Termination Power of Landlord for Non-Breach Circumstance not Construed as Requiring the Exercise of Reasonableness

In United Petroleum Pty Ltd v Coastal Service Centres Pty Ltd [2024] NSWCA 97 (3 May 2024), the New South Wales Court of Appeal addressed an argument as to whether a right of termination of the lease – vested in the landlord and tenant respectively upon substantial damage being wrought by fire or weather to the leased premises (albeit without breach of the lease) – was one which the landlord was obliged to exercise reasonably, including taking into account the interests of the tenant.  The court – Basten AJA writing for the court – concluded that the question was one of construction of the express terms of the lease, and ordinarily would not arise by way of implication of such a term as a matter of business efficacy.  The lease was construed as not harbouring such an obligation.  The court wrote:

[3]  The respondent, Coastal Service Centres Pty Ltd (Coastal), is the owner of land near the Pacific Highway at North Arm Cove, north of Newcastle. Pursuant to a lease which commenced on 1 July 2016 (Lease), part of the property was leased to the appellant, United Petroleum Pty Ltd (United). The site was known as “The Rock Roadhouse” because the building was in the form of a replica of Uluru.

[4]  On 31 July 2018, a fire destroyed the building. The fuel pumps and tanks were not damaged and United has continued, after a brief suspension of services, to operate as a service station with demountable buildings.

[5]  On 18 January 2022, Coastal served on United a notice pursuant to annexure B, cl 8.2.3 of the Lease that Coastal considered that “the damage is such as to make its repair impracticable or undesirable” (cl 8.2.3 notice). The effect of the notice was to permit Coastal to terminate the Lease on 14 days’ notice. The notice itself did not purport to terminate the lease.

[6]  Pursuant to proceedings in the Equity Division, heard between 24 and 27 July 2023, United challenged the validity of the notice and thus the entitlement of Coastal to rely upon the notice to terminate the lease. By orders made on 23 August 2023, the trial judge, Peden J, dismissed United’s claim.1  On 9 November 2023, United filed a notice of appeal.

…

Notice of Consideration — cl 8.2.3

[32]  On 18 January 2022 Coastal served on United its cl 8.2.3 notice advising that “Coastal considers that the damage is such as to make its repair impracticable or undesirable”. The notice also contained an express statement that “this is not a termination notice”, stating that “each of Coastal and United have the power under cl 8.2.3 to terminate the lease by giving not less than 14 days’ notice in writing of termination”.

[33]  The critical provision in the Lease was cl 8.2, which appeared under the heading “What happens if the property is damaged?”. Subclauses 8.2.1 and 8.2.2 provided for a suspension of the tenant’s obligation to pay rent if the property could not be used or was inaccessible due to the damage, and subcl 8.2.2 provided for an abatement of the liability to pay rent if useability was diminished due to the damage. Otherwise, cl 8.2 relevantly provided:

8.2 If the property or the building of which it is part is damaged (a term which includes destroyed) —

…

8.2.3 if the landlord notifies the tenant in writing that the landlord considers that the damage is such as to make its repair impracticable or undesirable, the landlord or the tenant can terminate this lease by giving not less than [14] days[’] notice in writing of termination to the other and no compensation is payable in respect of that termination;

8.2.4 if the landlord fails to repair the damage within a reasonable time after the tenant requests the landlord to do so, the tenant can terminate this lease by giving not less than [14] days[’] notice in writing of termination to the landlord …

[34]  In his principal affidavit of 19 January 2022, Mr Roberts gave evidence of having formed the belief that it was both “impracticable” and “undesirable” to proceed with the rebuilding of the roadhouse. He gave evidence of the circumstances which led him to that conclusion and the timing of his consideration of those circumstances. That evidence was the subject of challenge by way of cross-examination and the detail of those circumstances and Mr Roberts’ evidence will be addressed below in considering the relevant grounds of appeal. However, the reasoning may be summarised in the following terms.

(1) First, Mr Roberts made a fresh calculation of the likely cost of rebuilding the roadhouse based in part on Drayton’s quote, together with the expected cost of additional items which were not covered by the quote and by making allowance for an increase over Drayton’s June 2020 figure to take account of the surge in costs over the period of COVID and subsequent experience.

(2) Secondly, he took into account the likely increase in rental income which included an increase of 21% in the rental payable by United (which would no longer be subject to abatement) together with the income obtainable from three additional tenants.

(3) Thirdly, he calculated a rate of return as a percentage of the rebuilding costs, concluding that the rate of return would not satisfy a bank from whom a loan would be required to cover the costs. Furthermore, Mr Roberts reasoned, even if a bank would accept a lower estimated rate of return, he was not prepared to risk incurring a major liability for the anticipated lower rate of return.

