Court of Appeal Supreme Court New South Wales Medium Neutral Citation: Miwa Pty Ltd v Siantan Properties Pte Ltd [2011] NSWCA 297 Hearing dates: 16 June 2011 Decision date: 19 September 2011 Before: McColl JA at 1; Basten JA at 2; Campbell JA at 51 Decision: (1) Grant leave to appeal and direct that, within 7 days, the applicant file a notice of appeal in the terms of the draft notice contained in the white folder. (2) Allow the appeal and set aside orders made by Windeyer AJ on 21 October 2010. (3) Order that the first respondent be permanently restrained from making any demand in writing on Macquarie Bank Ltd pursuant to the guarantee given on 15 April 1996 numbered 323/03 96. (4) Order that the first respondent forthwith deliver the original of the bank guarantee referred to in the previous order to the appellant at its address for service in these proceedings. (5) Order that the first respondent pay the appellant's costs of the proceedings in this Court and in the Court below. [Note: The Uniform Civil Procedure Rules 2005 provide (Rule 36.11) that unless the Court otherwise orders, a judgment or order is taken to be entered when it is recorded in the Court's computerised court record system. Setting aside and variation of judgments or orders is dealt with by Rules 36.15, 36.16, 36.17 and 36.18. Parties should in particular note the time limit of fourteen days in Rule 36.16.] Catchwords: LANDLORD AND TENANT - construction of lease - option to renew - whether lease required lessor to make payment on lessee's exercise of option to renew - whether such a result absurd EQUITY - lease - unpaid amount due from lessor - whether lessee entitled to recoup the amount by deduction from the rent - right of recoupment, set-off, abatement or reduction LANDLORD AND TENANT - whether the lessor was entitled to call upon the bank to pay the guarantee, after the expiration of the limitation period with respect to the debts due by way of unpaid rent - whether there was a negative stipulation, express or implied, precluding the lessor from calling upon the guarantee - Limitation Act 1969 (NSW), ss 24(1) and 63 WORDS AND PHRASES - "without deduction" Legislation Cited: Civil Procedure Act 2005 (NSW), s 22 Limitation Act 1969 (NSW), ss 11, 24, 63 Supreme Court Act 1970 (NSW), s 101 Cases Cited: Batiste v Lenin [2002] NSWSC 233; 10 BPR 19441 Batiste v Lenin [2002] NSWCA 316 Batshita International (Pte) Ltd v Lim [1997] SLR 241 British Anzani (Felixstowe) Ltd v International Marine Management (UK) Ltd [1980] 1 QB 137 Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd [2008] FCAFC 136; 249 ALR 458 Concrete Constructions v Dalma Formwork [1999] NSWCA 16 Connaught Restaurants Ltd v Indoor Leisure Ltd [1994] 1 WLR 501 Cook v Cook (1986) 162 CLR 376 Courage Ltd v Crehan [1999] ECC 455 Edlington Properties Ltd v JH Fenner & Co Ltd [2006] 1 WLR 1583 Electricity Supply Nominees Ltd v IAF Group Ltd [1993] 1 WLR 1059 Fitzgerald v Masters [1956] HCA 53; 95 CLR 420 Fletcher Construction Australia Ltd v Varnsdorf Pty Ltd [1998] 3 VR 812 Franklins Pty Ltd v Metcash Trading Ltd [2009] NSWCA 407; 76 NSWLR 603 Grant v NZMC Ltd [1989] 1 NZLR 8 Jireh International Pty Ltd t/as Gloria Jean's Coffee v Western Export Services Inc [2011] NSWCA 137 Kooee Communications Pty Ltd v Primus Telecommunications Pty Ltd [2008] NSWCA 5 Moraitis Fresh Packaging (NSW) Pty Ltd v Fresh Express (Australia) Pty Ltd [2008] NSWCA 327; 14 BPR 98,339 Muscat v Smith [2003] 1 WLR 2853 Norman; in the matter of Forest Enterprises Ltd v FEA Plantation Ltd [2011] FCAFC 99 Reed Construction Services Pty Ltd v Kheng Seng (Australia) Pty Ltd (1999) 15 BCL 158 Watson v Phipps (1985) 60 ALJR 1 Roadshow Entertainment v (ACN 053 006 269) Pty Ltd Receiver & Manager Appointed (1997) 42 NSWLR 462 Tillman v Attorney General for the State of New South Wales [2007] NSWCA 327; 178 A Crim R 133 Tomlinson v Cut Price Deli Pty Ltd (1992) 38 FCR 490 Westpac Banking Corporation v Tanzone Pty Ltd [2000] NSWCA 25; 9 BPR 17,521 Wood Hall Ltd v The Pipeline Authority [1979] HCA 21; 141 CLR 443 Texts Cited: R Derham "Equitable set-off: a critique of Muscat v Smith" (2006) 122 Law Quarterly Review 469 at 470-471 K Gray and SF Gray, Elements of Land Law (5th ed, OUP, 2009) P W Young, C Croft & M Smith, On Equity (2009) at [15.390] Category: Principal judgment Parties: Miwa Pty Ltd - Applicant Siantan Properties Pte Ltd - First Respondent Macquarie Bank Ltd - Second Respondent Representation: Counsel: Mr P T Taylor SC - Applicant Mr P Newton - First Respondent Solicitors: Swaab Attorneys - Applicant Heidtman & Co - First Respondent File Number(s): CA 2010/112909 Decision under appeal Citation: Miwa Pty Ltd v Siantan Properties Pte Ltd [2010] NSWSC 1203 Date of Decision: 2010-10-21 00:00:00 Before: Windeyer AJ File Number(s): SC 2010/112909 HEADNOTE [This headnote is not to be read as part of the judgment] The applicant, Miwa Pty Ltd, was the lessee of commercial premises owned by the first respondent, Siantan Properties Pte Ltd. On entering into the lease, the lessee provided a bank guarantee, payable by the second respondent, Macquarie Bank Ltd, in favour of the lessor. The lease was for a term of five years, commencing on 16 April 1996, with an option to renew for a further period of three years. The option was exercised. On commencement of the lease, the lessee had been entitled to a sum of $45,000, described as the lessor's contribution to the fitout of the premises, in accordance with clause 17.7 of the lease. There was a dispute as to whether a similar payment was to be made on exercise of the option to renew the lease. The lessor refused to make the payment and, on 10 February 2003, the lessee gave notice that it intended to set off the unpaid amount against the rent, over a number of months, which it did. The lessee vacated the premises on 19 July 2004. The proceedings commenced in the Equity Division, the lessee seeking to restrain the lessor from calling on the Bank to pay the guarantee. Windeyer AJ dismissed the proceedings and dissolved an interim injunction: Miwa Pty Ltd v Siantan Properties Pte Ltd [2010] NSWSC 1203. There has, however, been a stay in place pending determination of the present application for leave to appeal. The issues for determination on appeal were: (i) whether the lease required the lessor to make a payment of $45,000 on exercise of the option to renew; (ii) if it did, whether the lessee was entitled to recoup the amount by deduction from the rent, and (iii) whether the lessor was entitled to call upon the bank to pay the guarantee, after the expiration of the limitation period with respect to the debts due by way of unpaid rent. The Court held, allowing the appeal and granting the restraining order In relation to (i) (per Basten JA, McColl and Campbell JJA agreeing) 1. The obligation to make the second payment was a term of the renewed lease, unless that reading lead to an absurdity. The courts have no mandate to rewrite agreements, so as to depart from the language used by the parties, merely to give a provision an operation which, as it appears to the court, might make more commercial sense:[1], [14] - [18] and [51]. Fitzgerald v Masters [1956] HCA 53; 95 CLR 420; Watson v Phipps (1985) 63 ALR 32; Franklins Pty Ltd v Metcash Trading Ltd [2009] NSWCA 407; Jireh International Pty Ltd t/as Gloria Jean's Coffee v Western Export Services Inc [2011] NSWCA 137; Kooee Communications Pty Ltd v Primus Telecommunications Pty Ltd [2008] NSWCA 5; Moraitis Fresh Packaging (NSW) Pty Ltd v Fresh Express (Australia) Pty Ltd [2008] NSWCA 327; Westpac Banking Corporation v Tanzone Pty Ltd [2000] NSWCA 25 followed. In relation to (ii) 2. The lessee having made deductions from the rent to the amount of $45,000, which it claimed to be owed by the lessor, the lessor took no steps for more than six years to recover that amount, which is now statute barred:[1], [33] and [51]. British Anzani (Felixstowe) Ltd v International Marine Management (UK) Ltd [1980] 1 QB 137; Connaught Restaurants Ltd v Indoor Leisure Ltd [1994] 1 WLR 501; Electricity Supply Nominees Ltd v IAF Group Ltd [1993] 1 WLR 1059; Grant v NZMC Ltd [1989] 1 NZLR 8; Batshita International (Pte) Ltd v Lim [1997] SLR 241; Batiste v Lenin [2002] NSWCA 316; Debonair Nominees Pty Ltd v J & K Berry Nominees Pty Ltd (2000) 77 SASR 261; Batiste v Lennon [2002] NSWSC 233; 10 BPR 19441 cited. Courage Ltd v Crehan [1999] ECC 455 distinguished. In relation to (iii) 3. Whether the lessor could properly be injuncted from making a demand on the bank pursuant to the guarantee depended on whether there was a negative stipulation, expressed or implied in the lease, precluding the lessor from calling upon the guarantee in the present circumstances:[1], [33] and [51]. Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd [2008] FCAFC 136; 249 ALR 458; Reed Construction Services Pty Ltd v Kheng Seng (Australia) Pty Ltd (1999) 15 BCL 158; Fletcher Construction Australia Ltd v Varnsdorf Pty Ltd [1998] 3 VR 812 followed. 4. The purpose of the guarantee, as reflected in clause 15 of the lease, was to provide security to the lessor in respect of its legal entitlements. It protected the lessor against the insolvency of the lessee and relieved it of the obligation to bring proceedings to enforce its entitlements. It did not absolve the lessor from the need to establish those entitlements if its right to call on the guarantee, or to retain moneys paid to it there-under, were challenged by the lessee. The lessor having no legal entitlement at the time it sought to call on the guarantee, the lessee was entitled to an order restraining it:[1], [44] - [45] and [51]. Judgment 1McCOLL JA : I agree with Basten JA and the orders his Honour proposes. I also agree with the additional reasons of Campbell JA. 2BASTEN JA : The applicant, Miwa Pty Ltd, was the lessee of commercial premises owned by the first respondent, Siantan Properties Pte Ltd. On entering into the lease, the lessee provided a bank guarantee, payable by the second respondent, Macquarie Bank Ltd, in favour of the lessor. 3The lease was for a term of five years, commencing on 16 April 1996, with an option to renew for a further period of three years. The option was exercised. On commencement of the lease, the lessee had been entitled to a sum of $45,000, described as the lessor's contribution to the fitout of the premises. There was a dispute as to whether a similar payment was to be made on exercise of the option to renew the lease. The lessor refused to make the payment and, on 10 February 2003, the lessee gave notice that it intended to set off the unpaid amount against the rent, over a number of months. The lessee vacated the premises on 19 July 2004. 4Three issues arose for determination on the appeal, namely whether: (a) the lease required the lessor to make a payment of $45,000 on exercise of the option to renew; (b) if it did, the lessee was entitled to recoup the amount by deduction from the rent, and (c) the lessor was entitled to call upon the bank to pay the guarantee, after the expiration of the limitation period with respect to the debts due by way of unpaid rent. 5The proceedings commenced in the Equity Division with the lessee seeking to restrain the lessor from calling on the bank to pay the guarantee. Windeyer AJ dismissed the proceedings and dissolved an interim injunction: Miwa Pty Ltd v Siantan Properties Pte Ltd [2010] NSWSC 1203. There has, however, been a stay in place pending determination of the present application for leave to appeal. Leave is required because the amount in issue is $45,000: Supreme Court Act 1970 (NSW), s 101(2)(r). 6The primary judge accepted that there were "difficult questions" involved. The case sought to be made good by the lessee is clearly arguable. The second and third questions give rise to issues of legal principle with potential ramifications beyond the resolution of the present dispute. For these reasons, the application for leave and the appeal were heard concurrently: the case is appropriate for a grant of leave to appeal. Second fitout payment: construction of lease 7The lease was expressed to commence on 16 April 1996, and to terminate on 15 April 2001. 8Amongst the special conditions were the following: " PART 17 - SPECIAL CONDITIONS ... 17.5 The Lessee is permitted to refurbish and reposition the partitioning on level 5 provided however that the Lessor is to maintain ownership and depreciation rights. 17.6 The Lessor covenants with the Lessee to undertake the following works in relation to the premises - (i) Carpets to be installed within the Premises of a similar quality to that laid on Level 1 of the building. The Lessee shall also have the right to lay more expensive carpet. PROVIDED HOWEVER the Lessor will make a maximum contribution for carpeting of $22,000; (ii) the Lessor will repaint all previously painted surfaces to a colour and standard approved by the Lessee. 