Taranui Motels Limited v McKay HC Auckland CIV 2010-485-353

[2010] NZHC 783

IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY

CIV 2010-485-000353

UNDER  The Property Law Act 2007

IN THE MATTER OF     relief against proposed cancellation of lease

- Section 253

BETWEEN  TARANUI MOTELS LIMITED Applicant

ANDROSS MCKAY Respondent

Hearing:         20 May 2010

Counsel:         G J Toebes for Applicant

T P Cleary for Respondent

Judgment:      20 May 2010

JUDGMENT OF WILD J

Introduction

[1]      This is an opposed application under s 253 Property Law Act 2007 for relief against the cancellation of a lease.

[2]      The application was filed on 2 March, consequent upon Notices of Intention to Cancel issued by the respondent (the lessor) pursuant to s 246 of the Act on 9 and

22 February.

[3]      The  lease  is  dated  26  September  2001  for  a  term  of  27  years  from  1

September 2001.   It thus has about 18 years to run.    It is of the Raceway Court

Motels at Feilding.  It is a valuable lease.

TARANUI MOTELS LIMITED V MCKAY HC WN CIV 2010-485-000353  20 May 2010

[4]      The opposing affidavits disclose a long and unfortunate stream of disputes since the applicant (the lessee) acquired the lease and the motel business from the previous owner, Kotare Holdings Ltd, on 12 December 2003.  My excursion into the factual background will be the minimum required to deal with this application.

The 9 February 2010 Notice

[5]      This Notice, given for the lessor by his solicitor, alleged that two building alterations carried out by the lessee breached three clauses of the lease.  The building alterations were:

a) The partial removal of an external firewall between the conference room and the sunroom. The firewall had been cut into and a non-fire rated bi-fold door installed in the opening. The work affected the building’s fire and structural integrity, and had been done without the building consent required by the Building Act 2004.

b)Partial removal of the firewall separating the storage shed from the owner’s accommodation.  This firewall had been cut into and a non- fire rated door installed.  This work seriously affected the building’s fire integrity and had been done without the building consent required by the Building Acts 1991 and 2004.

[6]      The Notice alleged that this building work breached:

a)       Clause 1.07 of the lease – demised premises not to be altered without the prior written consent of the landlord.

b)Clause 1.11 – lessee to  comply with all statutes etc affecting the demised premises ie the Building Act.

c)       Clause 1.13 – lessee not (without lessor’s prior written consent) to do anything on the demised premises that may void or render voidable

the insurance on the demised premises, or which might increase the premium.

[7]      The Notice required that the breaches be remedied by 5 March 2010.  In its application for relief the lessee asserts that its alterations to the building:

a)        Are not breaches of the lease by the lessee; and

b)In any case, relate to disputes that, by agreement between the parties, have been submitted to arbitration.

For those two reasons the lessee asserts that the first Notice is ineffective. [8]          The lessor’s position is:

a)        He did not consent to the building modifications undertaken by the lessee; and

b)The breaches of the lease involved in those modifications have not been submitted to arbitration.

[9]      A decision as to whether relief against cancellation is appropriate requires an analysis of these directly opposing positions.  In his affidavit the lessor claims that Mr Hopkins of the lessee company did ask him, he thinks in 2004, whether he could make some building modifications.  The lessor deposes that he told Mr Hopkins that he would first need to know what Mr Hopkins was proposing to do before agreeing to any work.  The lessor says he never heard anything further from Mr Hopkins and has never given him or anyone else permission to undertake the building modifications.   The lessor says that he first became aware that modifications had been  carried  out  after  he  had  a  building company assess  the  property in  2008. Although the lessor does not directly say so, I think he is referring to an inspection by Mr Lance Berry of Lance Berry Roofing Ltd, carried out in particular because of concerns raised by the lessee that the roof of the motel was leaking.   The lessor asserts that he was unaware in 2008 that the modifications to the motel buildings carried out by the lessee were in breach of building regulations or imperilled the

insurance cover on the buildings.  He says that his concern at the time was simply that the lessee had made changes to the buildings without his consent.  The lessor says that it is that limited dispute which he agreed to submit to arbitration by Mr Terence Sissons.