[35]  Apart from the third step in the analysis, challenges were made to the amounts relied upon at each of the two prior steps. Those challenges will be addressed below.

…

Contractual cases — effects of breach

[65]  Turning to the authorities relied upon by the appellant, two points should be borne in mind. The first is that a range of epithets is used to describe possible bases of intervention, without a consistent attempt to define their scope. That may appear bewildering, but the foregoing discussion indicates that most if not all of the terminology has been applied in other analogous situations. The second, and related, point is that where words have been used in analogous contexts, without further definition, they should be understood to refer to established concepts.

[66]  Although the application of principles of good faith to the performance of contracts is treated as commencing with a judgment in 1992, Renard Constructions (ME) Pty Ltd v Minister for Public Works,22  there is a separate line of authority dealing with the scope of express obligations to negotiate in good faith. Because there was no dispute, and the trial judge accepted, that Mr Roberts was required to give genuine consideration to matters relevant to the exercise of the cl 8.2.3 power, and not to exercise it arbitrarily or capriciously or, which may be much the same thing, for a purpose foreign to the purpose for which it was agreed upon in the contract, what the cases have to say generally about good faith is of limited significance. The material question is whether the cases prescribed that a criterion of objective reasonableness be read into the exercise of cl 8.2.3.

[67]  The contract in Renard Constructions established a scheme by which the principal was required to give the contractor a notice in writing to show cause why, in a case of default by the contractor, a power to take work away from the contractor should not be exercised. The default was to be specified in the show cause notice, and if the principal did not accept the contractor’s response, the contractor was entitled to refer the matter to arbitration on the basis of “objective considerations including questions of reasonableness in showing cause against the exercise of the powers”.23 

[68]  Priestley JA noted that questions had arisen as to whether there was an obligation imposed on the principal to act objectively reasonably either in exercising the power or in dealing with a response to a show cause notice. Priestley JA held:24 

For myself, I cannot see why a term should not be implied at both stages; that is, it seems to me relatively obvious that an objective and reasonable outsider to this contract upon reading subcl 44.1 would assume without serious question that the principal would have to give reasonable consideration to the question whether the contractor had failed to show cause and then, if the principal had reasonably concluded that the contractor had failed, that reasonable consideration must be given to whether any power and if any which power should be exercised.

[69]  Priestley JA implied such a term, considering it was justified both by reference to the implied actual intention of the parties and as a matter of law. (It is not necessary to explore why a court should look for “actual intention” in circumstances where the meaning and operation of a contract is determined objectively by reference to its text.) He reasoned, by reference to cl 44:25 

It seems clear that the words of the clause empower the principal to give a notice to show cause upon any default in carrying out any requirement in the contract. Thus for a completely trivial default the principal can give a notice to show cause. It is possible to imagine many situations in which, if a notice for some trivial breach were given the contractor might fail, as a matter of fact, to show cause within the specified period to the satisfaction of the principal why the powers should not be exercised against him.

[70]  As will be seen shortly, this reasoning was accepted in the second case involving an unqualified power exercisable upon breach or default. However, there is a question as to why the problem of trivial or insignificant defaults or breaches might not be resolved by reading the contract, including the consequences of the exercise of the power, as only applicable to breaches or defaults which were not trivial and were such as could warrant termination. This point was made by Gummow J in the Federal Court in Service Station Association Ltd v Berg Bennett & Associates Pty Ltd :26 

Where one party has an express power the exercise of which will significantly affect the interests of the other party (eg by cancellation of their supply contract) if the holder of the power is satisfied that a certain state of affairs exists, the words of the contract are fairly readily construed (and the more so when the parties have given such a power to a third party) as requiring a reasonable as well as honest state of satisfaction; see the authorities referred to by Priestley JA and Handley JA in Renard Constructions (supra) at 260, 279–280 … . But this is a result arrived at by a process of construction of the express terms in the setting of the contract as a whole. It is best not seen at all as the implication of a further term.

[71]  Gordon J adopted a similar approach in Realestate.com.au Pty Ltd v Hardingham.27  However, as the present case does not involve breach or default on the part of either party, nor a case where there is a show cause provision and the opportunity for arbitration, this question need not be pursued.

[72]  Two other observations should be made, regarding the reasoning in Renard Constructions. First, Priestley JA ended his reasoning by reference to two topics, the first of which was “ Good Faith ”.28  He stated:

The kind of reasonableness I have been discussing seems to me to have much in common with the notions of good faith which are regarded in many of the civil law systems of Europe and in all States in the United States as necessarily implied in many kinds of contract. Although this implication has not yet been accepted to the same extent in Australia as part of judge-made Australian contract law, there are many indications that the time may be fast approaching when the idea, long recognised as implicit in many of the orthodox techniques of solving contractual disputes, will gain explicit recognition in the same way as it has in Europe and in the United States.

