What’s needed to exercise an option to renew a lease?

Along with giving the landlord written notice, what else is needed to make the exercise of an option to renew a lease legally binding?

This was the question the NSW Court of Appeal considered in Willis Australia Ltd v AMP Capital Investors Ltd [2023] NSWCA 158 (11 July 2023) (Ward P; Beech-Jones JA; Griffiths AJA).

The Willis decision is significant because the option to renew in that case was in similar terms to clause 4.4 of the standard commercial lease in New South Wales.

This is an analysis.

The Options to renew and to expand the leased space

AMP (as landlord) and Willis (as tenant) entered into a lease of commercial office Suite 1 (i.e. part) of Level 15 and the whole of Level 16, Angel Place, 117-123 Pitt Street, Sydney. The lease was for a term of six years. The Lease commenced on 1 October 2014 and expired on 30 September 2020.

The lease contained two options, the first an option to renew the lease for a further term of four years, the second and option to expand the leased space to the whole of Level 15. The options needed to be exercised at least nine months before the expiry date, that is, by 30 December 2019.

The option to renew was:

New Lease 

20.1     The Landlord must grant a new lease under this clause 20 on the Expiry Date to    commence on the next day only if:

(a)   the Tenant gives the Landlord a notice stating that it wants a new lease of the Premises for the term specified in item 18; and

(b)   the Landlord receives that notice at least nine months before the Expiry Date; and

(c)   when the Tenant gives that notice, and on the Expiry Date, the Tenant is not in breach of this lease, notice of which breach has been given to the Tenant in writing; and

(d)   the Tenant delivers to the Landlord before the Expiry Date a Bank Guarantee.

Note: Conditions (a), (b) and (c) have counterparts in clause 4.4 of the Law Society of New South Wales copyright lease covenants.

The option to expand the leased space was in similar terms:

20.4     The Landlord must grant a new lease under clause 20.3 for the whole of levels 15 and 16 on the Expiry Date to commence on the next day only if:

(a)   the Tenant gives the Landlord a notice stating in accordance with clause 20.1 that it wants a new lease of the Premises for the term specified in item 18; and

(b)   at the same time as the Tenant gives the Landlord a notice pursuant to clause 20.1 the Tenant also gives a notice to the Landlord stating that it wants a lease of Expanded Premises; and

(c)   the Landlord receives both notices at least nine months before the Expiry Date; and

(d)   when the Tenant gives the notices, and on the Expiry Date, the Tenant is not in breach of this lease, notice of which breach has been given to the Tenant in writing; and

(e)   the Tenant delivers to the Landlord before the Expiry Date a Bank Guarantee for an amount that is equal to the proportion of Base Rent and Outgoings (plus GST) for the whole of level 15 and 16 that is shown in item 16.

The exercise of the option to renew the lease was not in issue. What was in issue was the exercise of the option to expand the leased space.

Willis submitted that it was not bound by its exercise of the option because it had not satisfied conditions (d) and (e).

The primary judge concluded that the option was a conditional contract, because that ‘avoids commercial inconvenience’, as opposed to the option being an irrevocable offer.  AMP had waived satisfaction of conditions (d) and (e), and therefore Willis was bound to take up a lease of the expanded premises.

The Court ordered specific performance of the agreement for lease by way of the execution of a new lease, completion of a market review of the rental and provision of a bank guarantee. 

The appeal – the central issue

The Court of Appeal framed the appeal as follows:

“The central issue in the appeal is whether, on the proper construction of an agreement for lease, an option to renew the lease with an expanded space was exercised only when all five conditions specified therein were satisfied or, alternatively, whether the option was exercised (and a binding agreement to proceed to a lease arose) when there was compliance with merely the first three of those conditions. 

There is also an issue as to whether AMP Capital Investors Limited (AMP or Landlord) could waive the timing of the condition to provide a bank guarantee, as held by the primary judge.” (at p1)

The appeal – outline of events  

There was a relatively long period of time of nine months between the time the options were exercised and the time the new lease was to commence. During that period there was a change in circumstances which made Willis reconsider taking the expanded space.

This is an outline of events:  

• The Options were exercised on 20 December 2019.
• By February 2020 (which coincided with the commencement of the COVID pandemic) Willis was having second thoughts about taking the expanded space in the light of the likely increase in rent payable.
• As a result of NSW Government lockdown orders from 30 March 2020, most office space in the Sydney CBD was not occupied.
• In August 2020, Willis ‘withdrew’ the notice of exercise of the option to expand the leased space, which was due to commence on 1 October 2020. The ‘withdrawal’ was not pressed at the hearing.
• The expanded space was available because the tenant had vacated by 1 October 2020.
• On 14 October 2020, Willis provided a bank guarantee in respect of the space it currently occupied.
• At the hearing, no breach of condition (d) was pressed, and so it was condition (e), the provision of a Bank Guarantee which included the expanded space that was the issue.