[10]     On 3 February 2010 a Mr Jim Edge of The Building Solution Group Ltd reported to the lessor.  Mr Edge introduces his report by stating that he had inspected the motel because there were “some unauthorised building works ... that we were specifically required to report upon for insurance purposes”.   This introduction is inconsistent with the lessor’s assertion that he only became aware that the lessee’s building works were unauthorised when he read Mr Edge’s report.  In this report Mr Edge states that the modification to the external firewall between the conference room and the sunroom affects the fire integrity of the original approved design, and may have compromised the structural integrity of the wall, because he could not determine how the wall and the structure above the bi-fold door is supported.  Mr Edge also reported that the installation of a door in the fire rated wall between the storage shed and the owner’s accommodation affects the fire integrity of the original approved design.  The lessor desposes:

22.      After reading his (Mr Edge’s) report I realised that the modifications the tenant had built were illegal and had put the insurance at risk because, according to the report, the works were not approved and compromised the firewall. Structural integrity was also at risk.

The lessor then states that that information elevated the issue beyond where it was before, namely whether he had consented to the works or is now obliged to consent to them.  The lessor states that his concern that the building modifications may have jeopardised the insurance cover on the motel buildings was the reason why he issued his 9 February 2010 Notice.

[11]     Responding to the lessor’s account of events, the lessee put in evidence a fax it  had  sent  the  lessor  on  6  April  2004  outlining  the  two  proposed  alterations (including a hand drawn plan of each), and seeking the lessor’s urgent consideration of them.  Mr Hopkins of the lessee company says that he subsequently telephoned the landlord in Queensland (the lessor had retired to live there).  The lessor’s concern was whether the Manawatu District Council (MDC) consented to the work.   Mr

Hopkins says he was able to assure the lessor that the MDC had inspected the buildings and consented  to the work, and that  the work would be done by the building firm HR Jones Ltd (which it was).

[12]     The lessor also put in evidence Project Information Memoranda (PIMs) No.s

114453/1 and 114454/1 dated 28 April 2004 relating to the alterations.  The nature and purpose of a PIM is covered in ss 30 and 31 of the now repealed Building Act

1991.  A PIM was issued upon application by an owner contemplating undertaking building work for which a building consent is required.

[13]     The lessee points out that, accompanied by the lessor Mr McKay, Mr Jim Edge inspected the motel buildings on 21 November 2005 “to identify maintenance issues and report on same”.  The lessee states that Mr Edge’s report did not mention any problem with the building alterations which had been completed well before that.   That is consistent only with the lessor having consented to those alterations (although it must be pointed out that clause 1.07 requires the lessor’s prior consent in writing, and there is no evidence that written consent was given).

[14]     Next, the lessee points to a letter dated 25 February 2009 its solicitor received from the lessor’s solicitor stating:

He (the lessor) agrees that it is sensible for the parties to deal with all issues that both parties have arising out of the lease by one process, namely arbitration.

[15]     On 28 June 2009 the parties agreed to submit their disputes to arbitration by Mr Terence Sissons, a Wellington barrister.  The agreement contains, in Schedule 1, a list of the disputes submitted.  This list included:

10.Whether the tenant  has made  any additions  or alterations to the premises which require the consent of the landlord under clause 1.07 of the lease and in respect of which the tenant did not obtain such consent and whether, if the tenant has made such additions or alterations, the landlord is now obliged to consent to these additions or alterations and if so, on what terms.

[16]     In further particulars provided on 22 July 2009, the lessor made it clear that dispute No. 10 included the altered wall in the restaurant/sunroom lounge area and the altered storeroom firewall.