17.7 The Lessor covenants with the Lessee that immediately upon receipt of the lease duly executed by the Lessee and the Bank Guarantee it will pay to the Lessee the sum of $45,000.00 being the Lessor's contribution to the Lessee's fitout of the premises." 9The lease also contained the following provision: " PART 16 - OPTION OF RENEWAL 16.1 If the Lessee shall desire to take a renewed Lease of the demised premises for a further term of years as set out in Item 8 of the Reference Schedule from the expiration of this Lease the Lessee shall give to the Lessor not less than three (3) months nor more than six (6) months previous notice [and shall not be in default]. The Lessor shall grant to the Lessee a lease of the demised premises for such further term of years commencing on the day following the date of expiry of the immediately preceding term and otherwise on the same terms as herein, provided that:- (a) this clause 16.1, clause 17.6 and paragraph 1 of Schedule A shall be excluded; and (b) the commencing annual rent shall be calculated in accordance with the provisions of clause 16.2 hereto, mutatis mutandis." 10The critical provision was the proviso in sub-clause (a), which did not exclude clause 17.7 from the renewed lease. Whether that was deliberate, or a mistake, is not an issue the Court is required to consider: there was no application for rectification of the lease. 11The primary judge held that, according to the ordinary meaning of clause 16.1, the renewed lease would include clause 17.7: at [14]. However, he concluded that such a reading would lead to an absurd result and that, accordingly, reference to clause 17.7 should be treated as part of the proviso to clause 16.1(a): at [17]. After referring to relevant authorities, his Honour held that, although rectification was not sought, "if the mistake is obvious and simple, rectification is not required": at [16]. His Honour continued: "There are some matters which go to indicate mistake in words. They are (a) a fit out usually takes place when premises are new or a new lessee takes possession; (b) clause 17.7 was added after the lease was originally prepared as it is in a different typeface; (c) the $45,000 is a fixed sum." 12He concluded that consideration (c) made the absurdity clear: at [17]. The reason why that was so appears to be found in the preceding paragraph where, after noting that counsel for the lessee claimed entitlement to that full amount as a debt (rather than a claim for damages for breach of covenant to pay that amount), his Honour stated, "it is difficult to imagine the parties intended that $45,000 would be paid irrespective of whether there was a fit out or paid in full in a case where the cost of fit out was less than $45,000". His Honour did not indicate how he would have construed the clause, as it appeared in the original lease. 13It will be necessary to return to this construction question shortly. Before doing so, it is helpful to identify the concept of "absurdity" as a basis for construing a document otherwise than according to its literal meaning. Although the case was run both in this Court and below on the issue of absurdity, it should not be forgotten that this is but one aspect of broader principles as to the construction of commercial contracts: see generally, Franklins Pty Ltd v Metcash Trading Ltd [2009] NSWCA 407; 76 NSWLR 603 at [19]-[23] (Allsop P), [49]-[53] (Giles J) and [240]-[305] (Campbell JA). While in common parlance, the word "absurd" may have a range of connotations, in this context it is used to mean something opposed to reason, or irrational. It can form a basis for resolving internal inconsistencies in a contract or giving commercial sense to language which is otherwise in a practical sense meaningless. 14The point is best illustrated by the examples which appear in the authorities, rather than by the descriptions used. Thus, in Fitzgerald v Masters [1956] HCA 53; 95 CLR 420, the High Court was faced with a contract for the sale of land which set out a number of specific provisions and then purported to incorporate the "usual conditions of sale" but only "so far as they are inconsistent herewith". As explained by McTiernan, Webb and Taylor JJ at 436-437, to read the word "inconsistent" literally, "would involve the notion that the declared terms should be regarded as tentative or provisional only and subject to displacement .... The adoption of this view would, it seems to us, make it difficult to say that, in the circumstances, the parties had reached agreement at all". This approach was rejected: see also Dixon CJ and Fullagar J at 426-427. 