He then gave examples of statutes dealing with unfair contracts, good faith and fair dealing and reasonableness.

[73]  Secondly, Meagher JA adopted a somewhat different approach, as did Handley JA However, relevant passages in their reasoning may be addressed having regard to an important element in the appellant’s case which derived from Renard Constructions.

[74]  Thus, a fundamental element in the appellant’s case, as identified in the grounds of appeal, was that Mr Roberts’ decision to issue the cl 8.2.3 notice was “not rational and informed but grounded upon misleading, incomplete and prejudicial information in important respects”.29  To similar effect, the appellant’s written submissions stated that the obligation of good faith was defined as requiring a party to “not act upon a fundamental misunderstanding of relevant matters, or upon misleading, incomplete and prejudicial information”.30  That terminology was sourced to Renard Constructions at 276, 279.

[75]  The passage at 276, in the judgment of Meagher JA, read as follows:

The pivotal fact found by the arbitrator — which, so far as I can see from the materials referred to by him is amply justified — is that the principal’s decision was based on a fundamental misunderstanding of relevant matters (principally, that the contractor had been in default since 7 March 1986) and was grounded on ‘misleading, incomplete and prejudicial information’.

[76]  The clause permitting the principal to take over the contract and exclude the contractor turned on the state of satisfaction of the principal as to certain matters. Meagher JA held that “[i]nherent in the notion of being ‘satisfied’ is an ability to comprehend the factual background on which satisfaction is required”. He then observed that, on the arbitrator’s findings, “the principal’s mind … was so distorted by prejudice and misinformation that he was unable to comprehend the facts in respect to which he had to pass judgment”.

[77]  To take the phrase “grounded on misleading, incomplete and prejudicial information” out of context is to give it a flavour as a finding of fact which is misleading; to ascribe to it status as a legal standard is to ignore both the context in which Meagher JA accepted it, and that it was merely a description of certain facts used by the arbitrator whose function it was to review the decision of the principal on the merits once a dispute had arisen.

[78]  The second passage (at 279) relied upon by the appellant was the following explanation given by Handley JA:

I also agree with the conclusion by Meagher JA that the principal’s ‘decision was based on a fundamental misunderstanding of relevant matters … and was grounded on misleading, incomplete and prejudicial information’. Meagher JA concludes that these findings demonstrate that the principal could not have given bona fide consideration to the contractor’s submissions and therefore could not have been satisfied that the power which had arisen should be exercised. For myself I prefer to regard these matters as demonstrating that the principal’s decision, however honest, was objectively unreasonable and therefore an invalid exercise of the power.

Handley JA stated that, “as a matter of construction, the power must be exercised reasonably”.31 

[79]  In concluding that the relevant contractual power was subject to a condition that it be exercised reasonably, Handley JA took into account a number of considerations. The first, reflecting the point made by Priestley JA set out above, was as follows:32 

The power arises on the happening of any breach, however minor, and whenever the breach occurs. It also arises upon the contractor neglecting to comply with any direction given by the principal, however minor, accidental or temporary that neglect might be, and regardless of the importance or otherwise of the subject matter. This express power therefore covers many cases where the principal would have no power to rescind the contract for breach under the general law.

[80]  Handley JA noted that the second matter depended upon the fact that the power is engaged by “the satisfaction of the principal”, which had been held in other cases to refer to “an opinion which is reasonable or to one which is merely honest” but stated that the implication of reasonableness was “readily made”. 33

[81]  The third matter was the existence of an opportunity for the contractor to show cause and to take the matter to arbitration. He described the provision for arbitration of disputes as “a further indication that the powers … are subject to some limitations other than honesty”. 34

[82]  A second case involving default was Hughes Bros Pty Ltd v Trustees of the Roman Catholic Church, Archdiocese of Sydney.35  Hughes Bros was decided a year after Renard Constructions and involved the same power to terminate upon default by the contractor, in cl 44 of the then standard construction contract. Default included the commission by the contractor of an act of bankruptcy.

[83]  Priestley JA adhered to what he had written in Renard Constructions and implied an obligation on the part of the parties to act reasonably in enforcing provisions in the contract. However, his references to “the reasonableness obligation” omitted references in Renard Constructions to the meaning of that term as an aspect of the implied obligation to act in good faith. Neither Kirby P nor Meagher JA commented on this apparent expansion of the principles stated in Renard. However, both the President and Meagher JA indicated that they were following Renard Constructions only because they were bound by it. Kirby P did not think it distinguishable, but Meagher JA did.