[17]     Following  service  of  the  s  246  Notice  of  9  February 2010,  the  lessee’s solicitor wrote to the lessor’s solicitor disputing the breaches alleged in the Notice and saying that the alleged defaults had been submitted to arbitration pursuant to the agreement of 26 June 2009.  This drew a response dated 25 February 2010 from the lessor’s solicitor in these terms:

That the tenant may have  breached statute or bylaws and/or voided the landlord’s insurance (the substance of the Section 246 Property Law Act Notice) is not before Mr Sissons in arbitration.  We accepted the scope of the current arbitration includes a narrowly constrained dispute under clause 1.07 of the lease about the particular alterations but only as to the landlord’s consent over those alterations.

The clause 1.07 dispute before arbitration does not extend to cover subject matters falling squarely under clauses 1.11 and 1.13 and arising as they do after the building inspection report makes it clear that there are serious potential consequences because of the tenant’s alterations.   Furthermore, a dispute about a possible breach of clause 1.11 or 1.13 is not susceptible to arbitration as suggested in your letter.

[18]     To complete the chronology, I note that on 22 February 2010 a building officer of the MDC issued a Site Inspection Notice in respect of the alteration to the wall between the storage shed and the owner’s accommodation.  This stated:

Please provide a letter to state when the building was first inhabited.   HR Jones to verify when a preline (ie pre-lining) inspection was carried out.

That instruction was to be actioned by 5 March.

[19]     On 10 March 2010 the lessor’s insurance brokers, PGG Wrightson AON of

Feilding, wrote to the lessor’s solicitor advising:

Further to our recent discussion, this is to confirm that I have discussed the non-compliance issue with the tenant.

I have explained to him that the non-compliance will be an issue if that non- compliance causes or contributes to a claim.

He has assured me he is in touch with the Manawatu District Council to seek retrospective sign off of the alterations.

...

[20]     In his reply affidavit for the lessee, Mr Hopkins deposes:

12.... Mr McKay says that the Project Information Memorandum is not a consent.  He is correct but there are underlying building consents and   that   is   why   the   Council   subsequently   issued   a   Project Information Memorandum.  Those PIMs are signed by the Council.

For the reasons explained in [12] above, this makes no sense:  the PIMs precede any application for a building consent.  However, the Site Inspection Notice to which I refer in [18] does support what Mr Hopkins says because it is stated to “relate to the building work being carried out under Building Consent No. 114454/1”.

[21]   None of this opposing evidence has been tested by cross-examination. Tentatively, it appears to me that the lessor is wrong in stating that he did not consent (at least orally) to the building alteration work.  A fax requesting his consent is in evidence.  I am inclined to believe the lessee’s evidence that, in a subsequent telephone call, Mr McKay consented to the alterations provided they were consented to by the MDC and carried out by a qualified builder.

[22] On the evidence as it stands, I am unable to make reliable findings as to the position in terms of consent by the MDC to the alterations. It appears the MDC did issue building consents for the work, at least for the dining room/sunroom wall alteration which I gathered from counsel is the contentious one. It also appears that no final “sign off” of the work has been given by the MDC, although it has obviously been sought, albeit only recently. I say that because of the Site Instruction Notice of 22 February 2010 set out in [18].

[23]     There is a further complication.   In his reply affidavit for the lessee, Mr Hopkins states that he has spoken to the MDC’s Building Inspector and also to its Head of Building Services, most recently on 13 May.   He states that the MDC is waiting for  a report from a Mr Peter Shelton who inspected the motels on the morning of 14 April on behalf of the lessor.  Mr Hopkins deposes that on 13 May the MDC’s Head of Building Services told him that he could state the position to the Court as follows:

•    They are dealing with the two consents together;

•There  is  no  problem  with  the  compliance  for  the  storeroom alterations;

•As regards to the conference room/sunroom, they will await a report from Mr McKay’s representative (Peter Shelton) regarding historical issues the Council was pursuing about the original building work (not the alterations).

[24]     Mr Hopkins’ reference to “historical issues” is to problems with the original construction work carried out by the lessor, Mr McKay.  Mr Hopkins annexed to his reply affidavit a considerable paper trail evidencing, amongst other matters:

•Continual problems with the plumbing and drain laying.  A Mr John Quirk was doing the work but he was not a registered drainlayer (although he was the plumber and drainlayer stipulated in the Building Consent Application).  The registered plumber Mr Brendan Brosnahan seemed to be constantly unavailable.

