How much control do you have, as a lessor, over the type and style of a proposed retail operation when it comes to a lease transfer? You’ve leased a shop to KFC and that’s the stated ‘usage’. Can you deny an assignment if Oporto is the proposed new tenant? This article, authored by Deren Hassan, Partner at Mills Oakley, is featured in the latest edition of Shopping Centre News.
In some states, the retail leases legislation expressly provides that an acceptable justification for a lessor withholding consent to assignment of a retail lease is when the incoming tenant intends to use the premises in a way that is not permitted by the lease. While the overarching purpose of retail leases legislation is generally to be remedial and to protect retail tenants, this protection does not extend so far as to conflict with a lessor’s right to decide the permitted use a lessee can operate from the leased premises.
In Southern Restaurants Pty Ltd v United Petroleum Pty Ltd(i), the Victorian Civil and Administrative Tribunal (VCAT) considered whether the lessor’s refusal to consent to an assignment on the grounds that there was a proposed change of permitted use of the premises from KFC to Oporto was in breach of the Retail Leases Act 2003 (VIC) (RLA).
United Petroleum Pty Limited (United) operates several petrol stations and convenience stores throughout Australia. It sub-let a part of its leased premises at 129 – 155 Cheltenham Road, Dandenong, Victoria (the premises) to Southern Restaurants Pty Ltd (Southern), the largest privately owned KFC franchisee in Australia. Southern took the sublease of the premises (lease), assuming it would be granted the right by the KFC franchisor to operate a KFC outlet from the premises. At the time of entering into the lease, Southern sought the KFC franchisor’s consent to operate a KFC outlet from the premises. After Southern commenced fit-out works, the KFC franchisor notified Southern that it did not approve a KFC franchise store at the premises, meaning Southern could not operate a KFC outlet from the premises.
Southern then found Oporto Leasing Pty Ltd trading as Oporto (Oporto) who agreed to take an assignment of the lease. Southern requested that United consent to a transfer of the lease including variations to the permitted use to allow Oporto to operate from the premises.
The ‘Permitted Use’ under the lease was:
Restaurant and takeaway food outlet with associated car parks, drive thru, loading bay and yard, including all ancillary retail and service offerings developed by the Tenant. The preparation, retail sale and home delivery of (as eat in and takeaway) food items usually sold in a KFC outlet from time to time. The menu shall otherwise include all items at KFC outlets throughout Australia from time to time, including special promotional items.
United withheld its consent to the assignment on the basis that Oporto would not be using the premises in a way permitted under the lease, given Oporto would not be selling KFC items. Under s60(1)(a) of the RLA, a lessor is entitled to withhold consent to the assignment of a retail premises lease if the proposed assignee proposes to use the retail premises in a way that is not permitted under the lease.
Southern sought declarations from VCAT on the grounds that United was obliged to consent to the assignment of the lease to Oporto pursuant to s 60 of the RLA. Southern argued the restriction in the Permitted Use for the sale of KFC products was inconsistent with s 60(1) of the RLA because it went against the purpose and policy of the RLA. Southern said the purpose of s60 is to allow retail tenants to freely deal with their leases without lessors restricting those dealings or using those restrictions to their economic advantage.
Southern submitted the Permitted Use was inconsistent with the policy of s60 because it restricted the tenancy to a KFC outlet and intentionally avoided the legislative limits of s60. Southern said there was no evidence that United had a legitimate reason to restrict the Permitted Use to a KFC outlet. The evidence showed that United’s real concern was whether Oporto had the same ‘pulling power’ as KFC to draw traffic to the premises. The purpose of s60(1) is to ensure the incoming tenant has sufficient financial resources and business experience to operate the business and pay the rent under the lease, and to otherwise allow the lessee to freely deal with its lease and assets. United sought to subvert that purpose and exploit the restrictions in the Permitted Use to commercially improve its business interests by ensuring the ‘pulling power’ of the fast-food business was co-located with its petrol station at the premises.
United asserted that it was incorrect to say the purpose of s 60(1) is to allow tenants to freely deal with their leases. One of the limited grounds under the RLA on which a lessor is entitled to withhold consent to assignment is where the proposed assignee intends to use the premises for a use not permitted under the lease. Oporto intended to use the premises to sell Oporto products, not KFC products. A lessor is not required to vary the lease to accommodate a change in use when consenting to assignment. The parties to a lease are still required to comply with its terms, especially where those terms are freely negotiated between experienced and well-resourced parties carrying on national businesses.
Ultimately, VCAT held the Permitted Use was not inconsistent with s 60(1) of the RLA. The express terms of s 60(1)(a) are unambiguous and must be given force. A lessor can refuse consent if the proposed assignee intends to use the retail premises in a way that is not permitted under the lease.
The request to vary the permitted use to reflect Oporto’s intended use of the premises reiterates that, without the variation, Oporto would be using the premises in breach of the Permitted Use of the lease proposed to be assigned.
VCAT found that United had a legitimate commercial interest in seeking to ensure the lessee operates a KFC outlet.
Section 60 sets the grounds on which a lessor may refuse a lessee’s request to assign a lease by framing the scope of the lessor’s discretion to deal with its own property and by recognising the lessee’s interest while limiting the grounds on which a lessee can deal with its leasehold.
The decision demonstrates the balance achieved by law-makers in enacting legislation governing the lessor and lessee relationship in retail leases. Unlike many legislative provisions that stipulate matters that are incorporated or taken to be provided for in a lease, the lessor’s entitlement to refuse consent to a lease assignment if there is a change in permitted use is a codified provision that operates directly by statutory force. This is not inconsistent with the parties’ freedom, at the same time, to enter into agreements containing contractual rights and obligations informed by legitimate proprietary and commercial self-interest.
(i)  VCAT 666