It’s very common in commercial and retail leasing transactions for the landlord and tenant to sign a preliminary document, such as a Letter of Offer, a Terms Sheet or Heads of Agreement, before signing the formal lease document. These preliminary documents will usually say that they are not legally binding unless and until a formal lease is agreed, signed and exchanged.
After signing the preliminary document parties will often proceed on the basis that the “deal is done” even though the formal lease is not yet finalised, or in some cases, all agreed but just not signed or exchanged. This can be a dangerous “grey zone” for either party.
If the preliminary document makes it clear that neither party is bound until the formal lease is signed, the courts will uphold this position unless there is some conduct or understanding, or other circumstances, that do create a legally binding commitment. For example, in the case of Waltons Stores (Interstate) Ltd v Maher (1988) 164 CLR 387, the High Court found that the parties were legally bound even though the lease documents had not been signed because the landlord had started work (demolition) on the assumption that the tenant would sign the documents, and the tenant allowed them to proceed without correcting their mistake. This is known as an “estoppel”.
However, in many cases there isn’t conduct that would create an “estoppel” – but instead one party simply changes its mind before the lease is signed. The recent NSW Supreme Court of Appeal case Centuria Property Funds Ltd v Thorn Australia Pty Ltd [2022] NSWCA 104 provides a salutary lesson for both landlords and tenants who do not diligently follow through with the signing and exchange formalities, but assume everything will be fine. While this case concerned an unsigned lease, the principle will apply equally to other commercial agreements which require the signing of formal legal documents.
Background
In April 2021, the landlord and tenant entered into and executed a Heads of Agreement for the lease of commercial premises in Eveleigh, NSW. The Heads of Agreement expressly stated that it was not intended to be a binding agreement and either party could withdraw from negotiations at any time prior to execution of formal lease documents.
The parties subsequently negotiated the terms of the formal lease documents, consisting of a lease and an incentive deed. The tenant duly signed the documents and their solicitors provided copies to the landlord’s solicitors for countersigning.
Due to the COVID-19 pandemic, the landlord delayed in signing the lease documents.
In the meantime, the tenant had:
- paid the deposit and lease registration fee to the landlord;
- provided the landlord with a bank guarantee and certificate of currency for its insurance, as required under the Heads of Agreement; and
- been granted early access to the premises for internet and telecommunications connections.
On 16 August 2021, the tenant changed its mind and withdrew from the lease transaction, saying that the formal lease documents had not yet been signed by the landlord and exchanged, as required under the Heads of Agreement. Three days later the landlord signed the lease documents and provided copies to the tenant’s solicitors. The tenant requested that its bank guarantee be returned but the landlord argued that the tenant was legally bound to the lease because all the terms were agreed, the tenant had proceeded on the basis that the lease was binding and that signing and exchange of the lease documents had become merely a formality.
The tenant commenced proceedings seeking to confirm that there was no binding lease between the parties and to restrain the landlord from taking steps to register the lease (which was required in NSW) and cash the bank guarantee for breach by the tenant.
Decision
Primary decision
The primary judge agreed with the tenant and held that the tenant could withdraw from the lease as no formal lease documents had been signed and exchanged.
The primary judge considered the intention of the parties and concluded the provision of the bank guarantee and taking access to connect telecommunication services were not enough to create a legally binding lease commitment in the absence of fully signed and exchanged lease documents.
The right contained in the Heads of Agreement to withdraw from negotiations at any time prior to execution of formal lease documents had not been abandoned or abrogated. The Heads of Agreement clearly allowed the right to withdraw until formal lease documents were signed by both parties.
Appeal decision
The landlord appealed the primary decision. The Court of Appeal agreed with the conclusions of the primary judge. The Heads of Agreement was stated to be non binding and there was nothing to suggest there had been a change in position agreed between the parties as to the right of withdrawal prior to execution of formal lease documents.
The fact the tenant had early access to the premises was of little significance in determining whether the tenant showed an intention to be immediately bound. It was held that the landlord providing access was similar to an informal licence arrangement and did not explicitly refer to any particular obligation or intention of the parties to be immediately bound.
Conclusion
This decision highlights the importance of diligently following through the formal signing and exchange of the lease documents, even though the other party might appear to be fully committed to the transaction. You have no way of knowing what circumstances might be impacting the other party, and things can change without warning.
So don’t rely on a Heads of Agreement or other preliminary document, and don’t rely on the apparent intent and goodwill of the other party – make sure the formal legal documents are signed and exchanged as soon as practical.
Hunt & Hunt’s Property Team can assist you with any questions about Heads of Agreements and leases and your rights in relation to withdrawing from negotiations.
~ with Peter Huang, Lawyer