•    A standoff between the building inspector and Mr and Mrs McKay.

•The MDC alleging (in its 29.9.97 letter) that the McKays “continue with  construction  work  despite  the  notices  issued  and  without seeking to have work inspected”.

•    A last document which is a Notice to Rectify dated 8 December

1997 and advice that a final inspection for plumbing and building is still required.

[25]     Mr Hopkins explains that, after the lessee company purchased the lease and motel business, it became aware that problems with the original construction work had emerged when Kotare Motels Ltd obtained a LIM report.

[26]     My point in mentioning this is that I am uncertain whether the lack of final sign off for the contentious alteration work carried out by the lessee results from concern about that work, or from concerns about the original construction work carried out by the lessee, or some combination of the two.

[27]     In that situation, the lessee must be entitled to relief against the cancellation of which notice was given on 9 February 2010.  That relief must run until it is clear whether final “sign off” from the MDC for the lessee’s building alterations will be granted and, if not, why not.  I am reinforced in that view by further considerations. Although I have pointed to a potential inconsistency in the lessor’s account, it may be  that  he did  not  appreciate,  until  after  the  submission  to  arbitration,  that  the lessee’s building works may have imperilled his insurance cover on the motel buildings and have breached building laws.  But those are further consequences of

the same essential breach of the lease, rather than new or different breaches.  The submission to arbitration encompasses the dispute as to whether or not the lessor consented to the lessee’s building alterations.   It would be undesirable to have a dispute as to those alterations being adjudicated upon both by this Court and by an arbitrator.  I asked Mr Cleary to explain on what basis the lessor contended that the two “new” breaches of lease were not susceptible of arbitration.  Mr Cleary’s answer was  that  the  arbitrator  will  not  have  power  to  order  the  lessee  to  carry  out rectification work.   If that is correct, then it is only because of the limited way in which dispute No. 10 is framed.   If the issue had encompassed the ordering of appropriate relief, then the arbitrator would have been able to order the lessee to carry out remedial work:  s 12(1)(a) Arbitration Act 1996.

The Notice of Cancellation dated 22 February 2010

[28]     This alleged the lessee, in breach of clause 1.01 of the lease, had failed to pay the $12,609.37 rent due for each of January and February 2010.  The Notice referred also to clause 3.14 of the lease which stipulated for interest of 14% per annum on rent in arrears and unpaid for 14 days after the due date.  The Notice required the lessee to pay the rent arrears and the interest by 10 March.

[29]     Clause 1.1 provides:

The tenant shall duly and punctually pay to the landlord the rent herein mentioned at the times and in the manner herein provided free of any deduction.

[30]     There is no dispute as to what has happened about the rent.   The lessee deducted $18,080.69 from the $25,214.74 rent payable for January and February, leaving a balance of $5,471.32 which it paid on 1 March along with the full March rent due on that date.  The $18,080.69 was the total of invoices paid by the lessee to replace water heaters and shower units in the motel, and to make temporary repairs to the water supply to the motel, and to the water filter(s) on that supply.

[31]     The lessee’s response to the 22 February Notice, as conveyed by its solicitor in a second letter of 23 February, was this:

All rent due to be paid under the lease has been paid on the due date and paid in full. There are no arrears.

Payment has been made by the effecting of a set-off of the monies due to be paid by the landlord to the tenant, which the landlord has failed to pay.

If the landlord does not accept that position, then that is a dispute and this letter is notice that such dispute is referred to arbitration of a sole arbitrator. In that regard, it is suggested that the sole arbitrator be Terence Sissons of Wellington, arbitrator.

The tenant would agree that any dispute in this regard would form part of the disputes already referred to the arbitration of Terence Sissons and the schedule of disputes referred to him as arbitrator would be amended by adding the dispute as to whether or not there are rent arrears as specified in the notice dated 22 February 2010.

As with the 9 February Notice, this 23 February letter advised that an injunction would be sought failing the lessor’s confirmation by 26 February that it agreed to submit this dispute to arbitration.