[84]  A third case involving default was Burger King Corporation v Hungry Jack’s Pty Ltd .36  The case involved a “development agreement” pursuant to which the principal, Burger King, authorised Hungry Jack’s to establish franchise operations in Australia. Burger King enjoyed broad powers under cl 4.1 to terminate the agreement where a franchisee had defaulted or failed to comply with a direction given by Burger King. The Court accepted the respondent’s submission that “unless some restriction was placed upon the operation of cl 4.1, the rights under the development agreement would be illusory”. The Court concluded that the contractual powers under cl 4.1 were to be exercised “in good faith and reasonably”.37  The joint reasons continued:

That does not mean that Burger King Corporation is not entitled to have regard only to its own legitimate interests in exercising its discretion. However, it must not do so for a purpose extraneous to the contract — for example, by withholding financial or operational approval where there is no basis to do so, so as to thwart Hungry Jack’s Pty Limited’s rights under the contract.

[85]  In considering Renard Constructions, the Court addressed the “[m]eaning of good faith and reasonableness”:

169 We have already touched upon this …. However, it is worth noting that the Australian cases make no distinction of substance between the implied term of reasonableness and that of good faith. As Priestley JA said in Renard at 263:

‘The kind of reasonableness I have been discussing seems to me to have much in common with the notions of good faith’.

170 Priestley JA commented further at 265 that:

‘… in ordinary English usage there has been constant association between the words fair and reasonable. Similarly there is a close association of ideas between the terms unreasonableness, lack of good faith and unconscionability.’

Distinguishing the breach cases

[86]  United’s claims arise in a different legal context. First, in the breach cases the contractor relied on the potentially arbitrary and capricious operation of a provision which allowed the principal to terminate the contract for any breach, either of a term of the contract or of a direction by the principal, no matter how insignificant. Thus, Renard Constructions involved default resulting from delay combined with a decision of the principal who did not know (because he was not informed) of the reason for the delay, namely unavailability of supplies. The principal was thereby misled by incomplete information which acted adversely (prejudicially) to the interests of the contractor. That finding involved a retrospectant consideration of past circumstances. Neither the language, nor the outcome, can readily be applied to a circumstance where the trigger for the lessor’s power (damage to the premises) is not in doubt and the lessor is required to make an evaluative, prospectant, judgment based on estimations of future costs. To say that a better estimate might have been made on other material is not to say that the lessor acted otherwise than in good faith nor, in the absence of evidence that other material would have led to a different conclusion and was readily available, could it be said that it acted unreasonably in the sense envisaged in Renard Constructions and Burger King.

[87]  Secondly, there was no provision in the Lease for arbitration of disputes. An arbitration effectively requires a review of the factual exercise of the power by an independent third party. The possibility of such a review, the result of which will be binding on the parties, takes away an element of control otherwise vested in the principal by the contract.

[88]  Thirdly, there was no default or breach. Through no fault of either party, the circumstances in which the contract was entered into had changed. It was not open to the tenant to require the landlord to rectify the situation by rebuilding; nor was it open to the tenant to insist on remaining in the premises at an abated rent for decades, thus diminishing the return to the landlord and the value of the property.

The lease cases

[89]  The approach adopted in Burger King reflected that which had earlier been adopted in Alcatel Australia Ltd v Scarcella.38  The appellant in that case was a lessor; the respondents were the lessees. Under the lease, the lessor was required to maintain the premises and keep them “in good and substantial repair”. The relevant issue was identified in the following passage: 39

In summary terms, the appellant claimed that because the respondents had pressured the council into imposing stricter and unreasonable fire requirements, it was not obliged to comply with [the covenant for repair]. This result flowed from an implied term of good faith or reasonableness in the respondents’ performance of their lease obligations or exercise of their lease rights which bound them to co-operate in a reasonable way to ensure that the appellant was not subjected to the expense and impact of an unreasonable fire order.

The appellant relied upon the reasons for judgment of Priestley JA in Renard Constructions … and of Finn J in Hughes Aircraft Systems International v Airservices Australia.40  In Renard Constructions, a clause in a building contract empowered the principal to take over the whole or any part of the work or to cancel the contract if the contractor neglected to comply with any direction given by the principal, however minor, accidental or temporary that neglect might be and regardless of the importance or otherwise of the subject matter.

[90]  After discussing the relevant cases, Sheller JA noted: 41

Sir Anthony Mason said that such cases come close to a recognition of the good faith doctrine described as ‘loyalty to the promise itself’. But such an obligation cannot over-ride the express provisions of the contract.

