Is this Deception on a Grand Scale? When Side Deeds Blur the Lines of Transparency

In the mid-1980's as a young(er) property lawyer, I was asked to advise on a leasing deal in which the landlord insisted that although the rent would be discounted for the first two years of the term, this arrangement would not be recorded in the lease document. Being quite naive, at first I didn't understand why the landlord insisted on recording the discount in a separate document and why the tenant would agree to this. At Law School (early classes Leasing 101) I had learned that if a tenant did not want to lose possession of the premises to a buyer of the premises or a mortgagee in possession or receiver, the tenant had to ensure that all of the lease terms were set out in the lease. I also had learned that for a lease in New South Wales, if the duration of the term and the options when added together exceeded 3 years, the lease terms would have to be included in a lease which would have to be registered at the Land Titles Office (now NSW LRS). Later (as a practising solicitor) I understood that if the landlord had mortgaged the premises, the mortgagee of the premises would review the lease and have to provide the mortgagee's consent to the lease before the lease could be registered.

In their early years, lawyers often learn as much from their clients as they did at Law School. My client told me not to worry about the discount being in a separate (unregistered) agreement. My client explained to me that the landlord wanted to "maintain" the value of his property and that not disclosing the discount in the lease would assist his cause. My client also explained to me the relationship between rental return and the value of a shopping centre.

However, I remained concerned for my client. At Law School I had also learned about the Trade Practices Act, 1974 which contained section 52(1) in the following terms:

"A corporation shall not, in trade or commerce, engage in conduct that is misleading or deceptive."

Now it seemed to me that by omitting the discount from the registered lease, someone was being misled or deceived — precisely what a corporation in trade of commerce was not entitled to do under section 52. The reason I was concerned for my client was that my client (a corporation), by being a party to this transaction with the separate "side agreement", might be regarded as an active participant in what appeared to me to be misleading or deceptive conduct.

Fast Forward

These days nearly all lease transactions include some sort of "incentive" as part of the commercial deal to entice the tenant to enter into the lease. The incentive may be a rent-free period, fitout contribution, or a rent reduction. If it is a rent reduction it may be described as a "discount", "rebate" or "promotion allowance". Of course there is nothing wrong with these arrangements when they are transparent and all of the affected parties have understood and agreed to them. However, despite having advised on literally thousands of these lease arrangements, I still from time to time have some disquiet about these arrangements when they are kept secret in ancillary documents such as "Agreements for Lease", "Side Deeds" or "Contribution Deeds". Not too long ago I received instructions to advise a client on such a transaction which caused me to reflect on current leasing practise.

The Transaction

The tenant and the landlord commenced negotiations for a large tenancy having an area of say, 3000 square metres. The tenant wanted a long lease, say 8 years, with an option to renew. After some negotiation regarding the rent, the tenant made a final offer of, say $370 per square metre, indexed annually in accordance with the consumer price index. The landlord responded by saying he would accept $370 per square metre provided that the registered lease specified a rent equal to $420 per square metre and the tenant accepted a $50 per square metre rebate (indexed) for the whole of the initial term of 8 years. The landlord insisted that the rebate would have to be documented in an unregistered "Side Deed". The landlord also offered an option to renew for 6 years, with rent to be determined by reference to a market review, subject to a cap. My client agreed to these terms.

When the "Heads of Agreement" landed on my desk (or in my inbox), I did some quick mental arithmetic and calculated that the rebate was worth about $150,000 during the first year alone of the initial term. I then got my calculator out and worked out that ignoring indexation, the value of the rebate over the 8 years term was $1 — a serious amount of money.

Although I had been involved as an advisor on many of these types of transactions, this one required particular care in that:

The initial term of the lease was long, increasing the possibility that during the initial term, the property might be sold. If the vendor did not disclose the arrangement to the purchaser prior to the sale contract being entered into, the purchaser may refuse to permit the rebate to continue;

• Given the duration of the lease, it is not out of the question that a mortgagee or receiver of the current or a future owner might take possession or ownership of the property. In any of these instances, if the rebate was not disclosed when the loan was made or the lease was given consent by the lender, the lender may refuse to permit the rebate to continue; and

• The amount of the rebate was substantial — both in dollar terms and in percentage terms - more than 10% of the total rent over the term.

These are all risks that a tenant has to deal with and attempt to minimise when transacting with a landlord who insists that the true rent be "inflated" in the lease document. There are steps that a tenant can take to minimise the risk of losing the rebate during the initial term. An agreement was negotiated with the landlord that if the premises are sold during the initial term, the landlord must either pay out the rebate (based on various assumptions about what the future cpi increases might be) or obtain the agreement of the purchaser in favour of the tenant to continue permitting the rebate to apply.

