be damaged so as to render the demised premises substantially unfit for use and occupation during a short part of the term, and that would present different considerations about whether the lease ought to be terminated or whether the rent ought to abate to those presented by other circumstances in which the whole building was completely destroyed. Clause 3.11 would work in a very strange way if either party could terminate the lease and bring the rights and obligations of the other party to an end without compensation on the happening of an event which made the premises unfit for use and occupation only for a short time and led to a small abatement of rent. 11 In my view the meaning of clause 3.11 must be understood with an implied limitation which the words used allow and without which the power to terminate could operate very unjustly. Unless there is an implied limitation there are no means to bring it about that termination without compensation is appropriately proportional to the difficulty created by the destruction or damage. An implied limitation of this kind is indicated and assumed by the mechanism in sub-clauses (a) and (e) in which one party may terminate the lease in the circumstances stated by notice in writing to the other, but in the event of any dispute the dispute is to be referred to arbitration. The matters which may be disputed are not only the factual matters - whether the building has been destroyed or damaged, whether the demised premises have been rendered substantially unfit for use and occupation, whether rebuilding or reconstruction is impracticable and so forth, but also the question whether termination without compensation is appropriate, which may be determined by a notice given by either party but if disputed is to be determined by an arbitrator. 12 My view on the approach I should take to implication is based on the approach in the Court of Appeal in Renard Constructions Pty Ltd v Minister of Public Works (1992) 26 NSWLR 234 to the contractual provisions there under consideration and their Honours' receptivity to ad hoc implications of obligations of reasonableness. The relevant provisions of clause 3.11 differ markedly from those provisions, but there are some similar elements in the manner in which they work. The provisions of clause 3.11 which refer to the lessor's opinion and the power of either party to terminate are mechanisms ancillary to the overall purposes of the parties' agreement and exist to achieve those purposes; they are not there so as to enable the party forming the opinion or deciding on termination to grasp an advantage for itself, and the implication of reasonableness, which is readily made, is required to be made and governs those steps. Such implications are made readily; see Hughes Brothers Pty Ltd v Trustees of the Roman Catholic Church (1993) 31 NSWLR 91, Alcatel Australia Limited v Scarcella (1998) 44 NSWLR 349. The purposes of the parties' leasehold relationship at large furnish context within which the reasonableness of a decision is to be evaluated. 13 Handley JA in Renard at 280-283 collected and reviewed case law in which provisions for reference of disputes to arbitration after decisions to the satisfaction or in the discretion of a party have been held to place the arbitrator in the position of hearing an appeal from the party's decision or discretion. The structure of clause 3.11 leads me to the view that the dispute which may be referred to arbitration may relate to any element of clause 3.11, whether a matter or fact, an opinion or a decision of a party. In clause 3.11 the opinion of the lessor or the decision of a party to terminate is, in my opinion, no more than provisional and the machinery for arbitration of a dispute is just as much a part of the mechanism for producing a decision as is the machinery for provisional decision by a party. 14 The purposes of the lease overall appear to me to require that termination should not follow automatically from damage and at the option of either party: there must be an implication that termination would only happen if the damage was such as to make termination appropriate, and there must be an implication that the dispute and arbitration mechanism would extend to reconsidering any decision by a party bearing on termination. Otherwise the lease would be futile, liable to be defeated by either party in relatively slight circumstances. It would lack business efficacy as a lease for 20 years. 15 It could very well be that an abatement of part (or even all) of the rent might be appropriate for some period yet termination without compensation of the entire lease relationship might be inappropriate; and if there was a dispute about this the parties agreed to be bound by what an arbitrator might decide. 16 In my opinion it is an implied obligation of the lessor to act reasonably in forming an opinion on the undesirability of reconstruction, and it is an implied obligation of each party to act reasonably in terminating the lease. Unless facts objectively exist in which it is reasonable to conclude that reconstruction is undesirable, an opinion that it was undesirable would not have any contractual effect. In an endeavour to articulate what is required by the test of reasonableness when it is to be applied to a decision to terminate under the lease, I will say that it requires proportionality between the outcome of termination without compensation and the nature of the underlying problem. 