The appeal – commercial convenience  

The Court of Appeal applied the principles of construction to the terms of the lease, and concluded that:

“The text of the relevant clause and a reading of the contract as a whole do not support AMP’s construction, nor do considerations of commercial nonsense or inconvenience.”

AMP had submitted that it was not necessary for there to be compliance with all five conditions for “commercial convenience”.

The Court of Appeal quoted Basten JA in Miwa Pty Ltd v Siantan Properties Pte Ltd {2011] NSWCA 297, where he stated:

“It is clear from these authorities that the test of absurdity [as a basis for constructing a document] is not easily satisfied. … The courts have no mandate to rewrite agreements, so as to depart from the language used by the parties, merely to give a provision an operation which, as it appears to the court, might make more commercial sense”. (at p 52, 53)

The Court of Appeal’s consideration on “commercial convenience” was:

“When the lease was executed in 2014, AMP or a reasonable businessperson in its position may well have thought (or hoped) that there would be a rising market when the expiry date arrived.”

Willis gave notice of exercise of the two options on 20 December 2019.

“upon receiving notices from the tenant, … the landlord would have to give notice to any existing tenant occupying the expanded space that the space would have to be vacated by the expiry date.”

The Court considered the position if the option was not exercised:

“even if there was not an expectation (or hope) of a rising market, AMP or a reasonable business person in its position may well have been confident that it could negotiate suitable terms with either Willis or another tenant.” (all at p 73)

Therefore, there was no “commercial nonsense” in insisting that all five conditions be satisfied.

The appeal – consideration and conclusion

The Court of Appeal upheld the appeal by Willis.

The Court of Appeal stated that: “the critical reasoning in Gilbert J McCaul … applies equally to cl 20.4.”

The case of Gilbert J McCaul (Aust) Pty Ltd v Pitt Club (1957) 59 SR (NSW) 122 (Full Court, NSW Supreme Court: Owen J, Roper CJ in Eq and Herron J) concerned an option to renew a commercial lease. The tenant gave written notice of exercise of the option to renew, but the landlord refused to grant a new lease because the rent was not paid punctually.

The clause was similar in terms to clause 20.4.  

The Full Court said:

“In the present case the lessor irrevocably offered to grant a lease. Its offer prescribed the time and manner for acceptance. Only by performing the conditions prescribed could it be accepted and result in an agreement for a lease.”

“the arguments on the subject of waiver addressed to us by counsel for the plaintiff [the tenant] fail. Waiver of performance connotes that a person has a right to have a condition performed and that that right has been waived. But cl. 4 gave the lessor no right to have the plaintiff perform any of the conditions stated in that clause.” (at p 84-85)

The Court of Appeal dealt with AMP’s submission that it had waived compliance with the conditions so that a binding agreement to lease the expanded space had arisen:

“Having regard to the language in cl 20.4, AMP had no “right” to have Willis perform any or all of the five conditions set out therein. Rather, as was the case in both Gilbert J McCaul and Stillwell, the conditions were such that Willis might or might not perform any of them as it thought fit. It was not obliged to give any notice if it did not wish to do so. Nor was it obliged to provide the Bank Guarantee if it did not wish to do so. Willis only needed to fulfil the five conditions in cl 20.4 if it wished to enliven AMP’s obligation to grant the new lease.” (at p 97)

Conclusions

An option to renew is an option in the tenant’s favour. The exercise of an option to renew a lease is binding only if all of the tenant complies with all the conditions set out.

Most disputes about the exercise of options to renew a lease centre upon whether or not the option was properly exercised.

The dispute that arose in this case is different. It was whether there must be compliance with all of the conditions.

But is the compliance to be strict? Although this was not part of the ratio of the decision, it is worth noting that the Court of Appeal contemplated some leniency in compliance with the conditions, by quoting this passage in Cheshire & Fifoot Law of Contract at [3.69]:

“Options (particularly options to renew a lease) are sometimes subject to the fulfilment of prior conditions, for example, that the lessee has performed all covenants. Non-fulfilment of the terms may preclude exercise of the option, that is, adhering to the terms is a condition precedent to the exercise of the option. But this can lead to harsh results if the non-fulfilment is a not very serious breach of the relevant condition or there has been tolerance of breaches. The failure to observe a condition may be a breach of an existing contract or a failure to perform the requested acts in a unilateral contract depending on which theory of option is adopted. The courts may be inclined to treat non-adherence to conditions with some leniency if the language of the option so permits. Further, there is statutory protection in some jurisdictions in the form of a requirement for the lessor to provide a notice specifying breaches where such breaches preclude the exercise of the option and a court discretion to overlook certain breaches.” (at p 76)