Then there was a further problem. The "real" starting rent was $370 per square metre and the intended effect of the lease and the side deed when read together, was that all future rent would be calculated having regard to this starting rent. However, the landlord and the tenant's agreement in relation to the rent payable at commencement of the option term was that it would be calculated by reference to the prevailing market rent, but any increase would be capped at 14% above the rent payable in the final year of the initial term. But which rent? The real rent or the inflated rent? Further provisions had to be drafted to ensure that the cap would be computed with reference to the net rent in final year of the initial term after taking into account the rebate — more drafting and more expense! In the end, somewhat to my surprise, the landlord agreed to a clause to be contained in the registered lease along the following lines:

Despite the review of the rent to the Market Rent at the commencement of the option term, the rent payable during the first year of the option term shall not exceed 114% of an amount equal to 88% of the rent payable under this lease during the final year of the initial term of this Lease.

Ironically, in the end, the landlord agreed to insert into the registered lease a clause which would suggest to any discerning mortgagee or purchaser that there might be more to the lease arrangement than what is contained in the registered lease. However, by no stretch of the imagination could one say that the registered lease gives an honest representation of the lease arrangement. And what about section 52 of the Trade Practices Act, 1974?

Australian Consumer Law

Section 52 of the Trade Practices Act, 1974 has been superseded by section 18 of the Australian Consumer Law, which is contained in the Competition and Consumer Act. Section 18 prohibits a person, in trade or commerce, from engaging in conduct which is misleading or deceptive or is likely to mislead or deceive.

So I return to the same questions which troubled me as a young lawyer, namely:

• Does a landlord who insists on incentives and rebates being contained in confidential unregistered documents engage in misleading or deceptive conduct (or conduct which is likely to mislead or deceive)?

• Does a tenant who participates in such a transaction similarly engage in misleading or deceptive conduct (or may the tenant be considered as having aided and abetted the landlord in engaging in misleading and deceptive conduct)?

  
  

Most major shopping centres are indirectly owned by the public via corporate or trust structures, often as part of a superannuation portfolio. Investors expect managers to provide accurate information regarding the performance of the shopping centre and investors are entitled to expect that managers do not operate the shopping centre in a manner which is likely to distort the manager's reported performance or mislead investors as to the true value of their investment.

Similarly, lenders have a strong interest in receiving information about the performance of the centre which will not mislead or deceive the lender. To this end, lenders expect that landlords will provide the lenders' valuers with an accurate and fair representation of the rents being paid by tenants so that their valuation reports are credible. Tenants also, are entitled to assume that if their rent is to be reviewed to market, the valuer will be able to readily obtain accurate information as to the rents being paid so that their rent as determined is truly the market rent.

By engaging in the practice of concealing the true rent by omitting rebates and the like from the lease document, a landlord risks engaging in misleading or deceptive conduct or conduct which is likely to mislead and deceive.

However, it is my view that in truth, the primary object of omitting rebates and other incentives from the lease document is to mislead and deceive. What other reason can there be for complicating transaction documents, such as in the transaction described above?

The incentives are getting bigger and bigger. In the Sydney office leasing market, incentives in the vicinity of 25% and even 30% of the face rents specified in the registered lease are not unheard of. In my view, if landlords continue on this path, it must only be a matter of time before an investor, a bank or perhaps a tenant who has relied on the misleading and deceptive registered lease and lost a lot of money, will decide to take legal action to recover their loss. And what is there to stop an aggrieved lender asserting against a tenant that he was also a party to misleading and deceptive conduct, by agreeing to split the commercial transaction over two documents, one public and one private?

A final comment

There is some irony in the fact that secret side deeds are such a prevalent leasing practise that their existence, at least, is no longer a secret at all. One might argue that everyone knows that side deeds are a regular feature of leasing transactions these days, so why be concerned? However, at the level of the individual parties concerned this is a zero-sum game — the benefit to one participant equals to cost to the other.

A contributing factor of the Global Financial Crisis was the deception on a grand scale within the banking industry, in respect of the quality and value of assets, namely mortgage and debt portfolios. Upwardly distorted valuations enabled poor quality assets to be packaged sold to unsuspecting investors resulting in enormous human suffering for many innocent individuals. In the long run, only truth and transparency can benefit all of society. The opposite benefits a few at the expense of many.