17 I do not accept the contention made on behalf of the lessor to the effect that by asserting a right to an abatement of rent to which the lessee was plainly entitled in the circumstances, and which the lessor did not dispute, the lessee has established, or is estopped from denying that facts exist on which a termination may be grounded. The contention was based on an incorrectly simple view of the wide range of circumstances in which there might be abatement, and in which there might be a termination of the lease. 18 The reference to termination being effected by a notice in writing should also in my opinion be understood by reference to the available mechanism for dispute and arbitration. First there is a need for a period of notice to attend to practicalities of bringing the relationship to an end, for which the need for a reasonable period of time is obvious, as is illustrated by the need of a lessee to wind up business in an orderly way and arrange for transfer of the licence. Secondly there is a need for a period of notice to establish whether there is any dispute and to set an arbitration in motion if there is. The course taken by the lessor in this case was to give the notice on 1 December, not specifying any period of notice, and then to re-enter the premises early in the morning of 2 December. Only nominally was there a period of notice at all; in substance, no notice was given, as no opportunity was given either to act on the Notice of Termination by winding up the business, or to act on it in any other way, such as by setting the arbitration machinery in motion. The lack of a reasonable period of notice, in substance the lack of any notice at all, is in my opinion a reason sufficient of itself why the Notice of Termination was not effective. 19 Lord Devlin speaking for the Judicial Committee in Australian Blue Metal Limited v Hughes [1963] AC 74 at 98 said:- "…it does not require very much to induce a Court to read into an agreement of a commercial character, either by construction or by implication, a provision that the arrangements between the parties, whatever they may be, shall be terminable only on reasonable notice." 20 This observation was not applied by their Lordships in that case, but in my opinion it is clearly applicable to the present case, where in the circumstances stated the lease is terminable on notice; clause 3.11 specifies that there is to be notice, and does not specify how long it is to be. 21 I take it that the basis of their Lordships' observation at 98 is the case law referred to at 102, particularly Wintergarden Theatre (London) Ltd v Millennium Productions Ltd [1948] AC 173 at 199 and 205 and Tool Metal Manufacturing Co Ltd v Tungsten Electric Co Ltd [1955] 1 WLR 761 at 765. The implication would require a notice of a reasonable time; it would not require a dated notice which specified the time when it was to expire, although that would be convenient, but it would be necessary that the notice should indicate that it was to operate in the future, and it would be necessary that a reasonable time should elapse between giving the notice and putting it in to effect. McHugh JA stated the effect of case law in this field in Crawford Fitting Co and Ors v Sydney Valve and Fittings Pty Ltd (1988) 14 NSWLR 438 at 444; see too Clarke JA at 454. 22 The alternative to a construction in which there is to be a reasonable period of notice is a construction in which a notice in writing is to be given but it is not required to be a notice for any length of time and can operate immediately. It is difficult to suppose that the parties can have intended to agree in those terms, in which the delivery of a document as a notice serves so little function that is hard to see why it would be required; re-entry would be enough. That reading would be difficult to reconcile with the use of the word "notice" to refer to the document, although not entirely inconsistent; it is conceivable that a notice could operate immediately on delivery, although that is not the most usual meaning of expressions which include the word "notice". 23 In fact however the lessees' solicitor within the extreme limitations imposed by the course taken by the lessor did indicate on 1 December that the termination was disputed, and in my opinion the consequence of this event pointed out by the terms of clause 3.11 was that the provision relating to arbitration was to be acted on and no other action under the Notice of Termination was available. 24 In my opinion the provisions of clause 3.11 did not in the circumstances entitle the lessor to re-enter the premises on 2 December 1998, because the dispute had not been arbitrated and also because, even if there had not been any dispute, there had not been reasonable notice. 25 The lessees' counsel put forward for consideration some issues which I do not regard as ultimately determinative, in view of what I have said about the operation of clause 3.11. One was a contention to the effect that the lessor had not acted reasonably and in good faith in forming the opinion upon which the purported Notice of Termination expressed itself to be based. I do not regard this question as determinative because of my view of the operation of clause 3.11 in which the opinion if formed and the decision to terminate are both open to dispute and in case of dispute the effective decisions on both subjects are to be made by the arbitrator. 