If a contract confers power on a contracting party in terms wider than necessary for the protection of the legitimate interests of that party, the courts may interpret the power as not extending to the action proposed by the party in whom the power is vested or, alternatively, conclude that the powers are being exercised in a capricious or arbitrary manner or for an extraneous purpose, which is another way of saying the same thing. Thus, a vendor may not be allowed to exercise a contractual power where it would be unconscionable in the circumstances to do so ….

[91]  Sheller JA concluded:42 

The decisions in Renard Constructions and Hughes Bros mean that in New South Wales a duty of good faith, both in performing obligations and exercising rights, may by implication be imposed upon parties as part of a contract. There is no reason why such a duty should not be implied as part of this lease. But it remains to decide whether the implication of that duty has any consequence in the resolution of the dispute the subject of this appeal.

The Court held it did not.

[92]  The second lease case upon which United placed reliance was a decision of Bryson J in McIntosh v Dylcote.43  The case concerned a hotel lease with a provision (cl 3.11) dealing with storm damage, which in fact occurred. The chapeau to the provision stated:

If the whole or any part of the building shall be destroyed or damaged by fire, flood, lightening, storm, tempest or other disabling cause so as to render the Demised Premises during the Term substantially unfit for the use and occupation of the Lessee or so as to render the rebuilding or reconstruction of the building in its previous form impracticable or undesirable, in the opinion of the Lessor, then:

(a) this lease may be terminated, without compensation, by either the Lessor or the Lessee, by notice in writing to the other provided always that in the latter case the Lessor shall have first failed to rebuild or reinstate the Demised Premises within a reasonable time after being requested so to do in writing by the Lessee;

…

(e) in the event of any dispute arising out of the operation of this Clause, the same shall be referred to arbitration under the provisions of the laws for the time being in force in the State of New South Wales.”

[93]  Bryson J identified his approach to this provision in the following terms:

My view on the approach I should take to implication is based on the approach in the Court of Appeal in Renard Constructions … to the contractual provisions there under consideration and their Honours’ receptivity to ad hoc implications of obligations of reasonableness. The relevant provisions of cl 3.11 differ markedly from those provisions, but there are some similar elements in the manner in which they work. The provisions of cl 3.11 which refer to the lessor’s opinion and the power of either party to terminate are mechanisms ancillary to the overall purposes of the parties’ agreement and exist to achieve those purposes; they are not there so as to enable the party forming the opinion or deciding on termination to grasp an advantage for itself, and the implication of reasonableness, which is readily made, is required to be made and governs those steps. Such implications are made readily; see Hughes Brothers…, Alcatel Australia Ltd v Scarcella …. The purposes of the parties’ leasehold relationship at large furnish context within which the reasonableness of a decision is to be evaluated.

Handley JA in Renard at 280–283 collected and reviewed case law in which provisions for reference of disputes to arbitration after decisions to the satisfaction or in the discretion of a party have been held to place the arbitrator in the position of hearing an appeal from the party’s decision or discretion. The structure of cl 3.11 leads me to the view that the dispute which may be referred to arbitration may relate to any element of cl 3.11, whether a matter or fact, an opinion or a decision of a party. In cl 3.11 the opinion of the lessor or the decision of a party to terminate is, in my opinion, no more than provisional and the machinery for arbitration of a dispute is just as much a part of the mechanism for producing a decision as is the machinery for provisional decision by a party.

The purposes of the lease overall appear to me to require that termination should not follow automatically from damage and at the option of either party: there must be an implication that termination would only happen if the damage was such as to make termination appropriate, and there must be an implication that the dispute and arbitration mechanism would extend to reconsidering any decision by a party bearing on termination. Otherwise the lease would be futile, liable to be defeated by either party in relatively slight circumstances. It would lack business efficacy as a lease for 20 years.

…

In my opinion it is an implied obligation of the lessor to act reasonably in forming an opinion on the undesirability of reconstruction, and it is an implied obligation of each party to act reasonably in terminating the lease. Unless facts objectively exist in which it is reasonable to conclude that reconstruction is undesirable, an opinion that it was undesirable would not have any contractual effect. In an endeavour to articulate what is required by the test of reasonableness when it is to be applied to a decision to terminate under the lease, I will say that it requires proportionality between the outcome of termination without compensation and the nature of the underlying problem.

[94]  Although a decision of a single judge and not binding on this Court, the clause in question was similar to cl 8.2.3 of the Lease. However, two points may be made in relation to this reasoning. First, although there were elements of similarity between the provision in the case of damage to premises in McIntosh and in the present case, there was also a major disparity: the present case involved no dispute resolution process, which was a significant factor in the reasoning set out above.

