Banking and finance update – July 2013
July 10, 2013
When an equipment lease is terminated before the end of its term, the lessor assumes that it will be entitled to claim a payout consisting of the rentals due over the remainder of the term rebated to their present values as at the termination date. The rebating or discounting is done in order to reflect the time value of money. It also precludes any concerns that the payout sum may constitute a penalty, and so be unenforceable.
The law characterises an early termination payout under such a lease as “loss of bargain damages”. A party is obliged to pay loss of bargain damages when, by reason of its breach, the party can be said to have repudiated (rejected) the entire contract. Repudiation occurs when the condition or term which the defaulting party has breached is so important or essential that the innocent party would not have entered into the contract but for a strict or at least substantial performance of that condition or term.
A lessee’s failure to pay rent on time and in full is a breach of what is commonly regarded as the essential term in an equipment lease. There may be other terms or conditions which of themselves are not necessarily so essential, but the lessor may still feel that if any is breached it is basically deprived of the benefit of the lease. So it is not uncommon to see lease documents in which the lessor specifies every obligation of the lessee and/or event of default as being essential. The intention is to ensure the lessor will be entitled to loss of bargain damages no matter what happens.
Since it was first settled upon in the 1980s there has been some uncertainty about the validity of this approach. The courts always have the capacity to override an express stipulation that a term is essential if its breach would only cause a trifling loss. However, in the case of Gumland Property Holdings Pty Ltd v Duffy Bros Fruit Market (Campbelltown) Pty Ltd (2008) 234 CLR 237, the High Court seems to have given support to the alternative “shotgun” approach which permits all terms to be stipulated as essential. In that case the Court held that parties may describe any term of a contract as being an essential condition in order to ground not just a power to terminate but also a right to recover loss of bargain damages.
The Court did however caution that a provision’s essentiality will be enhanced if it can be inferred from reinforcement given by other provisions of the contract. The essential clause in question must be viewed not in isolation but in the context of other related terms. The contract’s provisions should even go so far as to reveal a “preoccupation” with that condition, for example a lessee’s obligation to pay rent.
Thus a lease term gives the lessor a right to treat its breach by the lessee as grounds for early termination if it is described as essential. This also entitles the lessor to demand its payout, being loss of bargain damages. The lessor’s approach of listing all events of default as essential, is now given greater validity following Gumland, although as a matter of prudence there still should be some basis for the claimed essentiality.
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This article is intended to provide general information in summary form on a legal topic, current at the time of publication. The contents do not constitute legal advice and should not be relied on as such. Formal legal advice should be sought in specific circumstances.