Disclosure obligations in lease negotiations

By Peter McMahon and Crystal Eggleton.

Key Points:
If you want to make any disclosures at all about risks associated with a contract, then they should be comprehensive and complete.

A recent New South Wales case highlights the importance of disclosure in leasing negotiations and potential liability under section 52 of the Trade Practices Act 1974 ("TPA") for both the landlord and the tenant in the event of non-disclosure.

When is there a reasonable expectation of disclosure?

A reasonable expectation of disclosure in leasing and, in fact, all commercial negotiations arises from section 52 of the TPA which states that "A corporation shall not in trade or commerce engage in conduct that is misleading or deceptive or is likely to mislead or deceive."

A breach of section 52 of the TPA may arise from actual conduct or silence. Mere silence is not sufficient. Silence must be considered in the context of whether there is "a reasonable expectation of disclosure." In the case where silence alone is relied upon as constituting misleading or deceptive conduct, that conduct must be deliberately engaged in.

Whether there is a reasonable expectation of disclosure will depend on the particular circumstances of each transaction and silence is just one of the circumstances to be considered against the broader factual matrix such as the other acts, omissions and statements of the various parties.

An environmental report

One issue to be decided in Noor Al Houda Islamic College Pty Ltd v Bankstown Airport Ltd (2005) 215 ALR 625 was whether a landlord had misled or deceived a tenant by failing to disclose an environmental report, which revealed that there was contamination in the general area of the site, during lease negotiations.

In this case, the landlord was aware that the tenant intended to use the site for a school, that is, a "sensitive" purpose, and the landlord comprehensively pointed out numerous disadvantages of using the site for a school, such as noise problems from the airport and a lack of connected services.

The landlord’s knowledge of the tenant’s particular transactional requirements and the "sensitive" use for which the site was intended to be used laid the foundation for the tenant’s "reasonable expectation that had there been a risk of contamination, they would have been told".

In reaching this conclusion, the court also referred to the way in which the landlord’s representatives had carefully pointed out certain difficulties with the site, but made no mention of any contamination issues. In fact, the candour of the leasing representative actually "increased the misleading effect of the failure to mention the potential risk of contamination." Unfortunately in this case, the leasing representative was not actually aware of the environmental report, but, because other employees of the landlord were aware of the report, the landlord was deemed to be aware of the contents of the environmental report. These unfortunate circumstances also underline the importance of communication between different branches of the one organisation.

The reasonable expectation of disclosure was further added to because of the tenant’s clearly expressed intention to eventually construct permanent buildings on the site. Since the construction of permanent buildings would inevitably involve some excavation and disturbance of the contaminated sub-soil, the tenant could reasonably expect to be told about the contamination, particularly since that contamination made excavations and construction prohibitively expensive.

The combination of full disclosure of the various disadvantages of the site together with the landlord’s knowledge of the "sensitive" use of the site and the absence of any mention of the risk of the site being contaminated gave rise to a conclusion that the landlord had engaged in "conduct which was misleading or deceptive or was likely to mislead or deceive so as to constitute a breach of the norm of conduct required by section 52 of the TPA."

The court held the tenant would not have entered into the lease and would not have commenced operating a school on the site if it had been told about the risk of contamination. The tenant was awarded approximately $1m covering, among other things, lost profits (past and future), lost government funding grants, relocation costs and redundancy payments to staff etc.

Although not discussed in this article, the tenant also succeeded in a claim based on negligence. The court held that the landlord owed a duty to the tenant to exercise reasonable care to provide information which it possessed which was directly related to the use of the site as a school, that is, the potential contamination of the site.

What you should think about when negotiating a lease

The following are important points to keep in mind in negotiating a lease or other contract:

• If you want to make any disclosures at all about risks associated with a contract, then they should be comprehensive and complete. Partial disclosure may give rise to a reasonable expectation that all disadvantages will be disclosed. The safest approach may be to make no disclosures and tell the other party to make their own inquiries and maintain this position throughout the negotiations. However, taking this approach would not manage the risk of you being negligent by failing to make disclosures in pre-contractual negotiations. Your contract should specifically exclude liability in negligence if commercially possible. This is particularly important where the other party to the negotiations could be classified as vulnerable. In these circumstances, the other party should be aware of what they are agreeing to. At the minimum, you should recommend that they take legal advice on the contract.
• If a change in circumstances does occur, then it is important to consider the history between the parties and the actions that the other party may be taking and form a view on whether the other party needs to be informed about the change in circumstances to avoid the risk of the other party proceeding on a particular basis without a correction in their expectations, notwithstanding that there is generally not an obligation of full disclosure in commercial transactions.
• To avoid a situation where the information expected to be disclosed is withheld by accident rather than intentionally, such as in the Noor case, a vendor or lessor due diligence exercise may be valuable to reveal any information which may be relevant to the duty to disclose.

For further information, please contact Peter McMahon.