[95]  Secondly, the implication of reasonableness extending to a determination of whether relevant facts objectively exist, is a significant extrapolation on the principle in Renard. That extrapolation, it may be accepted, finds support in the reasoning of Priestley JA in Hughes Bros, discussed above. The expansion of the stringent obligation to act reasonably in enforcing the wide — ranging default provisions permitting termination, to a clause dealing with the effects of damage to the premises for which neither party was responsible, required consideration of the operation of the storm damage clause: that is not found in McIntosh.

Other authority

[96]  Before turning to the application of the relevant principles to the Lease, it is necessary to refer to one other case upon which the appellant placed reliance, namely the decision of this Court in Macquarie International Health Clinic Pty Ltd v Sydney South West Area Health Service.44  United relied on the discussion of “good faith” in the concurring reasons of Allsop P at [5]–[17]. In that passage, the President outlined the broad principles derived from earlier cases, key examples of which have been discussed above. However, it should be noted that the discussion took place in a context where the contract expressly stated that the standard of mutual behaviour was that of “utmost good faith”. The President stated:

14 It is important to recognise that these obligations must be assessed and interpreted in the light of the bargain itself and its contractual terms. Those terms, however, must be assessed and interpreted in the light of the presence of the obligation of good faith, here pursuant to an express clause.

That took the present matter no further.

[97]  One other case should be referred to in this context. In Royal Botanic Gardens and Domain Trust v South Sydney City Council,45 the High Court considered a dispute as to the basis upon which a landlord was entitled to determine the rent payable with respect to public land used by the Council as a recreation area in the City of Sydney. The lease provided that “in making any such determination the Trustees may have regard to additional costs and expenses which they may incur in regard to the surface of the Domain …”. The question was whether that was the only matter which the Trustees were entitled to consider or whether their discretion was at large. The High Court upheld the conclusion of this Court that the statement was exhaustive. In doing so, the joint reasons noted that there was no mechanism for dispute resolution in relation to periodic rent determinations and their conclusion was consistent with the non-commercial nature of the lease.46 

[98]  The trial judge (Hodgson J) had taken a different view, subject to an implied term that in making a rent determination “the lessor must act bona fide for the purposes of determining a rent which is no more than a fair and reasonable rent”.47  The High Court held that such an implied term “would contradict the express terms [the lease]”.48  However, the Court went on to make the following observations:

40  The second matter concerns the debate in various Australian authorities concerning the existence and content of an implied obligation or duty of good faith and fair dealing in contractual performance and the exercise of contractual rights and powers. It emerged in argument in this Court that both sides accepted the existence of such an obligation in the exercise by the Lessor of its rental determination power conferred by cl 4(b). Rather, the dispute between them was directed to the content of that power …. The result is that, whilst the issues respecting the existence and scope of a ‘good faith’ doctrine are important, this is an inappropriate occasion to consider them. [Footnote omitted.]

[99]  Kirby J in separate dicta opposed such an implied term:

87  Much time was taken in exploring the common law cases by which, in leases between private parties affording machinery for the determination of a ‘price’ but no explicit formula, obligations to act fairly and reasonably will be implied into the contract so as to save it from failure and to provide a measure by reference to which the ‘price’ can be objectively proved. The Court was taken to case law both in this country and overseas as well as to academic commentary to demonstrate a growing tendency to imply into private contractual dealings a covenant of good faith and fair dealing. As expressed in some United States decisions, this is a principle that is not confined to an obligation to exercise express contractual powers fairly and reasonably. In some parts of the United States, the obligation has been accepted as a general implied contractual term in its own right.

88  However, in Australia, such an implied term appears to conflict with fundamental notions of caveat emptor that are inherent (statute and equitable intervention apart) in common law conceptions of economic freedom. It also appears to be inconsistent with the law as it has developed in this country in respect of the introduction of implied terms into written contracts which the parties have omitted to include. [Footnotes omitted.]

[100]  Callinan J reached the same conclusion as to the operation of the clause. He concluded with the following observation:

156  In view of the conclusion I have reached, it is unnecessary to answer the questions raised by the rather far-reaching contentions of the appellant, and for which, it says, Alcatel Australia Ltd v Scarcella and [Burger King] stand as authorities: whether both in performing obligations and exercising rights under a contract, all parties owe to one another a duty of good faith; and, the extent to which, if such were to be the law, a duty of good faith might deny a party an opportunistic or commercial exercise of an otherwise lawful commercial right.

