Lease renewal clauses: Landlords and tenants beware

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

The facts of the case were that the parties had entered into a lease in relation to petrol station premises in Paarl. The lease started on 1 December 2007 and was to endure for an initial term of five years, with a renewal period of “5 plus 5 years”. The rental at commencement was R18,000 per month, escalating at 8% per year over the initial term.

As to the clause dealing with the determination of the terms that would apply on renewal of the lease agreement, it is worthwhile quoting the relevant text as provisions along the same lines are contained in many leases:

“[The] renewal for the second lease renewal period, shall be on terms and conditions in compliance with the Landlord’s then standard letting policy, except that there shall be no right of further renewal and that the rental and costs shall be mutually agreed upon in writing between the Landlord and the Tenant when the right of renewal is exercised.”

The lease also contained an arbitration clause.

The tenant validly exercised the option during the initial term and the lease was renewed for a further five-year term.

However, when the tenant tried to exercise the second option to renew for a third five-year term, the landlord said that it was amenable to the proposed renewal at an agreed rental of R150,000 per month, plus value-added tax. In response, the tenant contended that a fair rental was an 8% per year escalation on the then prevailing rental. The tenant also proposed that the matter be referred to arbitration. The landlord rejected that contention and that proposal, and proceeded with an application to evict the tenant as it considered the lease to have expired due to the effluxion of time.

The landlord argued that the rental amount for the renewal period was neither determined nor determinable; that the relevant provision of the renewal clause was “an agreement to agree” and, accordingly, was void for vagueness; and that there was no obligation on the parties to negotiate in good faith or to reach an agreement on a rental amount that is objectively reasonable.

The tenant argued that the renewal provision did not reflect the intention of the parties and that the provision should be rectified to reflect the correct intention or, alternatively, that there was a tacit term in the lease agreement that the rental would be reasonable rental which could be established and determined objectively. The tenant also contended that the parties had agreed to arbitration.

The High Court dismissed the landlord’s application. The landlord appealed to the SCA. The SCA ruled in favour of the landlord and upheld the appeal.

Judge Ponnan considered the essential legal propositions in cases such as these on the basis of the judgments in South African, English and Australian court cases.

The Judge concluded as follows at pages 11 and 12 of the ruling:

“[A]lthough the position in relation to ‘agreements to negotiate in good faith’ remains a complex one in Australia in the light of Coal Cliff Collieries, courts there, like other comparable jurisdictions, will not enforce ‘an agreement to agree’. That accords as well with the position in our law.”

(Footnote omitted.)

Judge Ponnan proceeded as follows at page 12 of his judgment:

The proper approach in an enquiry such as the present depends upon the construction of the particular agreement. Accordingly, it becomes necessary to analyse the relevant paragraph to decide whether its proper characterisation is merely an agreement to agree or whether it contained legally enforceable obligations.

The court essentially held (at page 13) that the renewal clause was too “illusory or too vague and uncertain to be enforceable “.

As to the notion that the matter should have been referred to an arbitrator, the court found that an arbitrator “could not give effect to arrangements that the parties themselves had not concluded and then require the party, who is resisting, to continue with the ongoing relationship”. The court also held that, as the lease agreement had terminated by effluxion of time, the tenant could in any event no longer invoke the arbitration clause.

The court made short shrift of the tenant’s arguments for the rectification of the provisions or the introduction of a tacit term. As to the former, the judge found that the tenant’s obligations were far-fetched or untenable, and, essentially, that the tenant had only itself to blame for signing an unfavourable contract. As to the introduction of a tacit term, it was essentially held that the parties had applied their minds to the lease agreement and had expressly agreed on the terms of the renewal clause, and that, accordingly, there was no scope for introducing a tacit term.

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.

For example, in the alternative arrangement, the parties could include a provision along the following lines:

“The monthly rental payable during the renewal period shall be a market-related rental escalating at a market-related rate as agreed in writing between the parties, failing which agreement, the rental and rate determined by an independent expert who shall be appointed by written agreement between the parties and, failing which agreement, by [some determined qualified person, eg a named registered valuer]. 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 rate has not been determined by the start 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 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.”