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Bulletin

A common pitfall with renewal of leases: be careful to avoid an ‘agreement to agree’

Fasken
Reading Time 7 minute read
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It is common for landlords and tenants to include a renewal clause in a lease agreement. Such a clause will mostly entitle a tenant to renew the term of the lease for a further term upon the same terms and conditions as the initial term.

Some of the renewal terms, for example the rental payable during the extended term can be unknown at the time of renewal.  If this is the case, the determination of such rental must be clearly specified in the renewal clause, or a mechanism to determine the rental must be agreed, failing which the agreement could be held as unenforceable.

The position in our law is that an agreement to agree is unenforceable, which means that landlords and tenants should therefore be careful in drafting a renewal clause.

Such a clause was again the subject matter of a recent Supreme Court of Appeals (SCA) case in the matter of Shepherd Real Estate Investments (Pty) Ltd v Roux Le Roux Motors CC (1318/2018) [2019] ZASCA 178 (2 December 2019).

In this note we will briefly discuss some takeaways of the effect and findings of the judgment.

We will also propose some recommended wording for a renewal clause that landlords and tenants could use which could avoid the common pitfalls as discussed.

Facts

The parties entered into a lease agreement commencing on 1 November 2007 in respect of a commercial property situated in Paarl for the purpose of conducting the business of a petrol station.  The Agreement was to endure for an initial term of five years, with a renewal period of ‘5 plus 5 years’.  The rental at commencement was R 18 000 per month, escalating at 8 per cent per annum over the initial term.

The lease made provision for a “Renewal Period” in clause 6 which provided that:

“The Tenant shall have the option to renew this Lease of the Premises for a further period as set out in the Terms of Lease subject to the following:

6.1 The strict adherence & compliance to all terms and conditions of this agreement by the Tenant and all moneys due being paid by him;

6.3 The Tenant requesting such renewal in writing from the Landlord no later than 6 (Six) months prior to the expiry of the lease period. The Landlord will remind the Tenant to exercise the option 8 (Eight) months prior to the expiry of the lease period.

Such first renewal period shall be on terms and conditions in compliance with this agreement and the rental payable by the Tenant to the Landlord during the option period shall be increased on each anniversary of the commencement date by 8% of the monthly rental, which was payable during the year proceeding the option period.”

The lease was subsequently renewed on two further occasions. The tenant attempted to exercise the option to renew for the third time, however, the landlord contended that it was amenable to the proposed renewal at an agreed rental of R150 000 per month including VAT. The tenant argued that a fair rental was an 8 per cent per annum escalation on the then prevailing rental.

Issue at hand

The SCA essentially had to determine whether the agreement to agree was enforceable. Both parties had made compelling arguments why the court should rule in their favour. The landlord denied that the lease constituted an ‘agreement to agree’ and that it is void for vagueness. Moreover, the landlord argued that the arbitration clause in the lease is not a deadlock-breaking mechanism.

The tenant on the other hand denied the fact that the rental amount cannot be determined or is not determinable. The tenant argued that the presence of the final paragraph as part of clause 6 is the result of a bona fide mistake or the intentional act of the landlord and doesn’t reflect the common intention. The tenant further submitted that a tacit term of the lease that the escalated rental, in respect of the last 5 year renewal would be a reasonable rental, and should be determined by both parties,  on the basis that both have to exercise a reasonable discretion.

Judgment

Ponnan JA took into consideration amongst other the following legal principles:

Agreement to agree

Ponnan JA refers to several positions reached in other jurisdictions. A key principle from these decisions is that courts will not enforce an agreement to agree. One of the cases referred to by Ponnan JA is Walford v Miles, whereby the House of Lords affirmed the correctness of Courtney v Fairbairn. Lord Ackner took the view that:

‘The reason why an agreement to negotiate, like an agreement to agree, is unenforceable is simply because it lacks the necessary certainty.’

