Perpetual Trustee Company Ltd v Paola

CATCHWORDS : MORTGAGE - commercial property - duty of mortgagee on sale - whether required to consent to lease that increases value - specific performance not appropriate - remedy, if any, in damages

Conveyancing Act 1919 Fair Trading Act 1987 LEGISLATION CITED : Real Property Act 1900 Supreme Court Act 1970 Trade Practices Act 1974 (Cth)

Apollo 169 Management Pty Ltd v Pinefield Nominees Pty Ltd [2010] VSC 40 Independent Order of Oddfellows of Victoria Friendly Society v Telford (1991) V ConvR 54-419, 240 CASES CITED : Park v Brothers [2005] HCA 73; (2005) 80 ALJR 317 Thanes Pty Ltd v Custom Credit Corporations Ltd (1985) 5 BPR 11, 955 Ultimate Property Group Pty Ltd v Lord [2004] NSWSC 114; (2004) 60 NSWLR 646

TEXTS CITED : WD Duncan, Commercial Leases in Australia, 5th ed (2008) at 445

Perpetual Trustee Company Ltd (First Plaintiff / First Cross-Defendant) PARTIES : Challenger Managed Investments Ltd (Second Plaintiff / Second Cross-Defendant) Lucia Paola (First Defendant / First Cross-Claimant) Maria Grazia Paola (Second Defendant / Second Cross-Claimant)

COUNSEL : D L Cook (Plaintiffs / Cross-Defendants) D A Allen (Defendants / Cross-Claimants)

SOLICITORS : Norton Rose Australia (Plaintiffs / Cross-Defendants) Barraket Ronayne (Defendants / Cross-Claimants)

IN THE SUPREME COURT OF NEW SOUTH WALES COMMON LAW DIVISION

296195/2009 Perpetual Trustee Company Ltd & Anor v Paola & Anor

JUDGMENT 1 HIS HONOUR: In these proceedings Perpetual Trustee Company Ltd ("Perpetual") has obtained default judgment and is about to execute a writ of possession in order to sell the property owned by Maria Paola and Lucia Paola ("the cross-claimants"). The cross-claimants seek urgent relief staying the writ at least until leases have been registered and requiring Perpetual to consent to certain proposed leases. 2 The proceedings (i.e. the Cross-Claim) is based on the duty imposed by law on Perpetual not to act unconscionably as mortgagee and to exercise its rights under the mortgage contract (and presumably under statute) reasonably. The proceedings 3 On 29 May 2008, the cross-claimants entered into a loan agreement with the second plaintiff, Challenger Managed Investments Ltd, for the amount of $2,400,000. The loan was secured by registered mortgage AD999828 over the property at Pittwater Road, North Narrabeen, New South Wales, which was owned by the cross-claimants. 4 On 13 July 2009, the cross-claimants defaulted on the loan, and then failed to comply with the default notice by the date specified in the notice, 21 August 2009. Accordingly, Perpetual sought, by Statement of Claim filed 10 September 2009, an entitlement to possession of the secured property and judgment in the sum of $2,440,515. 5 On 2 December 2009, default judgment was obtained by Perpetual for $2,548,709.78, leave for issue of a writ of possession over the property was granted. The writ of possession issued. 6 Subsequently, stays of the writs of possession were obtained as follows:

(i) The writ of possession due to be executed on 4 February 2010 was stayed by agreement; (ii) The writ of possession due to be executed on 30 April 2010 was stayed ex parte and extended on 7 May 2010 until 21 May 2010; and (iii) A stay of the writ of possession was granted on 2 July 2010 until 22 July 2010. 7 On 23 August 2010, the cross-claimants sought from me, as Duty Judge, and were granted, abridgment of time for service of a Notice of Motion, which motion was stood over until 24 August 2010. 8 By that Notice of Motion, on 24 August 2010 the cross-claimants sought orders setting aside the default judgment entered on 2 December 2009, staying the writ of execution to be executed on 25 August 2010 until further order of the Court, and an injunction restraining Perpetual from selling the property until it has consented to the proposed leases of the property and those leases were registered. During the course of seeking those orders, the cross-claimants sought leave to file a Defence to Perpetual's Statement of Claim and the Cross-Claim, and foreshadowed arguments that the failure of Perpetual, as mortgagee, to grant consent to the registration of three proposed leases at the property, amounted to unconscionable or unreasonable conduct. 9 In order that these matters might be given lengthier consideration, the Court made interlocutory orders to the following effect:

(i) The execution of the writ of possession for Pittwater Road, North Narrabeen, was stayed until 4.00pm on 6 September 2010; (ii) The Defendants were to file and serve the proposed Defence and Cross-Claim as tendered in the proceedings; (iii) The matter that is the question of a permanent injunction and any further directions which might be made, including orders for specific performance, were listed for 30 August 2010. 10 The Cross-Claim, which is the subject of these proceedings, sought an order from the Court, pursuant to s 23 of the Supreme Court Act 1970, s 87 of the Trade Practices Act 1974 (Cth), or s 72 of the Fair Trading Act 1987 that:

(a) the cross-defendant, Perpetual Trustee Company Ltd, consent to the granting of three leases; (b) the cross-defendant consent to and do all acts required by it to have the said leases registered; (c) the cross-defendant pay damages or equitable compensation, or give such further or other relief that the case may require. Facts 11 As already noted, on 13 July 2009, the cross-claimants defaulted on the loan, when they failed to pay $18,166.04. As at 21 August 2009, the cross-claimants remained in arrears, which brought the loan balance to $2,440,515.41, being the amount claimed in the Statement of Claim by Perpetual and being the sum of the amount in arrears and the total principal remaining unpaid. 12 Prior to Perpetual obtaining default judgment, the property went to auction but failed to reach the reserve price of $3,200,000; it remains on the market (Affidavit of Lucia Paola, 4 May 2010, paragraph 6). 13 In December 2009, following the unsuccessful auction of the property, the cross-claimants commenced negotiations to lease areas of the premises, because of a belief that this would result in a higher purchase price or assist in re-financing (Affidavit of Lucia and Maria Paolam, 29 April 2010, paragraph 6). In these proceedings, the cross-claimants sought to support this proposition with a valuation of the property by Alcorn Lupton Pty Ltd from 12 August 2010, which determined the value of the property on a fully tenanted basis at $3,125,000, and on an untenanted basis at $2,392,306 (Valuation Report of Alcorn Lupton & Associates, MGP1 to Affidavit of Maria Grazia Paola, 23 August 2010). 14 On the evidence of each of the cross-claimants, three leases were successfully negotiated. The draft leases formed Annexures A, B and C to the Affidavit of Lucia and Lucia Paola, 29 April 2010. 15 At the same time, the cross-claimants entered into negotiations for the sale of the family business, which the cross-claimants operated out of the property. 16 On 21 December 2009, the cross-claimants' solicitor wrote to Perpetual's solicitor requesting Perpetual's consent to the sale of business and leases (Annexure A, Affidavit of Thomas Hugh Walker, 4 May 2010). That letter expressed the cross-claimants' proposal to lease the property as four separate tenancies as per an attached plan. The letter briefly noted each of the proposed uses of the premises (a mechanical workshop, a bicycle workshop, a surfboard shop and a lease to Yandar Pty Ltd t/as Narrabeen Auto One). For the proposed lease to Yandar Pty Ltd, a commencement date for the lease, the amount of the deposit and the lessee's name (Yandar Pty Ltd) were provided, but otherwise no details of the consideration, length of the proposed lease, any options for a further term or other relevant provisions were given. Moreover, the negotiations for the remaining three leases were described to be "at an advanced stage", but no details were provided. A copy of a development application in respect of the proposed subdivision, or specific information about how the division might be effected, was not provided to Perpetual. 17 Raffaele Paola, the husband of the second cross-claimant, gave evidence that in or around December 2009, he spoke by telephone with Joe Merceica, an employee of the second plaintiff, in relation to the proposed leases (Affidavit of Raffaele Paola, 23 August 2010, paragraphs 1-6). In that conversation, Mr Paola explained that the leases would give a rental return of $350,000 per annum net, increasing the property's value to $4,000,000. Mr Merceica allegedly responded "fantastic". Mr Merceica does not recall this conversation, but gave evidence that he spoke with Mr Paola on 18 January 2010 telling him that: "any queries relating to the proposed leasing arrangements are to go through my solicitors, Norton Rose Australia" (Affidavit of Joseph George Merieca, 30 August 2010, paragraph 12). 18 On 7 January 2010, Perpetual's solicitor responded to the cross-claimants' solicitor's letter, requesting further information before Perpetual made a determination to consent to the registration of the proposed leases (Annexure B, Affidavit of Thomas Hugh Walker, 4 May 2010). Specifically, Perpetual requested:

(a) copies of the proposes leases; (b) copies of any development applications in respect of the property's subdivision; (c) details of any proposals otherwise to sub-divide the property prior to the registration of the leases; (d) copies of any other documents in respect of the proposed leases and subdivision of the property; and (e) an updated valuation to be conducted on the property to enable a determination of the cross-claimants' lease proposal. 19 On 12 January 2010, the cross-claimants' solicitor responded (Annexure C, Affidavit of Thomas Hugh Walker, 4 May 2010). The cross-claimants indicated that they would not prepare the Leases until the terms had been approved by Perpetual in principle, that the subdivision would not be effected by way of a registered Deposited Plan but the proposal was "merely to Lease the property in four parts as per the attached draft plan", and that there was no further documentation available. The cross-claimants suggested that Perpetual's valuer attend the property to conduct a valuation of the proposal, at the cross-claimants' expense. 20 On 19 January 2010, Perpetual's solicitor responded, stating that the cross-claimants' facility had been terminated due to continuous default, and requesting payment of the amount outstanding of $2,599,055.76 (Annexure D, Affidavit of Thomas Hugh Walker, 4 May 2010). Perpetual refused to send a valuer until the cross-claimants provided further details including:

(a) a detailed lease proposal providing details of the proposed lessee, amount of rent payable per year, commencement date, termination date, options to renew, options to purchase and rent review; (b) further information regarding the application for Development Consent from Pittwater Council; (c) details of how the cross-claimants proposed to discharge their indebtedness. Perpetual's solicitor also indicated their instructions to continue to lodge the Writ of Possession and exercise their power of sale. 21 On 28 January 2010 and 18 February 2010, Perpetual's consent was again sought, but not obtained. 22 In March 2010, the cross-claimants sold their family business to Yandar Pty Ltd for $200,000, at a reduced price to pay arrears of interest payments and vacate the premises, with a back lease (Affidavit of Lucia and Maria Paola, 29 April 2010, paragraph 7). 23 The cross-claimants' solicitor advised Perpetual of the sale of business to Yandar Pty Ltd and enclosed a copy of the proposed lease by letter dated 1 April 2010 (Annexure E, Affidavit of Thomas Hugh Walker, 4 May 2010). The cross-claimants' solicitor indicated that $180,000 of the sale price of the business was being held in its trust account, $140,000 of which was to be released to Perpetual but only after they had consented to the lease. The cross-claimants also advised that the Town Planner had lodged an application to the Council for approval, and once approval was obtained a second lease (of Suite 1 to Mitchell Beck and Neil Wheeler) could commence, and a draft lease was provided. In respect of Suite 4, the cross-claimants advised that a lease was proposed to Rafaelle Paola and Marco Paola, who are related to the cross-claimants, a draft of which was enclosed. For the remaining suite, the cross-claimants advised that a lease was still being negotiated. Finally, the cross-claimants indicated that they had received advice from their agent that the property was not saleable with vacant possession, but was saleable with the three leases in place and for an amount greater than the debt and interest. 24 By letter dated 13 April 2010, Perpetual's solicitor indicated that they would proceed with re-lodging the Writ of Possession and did not indicate their willingness to consent to the proposed leases. 25 On 15 April 2010, the cross-claimants requested a meeting to discuss the proposed leases. This meeting was refused by Perpetual on 19 April 2010, due to insufficient details of the leases being provided, including a copy of the lease to Yandar Pty Ltd, indications of how the $60,000 left from the sale of the business was to be paid, and summaries of current occupants of the property and rent being paid. Perpetual also expressed concerns about the completeness of the draft leases forwarded on 1 April 2010. 26 The cross-claimants endeavoured to comply and on 22, 23 and 28 April 2010 sent to Perpetual the requested information and the proposed leases. Further, they applied for refinance. By letter dated 29 April 2010, Perpetual refused consent and indicated that the execution of the Writ of Possession was intended to proceed the next day (Affidavit of Lucia and Maria Paola, 29 April 2010, Annexure F). 27 The remaining stays of the Writs of Possession were obtained, while negotiations over the consent to the leases continued. Following the temporary grant of the stay on 24 August 2010, Perpetual's solicitor wrote to the cross-claimants in relation to the three proposed leases (of suites 1, 2 and 4), setting out three pages of "issues and discrepancies that prejudice the security interest" of Perpetual, and requesting an urgent response (Annexure A to the Affidavit of Angelos Mitchell Mathas, 30 August 2010). The cross-claimants' solicitor responded by letter on Sunday 29 August 2010, which was received by Perpetual's solicitor at 2.45pm, seeking to answer each of Perpetual's concerns. Cross-Claimants' submissions 28 The cross-claimants' submissions rested on six propositions:

(a) that it is an implied term of the Mortgage that Perpetual would take no step that would have the effect of reducing the value of the property; (b) that it is an implied term of the Mortgage that Perpetual would not unreasonably withhold its consent to the registration of any leasehold interest in the property; (c) that Perpetual owes an equitable duty and an implied contractual duty to do any act which is reasonable and which will help obtain the best price for the property upon the sale by the mortgagee; (d) that, due to Perpetual's conduct, it is not proposing to sell the property in good faith; (e) that obtaining possession would amount to unconscionable conduct within the meaning of s 51AC(1)(a) of the Trade Practices Ac t; or (f) that obtaining possession would amount to unconscionable conduct within the meaning of s 43 of the Fair Trading Act (Statement of Cross-claim, paragraphs 6-9, 11 and 12). 29 The cross-claimants relied on the decision of the High Court of Australia in Park v Brothers [2005] HCA 73; (2005) 80 ALJR 317 for the proposition that Perpetual was, in granting or withholding consent, required to act reasonably, having regard to its legitimate interests (which the requirement of approval is there to protect). 30 In relation to unconscionability, the primary authority on which the cross-claimants sought to rely was the decision in Ultimate Property Group Pty Ltd v Lord [2004] NSWSC 114; (2004) 60 NSWLR 646 of Young CJ in Eq (as he then was) where, at [38], his Honour stated: "The duty [of a mortgagee] is a duty to act conscionably towards a mortgagor and persons under the mortgage. The duty is not to be considered in some mechanical way, but the whole of the mortgagee's conduct with respect to the sale is to be considered. The mortgagee may, up to a point, act solely in its own interests, but it must also act conscionably towards the mortgagor and those claiming under mortgagor." 31 In seeking to establish that Perpetual's refusal to consent was unreasonable or unconscionable, the cross-claimants emphasised the impact of the refusal on the value of the property and the position of the cross-claimants, because the refusal:

(a) prevented the cross-claimants obtaining an income stream with which to redeem the Mortgage by obtaining refinance; (b) devalued the property in that, without leases it is valued at $2,400,000 but with leases it is valued at over $3,100,000 (relying on the report of Alcorn Lupton & Associates); (c) prevented the cross-claimants redeeming the Mortgage by way of refinance, due to the devaluation; and (d) exposed the cross-claimants to claims by the potential lessees, who were led to believe that they could take possession on the basis that formal leases would be entered because representations were made to them to that effect based, it is alleged, on the representation of Mr Merceica. 32 Moreover, the cross-claimants suggested in submissions that the "issues and discrepancies", raised by Perpetual, in their letter of 26 August 2010, as a reason for not giving consent at that point of time, are "in no way issues which can be stated to prejudice the mortgagee's security interest" (Transcript of Proceedings, page 37). The cross-claimants also submitted that the letter of the cross-claimants' solicitor of 29 August 2010 "is a response to every one and every requisition or complaint made by the mortgagee" such that there ought be no remaining barrier to Perpetual's consent (Transcript of Proceedings, page 37). 33 The results of the refusal of consent outlined above, in the cross-claimants' submission, "can only be avoided by Perpetual consenting to the giving of and registration of [the] proposed leases … and selling the property as mortgagee subject to the proposed leases" (Statement of Cross-Claim, paragraph 14). 34 It was agreed or conceded that, were the relief sought denied, the cross-claimants could seek damages arising once the power of sale is exercised (Transcript of Proceedings, page 56), and the claim for damages or equitable compensation in this Cross-Claim was not pressed (Transcript of Proceedings, page 4). Consideration 35 Unless the terms of the Mortgage otherwise provide, a mortgagor in possession has a right to lease the mortgaged property (ss 106(1), 106(11), Conveyancing Act 1919). The terms of the Mortgage in the present case, at clause 3.2, require the mortgagee's consent before the cross-claimant can grant a lease. Clause 3.2 states that: "The Mortgagor will not: … (2)(a) dispose of; (b) create or allow any interest in, or (c) part with possession of, any Mortgaged Property, or agree, attempt or purport to do so, except with the consent in writing of the Mortgagee or as expressly permitted in any Transaction Document." 36 It was common ground that no such consent has been given by the mortgagee, and that any lease entered into by the defendants without such consent does not bind the mortgagee (s 53(4) Real Property Act 1900). 37 Clause 1.4 of the Mortgage further provides that if Perpetual's consent is required, Perpetual may grant or refuse consent in its "absolute discretion and without giving reasons". It was accepted by Perpetual that in exercising its power of sale, it owed a duty of good faith to the cross-claimants (Defence to Statement of Cross-claim, paragraph 8). 38 The correspondence between Perpetual and the cross-claimants on 26 August and 29 August 2010 indicate that there are ongoing negotiations about the giving of mortgagee's consent to the leases by Perpetual; Perpetual is yet to finalise its attitude to consent while these issues and discrepancies remain unresolved, although Perpetual's course of conduct might suggest some reluctance to consent. 39 The issues raised throughout this year by Perpetual for satisfactory resolution before the consent determination are not unreasonable. In circumstances where Perpetual has a legitimate right to protect its security interest, and has a strong commercial incentive to maximise the sale price of the property, it is not unreasonable to seek concrete details of the commencement and termination date of the lease, to draw attention to discrepancies between the lease period on the lease and the disclosure statement, to seek clarification of the rent review dates, to raise concerns about the amount of public liability insurance required under the lease, to query whether the use fits within the permitted uses of the property's zoning, to raise questions about the solvency, and capacity to pay rent, of the lessees and otherwise to note discrepancies and errors in the leases and disclosure statements. The numerous discrepancies uncovered by Perpetual in the draft lease documents would not have inspired confidence in the prudence of the transactions. 40 These concerns remained when Perpetual was served with the Cross-Claim, and legitimate concerns remained even after the cross-claimants assurances on 29 August 2010. For example, it would not be unreasonable for Perpetual to expect evidence of the cross-claimants' due diligence into the lessee's capacity to pay the rent over five years, given the application for winding up made against the lessee in December 2008, particularly given the length of the lease period (including lessee options to renew). 41 Moreover, although, as a general proposition for a commercial property of this kind, it might be accepted that a fully tenanted property would achieve a greater sale price than an untenanted property, there are a number of qualifications to this proposition which Perpetual was entitled to consider in granting or refusing consent. Although there was a significant disparity between the tenanted and untenanted valuations completed by Mr Lupton, Mr Lupton's valuations were based on the assumptions that the lessees were in situ, that the lessees were good tenants, and without consideration of the specific terms of the lease. Mr Lupton accepted that each of these were "riders" which could affect a prospective buyer's valuation of the property (Transcript of Proceedings, pages 24-25), although I accept that, absent proof of default by a lessee, the value of the property once leased would be higher than if not leased. It is not unreasonable or unconscionable for Perpetual to delay, or even refuse, consent until the cross-claimants satisfied Perpetual that the particular leases would in fact improve the property's value at sale. 42 I note the recent decision of Emerton J in Apollo 169 Management Pty Ltd v Pinefield Nominees Pty Ltd [2010] VSC 40, in which, in not significantly dissimilar circumstances involving a mortgagor in default seeking to compel the mortgagee's consent to a lease negotiated at arms' length, her Honour stated (at [121]) that: "It is true that consent to a lease cannot be arbitrarily or capriciously withheld. However, it does not follow that the second defendant was bound to consent to any lease on reasonable terms to any reasonable and solvent tenant, irrespective of the circumstances." 43 For these reasons, the cross-claimants have not satisfied the Court on the balance of probabilities that Perpetual has yet acted unreasonably or unconscionably. 44 Nor is the Court satisfied on the balance of probabilities that the alleged encouragement of the leases by Mr Merceica's statement to Mr Paola in December renders the refusal to give consent, as yet, unconscionable. 45 In any event, specific performance to force Perpetual's consent as mortgagee is an inappropriate remedy. In circumstances where the terms of the proposed leases were being negotiated up until the date of the hearing, it would be inappropriate for the Court to substitute its own view as to what would constitute reasonable terms for each of the four proposed leases. Further, the order, if granted, would require the Court to supervise the negotiation of reasonable terms in the lease. 46 In this regard, I note the decision of Young J (as his Honour then was) in Thanes Pty Ltd v Custom Credit Corporations Ltd (1985) 5 BPR 11, 955, where his Honour stated (at 956): "If the situation is that the mortgagee is offering ex gratia a consent then, in my view, the mortgagor must either take it or leave it and if it accepts the mortgagee's offer it must accept it wholly and not just the parts that are acceptable. Thus on this analysis whatever the conditions are they are not imposing on the mortgagor any burden because the mortgagee was not bound to make any offer to agree to a lease binding itself in any event." (See also Independent Order of Oddfellows of Victoria Friendly Society v Telford (1991) V ConvR 54-419, 240 (Gobbo J); WD Duncan, Commercial Leases in Australia, 5th ed (2008) at 445.) 47 The proper remedy, if there be one, and if unconscionability or unreasonableness were to be disclosed, would be damages. 48 No cause of action yet arises for damages or equitable compensation because, as was agreed or conceded by the parties, no damage will in fact be suffered until the power of sale is exercised. 49 Costs of these proceedings are dealt with in the Mortgage and the Court will make no order for costs. Orders 50 The Court makes the following orders:

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.