When a landlord’s failure to repair air-conditioning unit is not a ground for terminating a lease

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In the Supreme Court of Victoria decision of Red Pepper Property Group Pty Ltd v S 3 South Melb Pty Ltd [2019] VSC 41 (the Red Pepper Case) handed down on 22 February 2019, Justice Croft held that a commercial tenant was not permitted to terminate their lease on the basis that the landlord had failed to repair the air-conditioning unit.

At first instance in the Victorian Civil and Administrative Tribunal (the Tribunal) (see S 3 South Melb Pty Ltd v Red Pepper Property Group Pty Ltd (Building and Property) [2018] VCAT 1684) Deputy President Riegler held that the landlord was under a continuing obligation to maintain air-conditioning that serviced the premises and that the landlord’s failure to provide such air-conditioning and to repair the air-conditioning amounted to repudiation of the lease.  This decision was reversed on appeal.

This article will set out the facts of the Red Pepper Case, the court’s reasoning, and lessons that can be drawn by commercial landlords and tenants from this decision.

What happened in this case?

The tenant, S 3 South Melb Pty Ltd (S3), entered into a lease with the landlord, Red Pepper Property Group Pty Ltd (Red Pepper), for premises on Bank Street in South Melbourne on 26 February 2016.  S3 intended to use the premises to operate a pilates and barre studio business.

The air-conditioning unit for the premises was a roof-mounted air-conditioning system that Red Pepper recommissioned before S3 moved into the premises in June 2016.  During the term of the lease, the air-conditioning unit did not always function efficiently because the vents for supply and return air were situated next to each other, but it did function from June 2016 up until May 2017.

In May 2017, the air-conditioning began to malfunction – as it would only operate for approximately 20 minutes at a time before turning itself off.  This made it difficult for S3 to run its business, as it could not warm the premises to make it comfortable for its clients.

S3 notified Red Pepper that the air conditioning was malfunctioning and asked Red Pepper to send a technician by email on 15 May 2017.  In a further email on 21 June 2017, S3 stated that Red Pepper was obliged to install air-conditioning and had failed to do so and that the air-conditioning was beyond repair.  S3’s second notice included a report from a technician engaged by S3 which stated that there were serious issues with the air-conditioning unit and that it would cost in excess of $32,000 to repair it.  On both occasions, Red Pepper responded by stating that it was S3’s responsibility to have a maintenance contract for the air-conditioning unit and asked S3 whether it had satisfied this obligation.

There were further emails from Red Pepper to S3 that were not addressed by the Tribunal at first instance.  In these emails, Red Pepper asked S3 if it had maintained a service contract for the air-conditioning unit.  S3 repeatedly evaded this question.

On 1 August 2017, S3 served a notice on Red Pepper stating that S3 was terminating the lease on the basis that Red Pepper had repudiated the lease.  S3 then vacated the premises.  On 8 August 2017, Red Pepper served a notice on S3 stating that it considered that S3’s purported termination of the lease was a repudiation, and that Red Pepper was terminating the lease on that basis.

After S3 had vacated the premises, Red Pepper engaged technicians to inspect and repair the air-conditioning unit.  The cause of the malfunction was found to be that the condenser fan was broken and needed to be replaced.  This repair was completed quickly and relatively inexpensively.

What is repudiation, and why is it important?

In simple terms, ‘repudiation’ is where one party to an agreement refuses to be bound by either the whole agreement or one or more fundamental obligations under the agreement.  The legal test is whether the conduct of the repudiating party would convey to a reasonable person in the position of the innocent party that the repudiating party was refusing to be bound by the agreement.  When repudiation occurs, the innocent party can ‘accept’ the repudiation and terminate the agreement, even if they do not have an express right to terminate under the agreement.  The innocent party can then also claim damages from the repudiating party.

This was important in the Red Pepper Case because if Red Pepper had not, as contended by S3, repudiated the lease, S3 would have had no grounds for the notice of termination that it served on Red Pepper on 1 August 2017.  Determining which party repudiated the lease was also relevant to the remedies available to each party.

What were the relevant provisions of the lease?

The lease included two special conditions that were relevant to the installation and repair of the air-conditioning unit:

  • special condition 1(a)(xiii), which stated that as part of its portion of the fit out works, Red Pepper must ‘install air-conditioning to service the Premises’; and
  • special condition 1(e), which stated that that it was S3’s responsibility to take out a maintenance contract for the air conditioning unit and to have it serviced on a six-monthly basis, and Red Pepper’s responsibility, subject to S3 maintaining the maintenance contract, to carry out any capital repairs of the air-conditioning unit.

What were the parties’ arguments?