26 I state my opinion that the lessee acted reasonably and in good faith in deciding to terminate upon the material upon which the lessee acted, that is the report of Mr Madden, which if accepted in its entirety does provide a basis upon which a reasonable person could form the opinion that reconstruction of the building in its previous form is undesirable. Notwithstanding the consideration which Mr Courtney on behalf of the lessor had given to possibly entering into a different hotel venture in Fairy Meadow, I would not find that he acted unreasonably or without observing good faith in forming his opinion, if his action is tested only by reference to the material which he considered. He did not act for any improper purpose or any purpose extraneous to the purposes of clause 3.11 in deciding to issue a Notice of Termination. I say this because the consideration which had been given to disposing of the property after demolition or turning it to account, and to entering into another hotel venture with other persons, had not proceeded very far, and in any event the fact that Mr Courtney turned his mind to those questions does not establish a lack of good faith, as there is no unrealistic requirement that the party acting under clause 3.11 should act with indifference to the party's own interests. 27 However the effectiveness of a termination and the question whether reconstruction is undesirable are not finally decided according to the opinion of the lessor, and there is a very considerable body of material to be set against Mr Madden's opinions about the stability of the structure upon which a quite different conclusion could be based. An arbitrator deciding the dispute would have to have regard to the report of Mr Anderson, a builder who prepared a report on the Cabbage Tree Hotel on 23 April 1993, and that report would show that many of the processes of deterioration and decay which Mr Madden noted were already present in the building before 17 August 1998 and that their presence was not inconsistent with fitness of the demised premises for use and occupation and did not make rebuilding or reconstruction necessary; they were in no way inconsistent with carrying on business, to the standard at which it was being carried on before that day, and they set an important part of the context for any decision about whether, in effect, the building and the lease ought to be written off and all rights and obligations of the lessor or the lessee brought to an end. 28 It would also be necessary to have regard to the observations and the views of Mr D R Sherson, who reported on inspections of the hotel which he made in December 1998 and whose report was in evidence. Although Mr Madden's observations were very detailed and fully and clearly expressed, and appear to have been well considered, they are by no means the last word on the subject, and the lesson of experience is that hotel business can be carried on in the premises for years on end while the premises are in a very deteriorated state. The right answer to this conflict can only be known when the conflict is resolved by the means pointed out by clause 3.11, that is to say by arbitration. 29 The lessees' counsel also contended that the lessor is estopped by its conduct from relying on its power of termination; the contention was to the effect that the lessor's conduct from 17 August to 30 November 1998 and in particular its giving no indication that the lease would be terminated, while it was known and obvious that the lessees were engaged in some works of restoration, in some way brings about the result that there is an estoppel. As is very common with contentions in which estoppel is invoked the factual basis for an estoppel was not well elucidated. In my view there is no estoppel because the conduct of the lessee could not be said to have clearly had the effect of representing to the lessee or giving the lessee to understand that the power of termination would not be exercised; there was simply no communication on that subject either way. Further there is no real basis for thinking that the lessees' conduct was influenced by conduct of the lessor; that is to say no basis for thinking that but for some such representation as must be supposed the lessees would not have bothered with the works of restoration which they did engage in. Quite to the contrary the modest work which the lessees undertook is well explicable by attention to their own interests, without reference to any representation imputed to the lessor. In my view there was no estoppel. 30 For the reasons stated I am of the view that the Notice of Termination did not have the effect of entitling the lessor to re-enter the premises and I will make orders and declarations to that effect. The parties should remain in their present position, with the lessees in possession under the lease for the balance of the term unless and until a decision for termination is obtained on arbitration. 31

ORDERS: 1. Order that the defendants by themselves, their employees and agents be permanently restrained from acting on the purported Notice of Termination of Lease from the first defendant to the plaintiffs dated 30 November 1998 and from interfering on the basis of that Notice with the plaintiffs' quiet possession of the hotel premises known as The Cabbage Tree Hotel, 73 Princes Highway, Fairy Meadow, in accordance with the terms of lease 275736H. 2. Declare that the purported Notice of Termination of Lease from the first defendant to the plaintiffs dated 30 November 1998 is of no force or effect.

3. Order that it be referred to a Master in the Equity Division to enquire into and certify the damages to which the plaintiffs are entitled by reason of the defendants' trespass on 2 December 1998 and the interest which ought to be allowed thereon: and direct that judgment be entered for the plaintiffs against the defendants for the amount so certified.

(4) Order that the defendants pay the plaintiffs' costs of the proceedings. I hereby certify that paragraphs 1-31 are the reasons for judgment of the Honourable Justice John Bryson.

Last Modified: DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.