[32]     The lessor’s position is that the lessee had no right to make the deductions from the rent that it has made.  It relies on clause 1.01 which stipulates that the rent is to be paid “free from any deduction”.  The lessee responds that it has not made a deduction, but rather exercised a power of set-off not excluded by clause 1.01.

[33]     The leading authority on set-off remains the judgment of Somers J for the Court of Appeal in Grant v New Zealand Motor Corporation Ltd [1989] 1 NZLR 8. The following passage in Grant was relied upon by Mr Toebes as authority that the lessee may be entitled to set-off the $18,080.69 of payments it deducted from the rent:

Statute apart, the recognised deductions which a tenant may make against his rent are those authorised by the lease itself and those in respect of moneys paid by the tenant which it was the landlord’s obligation to pay.  The latter include moneys outlaid on repairs covenanted to be, but not in fact done by the landlord (as in Lee-Parker v Izzet [1971] 1 WLR 1688 in which the right to deduct was described as one of “ancient common law”) and moneys payable by the landlord, the failure to pay which imperils the tenant’s possession (as in Sapsford v Fletcher (1792) 4 Term Rep 511 and the other cases mentioned in 27 Halsbury’s Laws of England (4th  ed) para 232, note

7).

The covenant to pay rent without deduction may embrace such matters.  It is not easy to envisage any other subject-matter to which they relate.  We do not think the word “deduction” is clear enough to hold that it was agreed that

a set-off of the kind claimed by Mr and Mrs Grant could not be made.  The word “deduction” does not in its natural sense embrace a set-off.

[34]     Ironically,  Mr  Cleary  relied  upon  the  last  paragraph  of  that  passage  as authority that the $18,080.69 of deductions was not permitted by clause 1.01.  Mr Cleary fastened on the observation by Somers J that (as applied here) clause 1.01 embraces  the  $18,080.69,  because  it  is  otherwise  difficult  to  envisage  what deductions it proscribes.

[35]     I need not resolve that interesting issue.  The point is that the lessee here has no present right of set-off.  That is because the lessor has not commenced against the lessee a proceeding seeking judgment for the $18,080.69 unpaid rent.   There is therefore no claim by the lessor triggering any right to set-off which the lessee may have.  In short, any consideration of set-off is premature.  That is implicit in the very nature of set-off, as so authoritatively explained by Somers J in Grant.  The nub of a set-off is captured in these two passages in the judgment:

Set-off affords a defence to an action wholly or in part depending upon the amount and is by its very nature limited to money claims.  When a set-off is established by judgment it will pro tanto extinguish the plaintiff’s claim ...

(p 11)

The principle is, we think, clear.  The defendant may set-off a cross-claim which so affects the plaintiff’s claim that it would be unjust to allow the plaintiff to have judgment without bringing the cross-claim to account.  The link must be such that the two are in effect interdependent:  judgment on one cannot fairly be given without regard to the other; ...

(pp 12-13)

[36]     To summarise thus far:

a)       The lessee may – or may not – have been entitled to deduct the

$18,080.69 from the rent.  The point is open to serious argument.

b)If the $18,080.69 was the lessor’s liability, and if the lessor sued the lessee for that sum as unpaid rent, then the lessee would have a right of set-off.  Grant is squarely in point there.

[37]     A further consideration is that the dispute as to whether the lessor or the lessee is liable for the $18,080.69 was one of the issues submitted by the parties to arbitration  on  28 June 2009.    It  is  dispute  No.  12  listed  on Schedule  1  to the Agreement  to  Submit  Disputes  to  Arbitration.     At  the  lessee’s  instance,  the arbitration before Mr Sissons has been revived and is scheduled for 12-13 July.

[38]     Another point is that Mr Toebes assures me that there is no issue about the lessee’s  solvency.    It  is  perfectly capable  of  paying the  $18,080.69,  indeed  Mr Toebes for the lessee offered to pay that money into Court.  Mr Cleary did not take issue with the lessee’s solvency.