Ponnan JA remarked that vagueness and invalidity could have been remedied by a deadlock-breaking mechanism however, there is no deadlock-breaking mechanism contained in the lease. The relevant arbitration clause in the lease requiring certain disputes relating to the interpretation and enforcement of the agreement does not contain a deadlock-breaking mechanism.

Arbitration

It was held that an arbitrator would have been ill-equipped to fill in the blanks or resolve the questions that the parties could not. An arbitrator certainly could not give effect to arrangements that the parties themselves had not concluded and then require the party, who is resisting, continuing with the ongoing relationship. Nor, for that matter, could the arbitrator simply invoke certain vague, ill-defined objective standards. Moreover, once the lease is terminated by effluxion of time, the tenant would be precluded from invoking the arbitration clause.

Rectification

Rectification is a remedy that allows the parties to a contract to apply to the court to rectify a common mistake in the terms of the contract in order to reflect the true intentions of the parties. In this case it was held that there is no common mistake and that the tenant is not seeking rectification but the creation of a new contract.

Ponnan JA relying on Plascon-Evans, mentioned that the allegations of the tenant are so far-fetched or clearly untenable that a court would be justified in rejecting them merely on the papers. Moreover, Ponnan JA quotes that “a person who signs a contractual document thereby signifies assent to the contents of the document, and if these subsequently turn out unfavourably there is no one to blame but him-or herself”.

Tacit term

Ponnan JA quoted an explanation of what a tacit term entails as illustrated by Corbett JA in Alfred McAlpine & Son (Pty) Ltd v Transvaal Provincial Administration:

“... is a provision which must be found, if it is to be found at all, in the unexpressed intention of the parties ... The Court does not readily import a tacit term. It cannot make contracts for people; nor can it supplement the agreement of the parties merely because it might be reasonable to do so. Before it can imply a tacit term the Court must be satisfied, upon a consideration in a reasonable and businesslike manner of the terms of the contract and the admissible evidence of surrounding circumstances, that an implication necessarily arises that the parties intended to contract on the basis of the suggested term.”

Ponnan JA found that given the express terms of the agreement, there plainly can be no room for importing the alleged tacit term asserted by the tenant. Indeed, as it was put it in Robin v Guarantee Life Assurance Ltd:

“A tacit term cannot be imported into a contract in respect of any matter to which the parties have applied their minds and for which they have made express provision in the contract.”

Conclusion

This judgment firstly serves as a reminder that courts will not interfere with the course of the terms of an agreement and will always respect the parties’ discretion to agree or disagree. In the words of Chief Justice Innes, “it is a sound principle of law that a man, when he signs a contract, is taken to be bound by the ordinary meaning and effect of the words which appear over his signature”.

Secondly, what the judgment highlights is that it is absolutely critical that renewal clauses in leases be drafted with great care. The parties must either provide for an agreed and fixed amount of rental that will apply on renewal or, alternatively, if they do leave the rental to be determined at the time of the renewal, they should provide for a deadlock-breaking mechanism.

In order to avoid the pitfalls as described, parties could consider using words along the following lines:

“The monthly rental payable during the renewal period shall be a market-related rental as agreed in writing between the parties, failing which agreement, the rental and further escalation rate shall be determined by an independent expert.  Such independent expert shall be appointed by written agreement between the parties and, failing which agreement, by [the [chief executive officer] of the South African Institute of Valuers]. The independent expert shall act as an expert and not as an arbitrator, and his or her decision shall be final and binding on the parties.”

 

“If the rental and escalation rates have not been determined by the commencement date of the renewal period, then the following rental shall be paid until such time as the new rental and rate has been finally determined, when suitable adjustments in rental shall be made with retrospective effect: the rental payable in respect of the month immediately prior to the termination date prior to the renewal date escalated by [X]%, and thereafter escalating annually on each anniversary of the start date of the renewal period at a rate of [X]% per year.”

 

This bulletin was prepared by Fasken partner Johan Coetzee and candidate attorney Barr-Mary Tyzack.

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