[101]  The observations of Kirby J reflected concerns he had raised whilst on this Court in Hughes Bros . Callinan J, although describing the submissions of the appellant as “far-reaching”, provided no comfort for, or support of, such a conclusion based on the cases referred to. The language of the joint judgment was more neutral, but was certainly not supportive. As noted above, Gummow J, one of the joint authors, whilst on the Federal Court, had rejected the generic implication of a term of good faith.49 

Legal principles — conclusions

[102]  Is the conduct of the landlord in giving notice under a clause of the Lease dealing with the consequences of damage to the leased premises required to justify that conduct according to a standard of objective reasonableness, as assessed by the court? The trial judge used the term “subjective reasonableness” in this context,50  which has the appearance of an oxymoron. However, it is best understood as reflecting the fact that it involves no obligation to take the lessee’s interests into account, on the one hand, but on the other is to be judged against the circumstances, knowledge and interests of the lessor itself. It aptly describes a standard which precludes capricious or arbitrary decision-making and is, in substance, a requirement to act in accordance with the purpose for which the power was agreed upon in the contract.

[103]  As explained above, the cases dealing with clauses permitting termination for even the most insignificant default or breach, which permit review by an independent arbitrator, have no necessary application to cl 8.2.3. Nor is it clear that the concept of unreasonableness engaged in those cases is anything less than a standard of gross or serious unreasonableness, described in public law as legal unreasonableness. Expansion of those principles should be approached with caution, given the doubts expressed by two members of this Court in Hughes Bros and the cautious comments of the High Court in Royal Botanic Gardens.

[104]  There is a further consideration of principle which militates against the imposition of an objective standard of mere reasonableness. Meagher JA noted in Renard Constructions that counsel for the contractor had “conceded that the principal was not burdened by any element of altruism”. In Burger King the Court observed that the principal was “entitled to have regard only to its own legitimate interests in exercising its discretion”. That is, it was not required to take the contractor’s interests into account in reaching a decision. However, it is difficult to envisage a standard of objective reasonableness which, at least in the present circumstances, would not require the lessor to have regard to the lessee’s interests.

[105]  It follows that the trial judge was correct to assess the validity of the notice given by Coastal on the basis that it was the product of an honest and genuine consideration in good faith of the circumstances justifying the notice. There was no requirement to assess Coastal’s conduct according to a standard of objective reasonableness.

[106]  Nevertheless, for reasons which will be explained below, the case based on objective reasonableness must fail, in no little part because there was no significant independent evidence against which Mr Roberts’ opinions could be judged to be unreasonable.

Application of principles

Background considerations

[107]  The issue for present purposes is not whether the parties were subject to an implied obligation to exercise powers under the Lease bona fide or in good faith; rather, the question is whether such an implied constraint extends to a requirement that the landlord act reasonably, on the basis of facts found by the Court in the case of a challenge, in giving a cl 8.2.3 notice.

[108]  Indeed, there is an issue as to whether the question should be limited further. There are three acts encompassed within cl 8.2.3, namely (i) the landlord’s formation of the relevant opinion, (ii) the landlord giving notice to the tenant of that opinion, and (iii) either the landlord or the tenant terminating the lease. No doubt these actions are interrelated. There would be no purpose in the landlord forming the opinion unless it intended to notify the tenant of the opinion formed. In the circumstance that the landlord did not intend to repair the premises (and the tenant could not force it to do so) it might be assumed that in most cases the landlord would form the opinion and serve the notice because it wished to terminate the lease. However, that would not necessarily be so: the tenant, which could itself make a request to the landlord to repair within a reasonable time and then terminate if the landlord failed to comply with the request, could terminate the lease. It is not, however, clear that the tenant would wish to take that step in all circumstances. The request might force the landlord’s hand in circumstances where that was not in the tenant’s interest; it might also leave the tenant’s right in suspension until it became clear that the landlord was not complying with the request. Accordingly, the conferral on the tenant of a right to terminate pursuant to cl 8.2.3 may have utility. That in turn raises a question as to whether the third step (termination) was a step which could only be taken by either party acting in good faith. However, given the nature of the precondition, it is difficult to give utility to such an implication in relation to termination, which is not subject to any preconditions beyond the service of a valid notice.

[109]  No doubt it is entirely possible to imply a condition of good faith with respect to some activities under the lease, but not others. This analysis demonstrates the danger of some global implication of a term requiring all activities to be the subject of an implied obligation to act in good faith.

[110]  Turning then to the other aspects of cl 8.2.3, it may be accepted that the landlord was not entitled to serve a notice unless it had formed the requisite opinion. It is possible to add the epithets “honest” or “genuine” to the opinion, but neither serves any purpose. A dishonest opinion or a non-genuine opinion is not an opinion held by the landlord.