S3 set out a number of bases on which it contended that Red Pepper had failed to satisfy the requirement in special condition 1(a)(xiii) to install air-conditioning to service the premises.  Most of these bases were rejected at first instance by the Tribunal, except for the argument that the obligation was not satisfied because special condition 1(a)(xiii) imposed an ongoing obligation on Red Pepper to ensure that the air-conditioning ‘serviced’ the premises during the whole term of the lease.  The Tribunal also held that Red Pepper’s failure to undertake capital repairs to the air-conditioning amounted to repudiation of the lease, even though special condition 1(e) was not raised by S3 in its submissions.  S3 argued that it was entitled to terminate the lease and recover its security deposit.

Red Pepper argued on appeal that that the obligation in special condition 1(a)(xiii) only extended to installing the air-conditioning at the beginning of the lease, which Red Pepper had satisfied by recommissioning the roof-mounted air-conditioning unit, and that there was no repudiation of the lease by Red Pepper because S3 had not given sufficient notice of the defects in the air-conditioning, S3 had refused to answer Red Pepper’s legitimate questions about the service contract, and S3 had been in breach of its obligation to maintain a service contract and so was not legally entitled to accept a repudiation of the lease.  Red Pepper contended that S3’s purported termination of the lease was a repudiation of the lease by S3, and that Red Pepper was entitled to recover from S3 losses suffered by Red Pepper both during the lease and after termination.

What was the court’s decision?

Justice Croft accepted the arguments of Red Pepper.  In summary, Justice Croft held the following:

  1. Red Pepper had satisfied the requirement in special condition 1(a)(xiii) to install air-conditioning to service the premises by recommissioning the existing air-conditioning unit. This obligation was limited in time, not an ongoing obligation, and needed to be performed at or within a reasonable time after commencement of the lease.  The requirement that the air-conditioning ‘service’ the premises merely described the purpose that the air-conditioning unit must satisfy when it was installed.  Because special condition 1(a)(xiii) of the lease had been satisfied by Red Pepper, there was no breach of or failure to comply with this special condition on which S3 could base a conclusion that Red Pepper had repudiated the lease.
  2. There was no repudiation by the landlord of any obligation to repair the air-conditioning because:
    • the lease did not include a fixed time within which Red Pepper must repair the air-conditioning, and S3 had not fixed a reasonable time for performance of the obligation by giving a notice stipulating a time in which the repair must be carried out;
    • at law, a landlord is not obliged to carry out a repair until it has received notice of the defect that would be sufficient to ‘put a reasonable person on enquiry as to whether repair works are needed’;
    • S3’s emails of 15 May 2017 and 21 June 2017 did not put Red Pepper on notice because they did not refer to Red Pepper’s obligation to repair the air-conditioning unit. The email of 15 May 2017 simply stated that the air-conditioning was not working.  The email of 21 June 2017 incorrectly stated that Red Pepper had not installed air-conditioning at all, and the attached technician’s report listed defects that were not substantiated by Red Pepper’s technician or the Tribunal;
    • any delay by Red Pepper to carry out a repair could not have commenced until it received sufficient notice of the relevant defect. Red Pepper did not receive such a notice;
    • Red Pepper did not outright refuse to repair the air-conditioning, it persistently asked S3 to advise whether S3 had maintained its service contract as S3 was obliged to do under the lease. S3 repeatedly evaded these legitimate questions.  It is open to a landlord to question a tenant’s notice of a defect before proceeding with a repair where an objective person would be sceptical of that notice; and
    • it was always open to S3 to itself arrange to have the simple repair undertaken and to seek to recover the costs of doing so from Red Pepper, even if this would be an unconventional approach.
  1. In any event, S3 could not accept a repudiation of the lease from Red Pepper because S3 was not willing and able to perform its own obligations under the lease. The Tribunal found at first instance that S3 had failed to maintain a service contract for the air-conditioning unit.
  2. In light of these circumstances, a reasonable person in S3’s position could not reasonably infer that Red Pepper had refused to be bound by its obligations under the lease.

Justice Croft also considered that the Tribunal had incorrectly considered and drawn conclusions on special condition 1(e) of the lease, because S3 had not relied on this special condition in its submissions (meaning that it was procedurally unfair for the Tribunal to draw conclusions on this clause without taking submissions from the parties) and also because Red Pepper’s obligation to make capital repairs to the air-conditioning unit under special condition 1(e) only applied if S3 had complied with its obligation to maintain a service contract, which S3 had not done.

Implications of the Red Pepper Case

This decision serves as a reminder that obligations in relation to the installation and repairs of expensive equipment and services, including air-conditioning, need to be clearly stated and understood in the lease in order to avoid lengthy disputes.

It is also important after the lease is finalised for both parties to take their obligations seriously and to ensure that all correspondence is clear, unambiguous, and provides the other party with sufficient information so that they can exercise their rights and fulfil their obligations under the lease.  An aggrieved party, like S3 in this case, may be unable to obtain a remedy if they have not discharged their own obligations and given the other party the appropriate opportunity to perform theirs.

At Bryks Lawyers, we have extensive experience in advising commercial landlords and tenants on their rights and obligations.  Contact us today to see how we can assist you!

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