[39]     In those circumstances relief should be granted to the lessee in respect of the lessor’s 22 February 2010 Notice.  The more difficult issue is whether relief should be granted on any condition(s), as permitted by s 156.  I view the situation as finely balanced.  On the one hand, the lessor can with force complain (as Mr Cleary did) that the lessee should have paid its rent without deduction, if only because the issue of liability for the $18,080.69 had been submitted to arbitration.  By deducting that sum from the rent, the lessee cut across and pre-empted the agreed method of resolution.  In short, Mr Cleary raised what he termed “a process issue”.  Further, Mr Cleary emphasised the fundamental importance of rent for any lessor, and he pointed to the particular problems non-payment had posed for the lessor here.  This is what the lessor said about those:

30.When I sold the lease I did so with the intention of retiring and using the rent as income to support myself and my wife in Australia.  I also used part of the rent to pay debt which I had incurred in buying the land and building the motel.  If the rent was not paid on time it put me in a difficult position with other obligations I had to meet.  When two months’ rent was not paid and there was no explanation for it I needed to act to avoid greater problems later on in terms of my own cash-flow position.

[40]     On the other hand, and also with force, the lessee can complain that the lessor ought, if it challenged the $18,080.69 deduction as in breach of the lease, to have sued for that money.  That would have activated the lessee’s right of set-off.  If the deduction was a pre-emptive strike by the lessee, the issue of the 22 February 2010

Notice was no less a pre-emptive strike by the lessor.  Service of the Notice obliged

the lessee to seek relief, and effectively deprived the lessee of the right of set-off it may have.

[41]     Further, Mr Toebes was despondent about what may happen if the arbitrator determines that the lessor is liable for the $18,080.69.  Mr Toebes intimated that the lessor was unlikely to pay that sum, and that he foresaw the lessee facing expensive recovery action.  I would be disappointed if that is a real possibility.  If it is, surely it would be sensible for the parties to alter the way in which the disputes are framed for the arbitrator, to give him the power to award the $18,080.69 to the lessee if he finds in the lessee’s favour on issue No. 12.  In fact, I query whether the power to make such an award is not implicit in issue No. 12 as presently framed.

[42]     The way in which I resolve the fine balance is set out in the paragraphs that follow.   Essentially, I grant the lessee relief against cancellation, but on condition that it pays the $18,080.69 plus interest to the lessor.  But I allow the lessee its costs of this application.   I see that as the appropriate way to reflect my view that each party has taken a pre-emptive step that it perhaps should not have taken.

Result

[43]     The application is granted.  I make orders restraining the lessor from taking any steps pursuant to the s 246 Notices dated 9 and 22 February 2010 it has given the lessee.

[44]     Those restraining orders are made on condition that the lessee is to pay to the lessor by 5pm on Thursday 27 May 2010 the $18,080.69 together with interest on that sum in terms of clause 3.14 of the lease, from 1 January 2010 to the date of payment on $12,500, and from 1 February 2010 to the date of payment on the balance of $5,580.69.

[45]     Leave is reserved to both parties to apply, should the need arise.

Costs

[46]     The respondent lessor is to pay the applicant lessee’s costs of and incidental to this application on a 2B basis, together with disbursements to be fixed by the Registrar failing agreement.

[47]     Mr Cleary should not think that I have overlooked his submission as to the application of clause 1.04 of the lease and his reliance on Curreen v Hodgson HC Auckland M945/98, 19 August 1998.  Clause 1.04 does not apply because a default by the lessee has not been established.  The position is as I set it out in [36]a) above. Curreen was an altogether different case.   Anderson J  found the lessee was in default, albeit in the “relatively minor” sum of $5,249.  However, the lessor had re- entered and granted, albeit with “at least extraordinary haste” new tenancies to the previous sub-tenants.  In that situation, granting relief against forfeiture of the lease (which Anderson J did) was a significant indulgence to the lessee, and the Court felt obliged to order the lessee to pay the costs not only of the lessor but also of the sub- tenants.

Solicitors:

J T Law, Wellington for the Applicant

Macalister Mazengarb, Wellington for the Respondent