Leasing update: Essential Safety Measures – No more cost recovery?

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By Tom Cantwell, Partner, and Pablo Fernandez, Special Counsel

The question of whether a landlord can recover its costs of complying with its essential safety measure (ESM) obligations under the Building Act 1993 (Vic) (Building Act) has been considered by President Garde of the Victorian Civil and Administrative Tribunal (VCAT) in an advisory opinion released on 1 May 2015 (Opinion).

Key points
The Opinion indicates that:

  1. a landlord cannot recover the cost of complying with its ESM obligations from a tenant;
  2. in limited circumstances, a landlord can require a tenant to comply with a landlord’s ESM obligations, provided the costs of doing so are reimbursed by the landlord;
  3. regardless of who undertakes the work necessary to comply with the landlord’s ESM obligations, the related costs must be paid by the landlord; and
  4. outgoings provisions in leases which require the tenant to reimburse the landlord for its ESM expenses or incur those costs directly, are not enforceable.

This is in direct contrast to the prevailing industry practice to pass such costs on to tenants as part of a building’s operating expenses.

Examples of ESM are firefighting equipment including detection and alarm systems, smoke detectors, sprinklers, control centres, hydrants, fire window, fire stairs, as well as paths of travel, exit doors, emergency lifts, heating ventilation and cooling systems etc. Accordingly, a landlord’s compliance costs could be substantial. A complete definition of ESM is in Part 12 and Schedule 9 of the Building Regulations 2006 (Vic). The definition can be found here.

The potential ramifications of the Opinion are therefore significant.

Application of the Opinion

The Opinion was given in response to a number of questions referred to VCAT by the Victorian Small Business Commissioner, which arose as a result of debate in the property industry as to whether a landlord may recover the cost of complying with its ESM obligations from retail tenants, given the wording of section 52 of the Retail Leases Act 2003 (Vic) (RLA).

While the Opinion arose out of an RLA query, its application is potentially much broader and may extend to all commercial and industrial tenants, not just retail tenants, as the Opinion was based on the President’s interpretation of the Building Act provisions.

While the Opinion is not binding in the same way that a decision of VCAT or a Victorian Court would be, at a minimum it is anticipated that it will be highly persuasive in VCAT and potentially also in Victorian Courts.

The Opinion has ramifications going forward but potentially also retrospectively. For instance, landlords who have previously recovered the costs of ESM compliance from tenants may now face claims from tenants looking to set-off such payments made against future rent (section 251(2)(b) of the Building Act). However, the Opinion does not address this issue and the position will depend on the particular lease. We would therefore recommend advice be obtained prior to withholding moneys or conceding a set-off claim.

The Opinion could be contradicted by a judgment of a Victorian Court but until that time, we would expect tenants (especially retail tenants) will object to the payment of any outgoings which relate to the landlord’s ESM compliance.

Next steps
Mitigation strategies for landlords will vary on a case by case basis, dependent on their portfolios, tenant mix etc. Landlords should therefore seek advice about their ability to retain payments made by tenants in respect of the landlord’s ESM obligations and possible options to recover the future costs associated with ESM compliance.

Likewise, tenants should seek advice about their rights in respect of previous payments made on account of a landlord’s ESM obligations and their obligations in respect of any future payments.

For further information, please do not hesitate to contact us.

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