[111]  In what other circumstances may the opinion be dismissed as not formed according to law? If the opinion relied on by the landlord is not expressed in terms of impracticability or undesirability, that would not be a relevant opinion. As noted above, practicability may be based upon an assessment of likely costs and benefits, but is not necessarily limited to such circumstances. There will be overlap between such an assessment and an assessment of desirability. Such a broad concept as desirability cannot be judged by any fixed set of criteria. Although the analysis was not undertaken by the parties in this case, perhaps the best that can be said is that the criteria must reflect the legitimate business interests of the landlord. The clause envisages, in effect, that the landlord might find it desirable to terminate the Lease and conduct a more profitable activity on the land. If that were so, it is not clear why such a purpose would fail to satisfy the clause, even if there were an obligation to act in good faith.

[112]  In the present case (which may not be uncommon in this respect) impracticability and undesirability were both addressed by reference to the same set of financial considerations. The appellant sought to undermine the opinion formed by the landlord on three overlapping bases, namely that Mr Roberts, (i) had overestimated the costs of repair and underestimated the likely revenue once repairs were completed; (ii) had deliberately (or unreasonably) skewed the estimates so as to produce the result he wanted; and (iii) did not hold a genuine view that repairs would be either impracticable or undesirable. In the end, it was only the basis of the calculations which could be assessed against a reasonableness standard. If the Court is not to take over the decision-making process conferred by the parties on the landlord, the first step in the challenge can only succeed if the estimates relied on by Mr Roberts were beyond any range of figures which a reasonable businessperson in his shoes could adopt. In my view, that is an available approach and, if the excess is predominantly in one direction, it may provide a basis for upholding the second step in the challenge and possibly the third.

…

[127]  The trial judge addressed the direct attack on the genuineness of the analysis undertaken by Mr Roberts in his affidavit as to the financial considerations involved in the rebuilding exercise. The trial judge stated:

63  I do not accept that what is required by a landlord to validly exercise the right in clause 8.2.3 is an analysis of the best sources of information, judged after the event. Rather, the necessary inquiry is whether the analysis was rational and genuine at the time it was considered. Merely because other matters might have been considered, or the analysis could have been carried out in a different way, is not determinative of whether there was a failure to act genuinely or in good faith.

[128]  That proposition should be accepted, as must the trial judge’s further step in assessing the challenges raised by United to determine whether it should be inferred that Mr Roberts’ calculations were “not genuine”. It is true that the trial judge did not consider whether the calculations were objectively unreasonable, although for reasons set out above, that exercise was not required. However, it will be convenient to apply that standard against the possibility that a different view may be taken of the correct approach.

…

1  Coastal Service Centres v United Petroleum [2023] NSWSC 1010 ( Coastal v United).

…

22 (1992) 26 NSWLR 234 (Priestley JA, Meagher JA and Handley JA).

23 Renard Constructions at 279G (Handley JA).

24 Renard Constructions at 257C.

25 Renard Constructions at 258C (emphasis in original).

26 (1993) 45 FCR 84, 94; [1993] FCA 638 .

27 [2022] HCA 39; (2022) 97 ALJR 40 at [50] –[51] , [72] –[73] ; see also Kiefel CJ and Gageler J at [22]; Edelman and Steward JJ at [103]–[107].

28 Renard Constructions at 263G-264A.

29 Ground 7, par (a).

30 Appellant’s written submissions, par 29(c).

31 Renard Constructions at 279C.

32 Renard Constructions at p 279F.

33 Renard Constructions at p 280A.

34 Renard Constructions at p 281C.

35 (1993) 31 NSWLR 91 (Kirby P, Priestley JA and Meagher JA).

36 (2001) 69 NSWLR 558; [2001] NSWCA 187 (Sheller, Beazley and Stein JJA).

37 Burger King at [185]; see also [187].

38 (1998) 44 NSWLR 349 (Sheller JA, Powell and Beazley JJA agreeing).

39 Alcatel at 363C-E.

40 (1997) 146 ALR 1 at 36ff .

41 Alcatel at 368C-D.

42 Alcatel at 369B.

43 See fn 14 above.

44 [2010] NSWCA 268; 383 ALR 577 (Allsop P, Hodgson and Macfarlan JJA).

45 (2002) 240 CLR 45; [2002] HCA 5 .

46 Royal Botanic Gardens at [37] (Gleeson CJ, Gaudron, McHugh, Gummow and Hayne JJ).

47 Royal Botanic Gardens at [6].

48 Royal Botanic Gardens at [38].

49 See at [70] above.

50 Coastal v United at [47].

(emphasis added)

The full case is to be found here.