The High Court has indicated that a termination provision in a lease agreement that allows a lessor to recover on default the balance of the rental owing for the whole term, as well as the amounts already due and unpaid, may be viewed as a penalty and therefore be unenforceable.
In our experience, this type of provision is reasonably common and therefore the High Court's judgment may have important consequences for lessors. However, the decision was made in an application for summary judgment and further arguments will be heard at a full defended hearing.
The High Court heard an application for summary judgmentfrom a lessor, Steelbro, for amounts due under two commercial trailer lease agreements of 60 months each.
The lessee, Marshall, only made payments under the two leases for periods of five months and two months respectively. The trailers were repossessed, and Steelbro subsequently leased one trailer to another lessee and sold the other.
The amounts that Steelbro sought to recover from Marshall by way of summary judgement included (in accordance with the termination provisions of each lease agreement) the due and unpaid amounts under both leases, the balance of the rental payments for the whole 60 month term under both leases, and penalty interest on all amounts.
The Court granted summary judgment for the amounts outstanding as at the termination date of the leases together with penalty interest on those amounts, but refused summary judgment on the balance of the rental payments or penalty interest on those payments.
Associate Judge Abbott agreed with Marshall's counsel that there were substantial benefits to Steelbro in receiving a lump sum for future rentals as distinct to receipt of that money over the remaining term of the agreements. He noted that "in my view the requirement for immediate payment of all future rental without allowing any discount for acceleration or payment (by as much as 4 1/2 years) means that the plaintiff would recover significantly more as a result of the defendant's default than it would have had the lease run its course. On that basis alone I find that [the termination provision] is penal in nature and unenforceable".
The Court acknowledged that a lessor is entitled to recover non-penal liquidated damages following default and, in that respect, a lessor may rely on the "worst case scenario" to calculate a genuine pre-estimate of damages. However, Associate Judge Abbott expressed serious doubt as to whether the relevant termination provisions in this case were a genuine pre-estimate given the context (in other words, whether Steelbro's trading position and the state of the market for such trailers at the time was such that it was a real and reasonable likelihood that Steelbro could not re-sell or re-let the trailers in the event of a breach).
Steelbro New Zealand Limited v Marshall and others (CIV 2004-404-3233, High Court Auckland, 22 June 2005)
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