RETAIL LEASES LAW – CAN A RETAIL PREMISES LEASE “JUMP OUT” OF THE RETAIL LEASES ACT 2003 (VIC)?
What is a retail premises lease?
The Court of the Appeal of the Victorian Supreme Court in the Cold Storage case laid down the ultimate consumer test whereby a retail premises lease depended upon there being retail activity on those premises. In other words, goods and services would not be passed on to anyone else by the tenant’s clients or customers. The Cold Storage case enshrines the concept of “retail” – namely the provision of goods and services to an ultimate consumer. Such activity will mean that the lease of any premises is a retail lease under Victorian law. Put differently, if the tenant merely re-supplies goods, then the business is wholesale so a commercial lease will apply. There is no connection between the tenant and the ultimate consumer.
To give a practical example, a tenant has a business of purchasing fruit and vegetables from farmers. If that tenant is a wholesale distributor, who supplies fruit shops, greengrocers and supermarkets, he or she is not dealing with an ultimate consumer. Any leased premises from which that tenant does business is not retail. However, if the tenant suddenly commences selling direct to the public, he or she is providing goods or services to an ultimate consumer so there is retail activity under the Retail Leases Act.
One of the issues that has been unresolved under the Retail Leases Act is when and in what circumstances a retail lease can change into a commercial lease and vice versa.
Take the following example. A tenant has a commercial lease. In other words, the tenant is a wholesaler and does not deal with ultimate consumers. The tenant, for economic reasons, decides to start supplying goods or services to an ultimate consumer, which means that his business is a retail activity. Does the tenant’s commercial lease become a retail property lease from the date of the business transformation?
Alternatively, we have a tenant occupying premises under a retail lease. The tenant is passing on goods and services to customers. However, that tenant changes mid-lease to only supply wholesalers. Does the retail lease become a commercial property lease from that date onwards?
This question has remained unanswered for over a decade. However, it has been specifically addressed by the Victorian Civil and Administrative Tribunal in July 2019 in Verraty Pty Ltd v. Richmond Football Club and by his Honour Justice Croft of the Supreme Court of Victoria in Richmond Football Club v. Verraty Pty Ltd  VSC 597.
In the VCAT decision, Senior Member Forde in the Building and Property List came to the following conclusions. First, under Section 11(2) of the Retail Leases Act, a commercial lease remains a commercial lease even if the tenant commences retailing mid-way through. It does not change its complexion like a chameleon to become a retail lease. However, readers should be aware that such a change in occupation might be a breach of the lease or might be a breach of any relevant planning scheme. Some council planning schemes prohibit retail activities in circumstances where wholesale activities are permitted. That conclusion applies to options as well as to initial terms of commercial leases.
The situation in relation to retail premises leases is different. Senior Member Forde confirmed that a retail premises lease can “jump out” of the Retail Leases Act and can become a commercial lease. This conclusion was contrary to previous judicial thought whereby a Retail Leases Act lease only “stops” when a new lease is entered into even if the tenant becomes a wholesaler or if occupancy costs exceed $1 million. In other words, it had been thought that a retail lease did not “jump” into a commercial lease just as a commercial lease did not “jump” into a retail lease under Section 11(2). Nevertheless, Senior Member Forde disagreed with the previous legal thought and concluded that a retail lease could become a commercial lease. The facts of the Verraty Pty Ltd v. Richmond Football Club related to the million dollar occupancy costs exclusion. This means that if occupancy costs (this includes rent, GST on rent, as well as outgoings) exceed $1 million, the lease is no longer retail but is commercial. Nevertheless, if a retail lease can become a commercial lease in those circumstances, it can also become a commercial lease if the tenant’s business ceases being to ultimate consumers and becomes exclusively wholesaler.
What then are the consequences of a retail lease jumping to become a commercial lease?
The consequences are quite important. Under the Retail Leases Act, retail leases carry significant protections. These include prohibiting ratchet clauses in relation to valuing future rental for new options. In a retail lease, if the valuation indicates that the current rental is too high, the landlord is bound to lower the rent in accordance with the valuation. In a commercial lease, rents cannot go down even if the valuation indicates that the current rent is too high. If the commercial lease provides that the rent will remain the same, that is what occurs. Another important protection in a retail lease, which is not in a commercial lease, is that a landlord cannot recover land tax as outgoings. Likewise, a retail lease will impose repair obligations on a landlord under Section 52 relating to essential services and including keeping premises wind and water tight. Retail lease disputes are also heard in VCAT whereas commercial lease disputes must be heard in the traditional courts. The advantage of the VCAT jurisdiction is that it is virtually impossible for a landlord to recover costs against a tenant even if the tenant loses.
What are the consequences for landlords or for tenants from this VCAT decision?
In relation to landlords, if a tenant’s business changes from retail to wholesale, landlords should alter outgoing payments to ensure the recovery of land tax. In relation to tenants, changes from retail to wholesaling activity will involve persuading landlords to agree to Retail Leases Act type protections by way of special conditions in the lease or at the next option renewal. It will also be important for the tenant to obtain higher insurance protection for tenant fixtures, fitting, stock, plant and equipment, as well as mechanical breakdown insurance in case a landlord will not provide the type of protection which the tenant was entitled to receive under the retail lease.
Croft, J., came to a different conclusion to VCAT. Essentially, the Supreme Court of Victoria has now ruled that a lease that is a “retail premises lease” when it is entered into cannot “jump out of” the Retail Leases Act and therefore cannot cease to be a retail lease during its term. Croft, J., upheld the appeal by the tenant football club from the decision reached by Senior Member Forde and concluded that a lease that was a “retail premises lease” when entered into could not cease to be such a lease during the leased term.
The reasoning adopted by Croft, J., was that the criteria of what is a “retail premises” contained in the definitions in Section 4(1) of the Retail Leases Act are relevant only when the lease is entered into. They are not relevant after that time. Accordingly, unless one of the exclusions in Section 4(2) applies, where for instance the Minister makes a declaration of the premises are premises to which Section 4(2)(f) applies, when the lease is entered into, then the lease will remain a retail premises lease for the term of the lease.
Croft, J.’s judgement is less clear concerning the terms of the lease resulting from the exercise of an option. It appears, however, that even if an exclusion under the Retail Leases Act does apply (so that premises are not “retail premises”) when a renewed lease commences following upon the exercise of an option, the renewed lease will nevertheless contain the provisions implied into the lease by the Act. This means that the provisions of the lease that are made void by the Act (such as ratchet and land tax clauses) will remain void. The only way to avoid the renewed lease containing the terms implied by the Act, or to revive provisions made void by the Act, would be to include appropriately worded provisions in the lease that are to apply if the Act ceases to apply. However, at face value, the Supreme Court decision stands for the proposition that no “jumping out” of the Act will occur where, for instance, estimated outgoings plus rent exceed $1 million exclusive of GST or where the tenant’s occupation ceases being retail and becomes wholesale.
It may be that the landlord will appeal Croft, J.’s, decision to the Court of Appeal of the Supreme Court of Victoria. If so, a further article will be posted on the DML website.
This article is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render legal advice. No reader should act on the basis of any matter contained in this article without first obtaining specific professional advice.
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