15In Watson v Phipps (1985) 60 ALJR 1 the Privy Council considered the proper construction of a clause in a lease which stated that the lessee "may offer to purchase the demised land from the lessor for the consideration equivalent to $1,000 per acre". The Privy Council construed the language as an option to purchase. Reading the clause literally the judgment delivered by Lord Brightman remarked, "[s]uch a right is ... utterly meaningless". The judgment continued: "The lessee does not need a sub-clause to tell him that he may make an offer to buy the demised land, nor does he need to be told at what price he may make such offer. Anyone in the world, be he the lessee or anyone else, is at liberty to offer to buy the demised premises at any price he chooses to name." 16Similarly, in Westpac Banking Corporation v Tanzone Pty Ltd [2000] NSWCA 25; 9 BPR 17,521 this Court (Priestley and Fitzgerald JJA, Foster AJA) considered a lease containing two alternative bases of calculating rent increases. One basis allowed increases by reference to the change in the consumer price index over consecutive biennial periods; the other required cumulative increases, each of which was calculated by the increase in the consumer price index from the commencement of the contract. The result, over a 14 year period, under the first approach trebled the rental, but the second would have increased it 24 times. The Court was satisfied that the literal meaning "could not have represented the intention of the parties, looked at objectively, because of the absurd results it could produce": at [25]. 17In Moraitis Fresh Packaging (NSW) Pty Ltd v Fresh Express (Australia) Pty Ltd [2008] NSWCA 327; 14 BPR 98,339, a challenge was made to a contractual arrangement by which the appellant purported to exercise a deemed offer pursuant to a right of first refusal, in respect of a right to occupy a stand in Sydney Markets for the price of $85,971, although the stand was said to be worth of the order of $1.8 million: at [1]. The respondent owner argued that the literal reading of the offer price gave rise to an absurd result. The challenge was rejected by Giles JA, who was satisfied that the amount provided for in the contract was not intended to reflect the true value of the stand, but a fixed amount based on a broader commercial arrangement: [64]-[65]. Thus, even at the time the contract was entered into, the stand was recorded in the accounts of a trust involving the parties at more than $500,000: [55]. Hodgson JA (Ipp JA agreeing) took a different view of the nature of the transaction: at [133]-[138]. The case provides little assistance in resolving the present dispute. 18It is clear from these authorities that the test of absurdity is not easily satisfied. Nor was there any evidence suggesting a commercial context which might demonstrate that a lump sum payment, expressed to be for fit out, would make commercial sense at the commencement of a lease, but not on its renewal. The courts have no mandate to rewrite agreements, so as to depart from the language used by the parties, merely to give a provision an operation which, as it appears to the court, might make more commercial sense: see Jireh International Pty Ltd t/as Gloria Jean's Coffee v Western Export Services Inc [2011] NSWCA 137 at [55]-[56] (Macfarlan JA, Young JA and Tobias AJA agreeing); Kooee Communications Pty Ltd v Primus Telecommunications Pty Ltd [2008] NSWCA 5 at [27]-[31]. In the present case, in order to formulate the alleged absurdity, it is necessary to commence by considering how clause 17.7 operated at the commencement of the lease. 19Before undertaking that task, it is necessary to dispose of an evidential issue. The lessee tendered a bundle of material in order to demonstrate that the between October 2001 and approximately March 2003 the lessee incurred significant expenses in refurbishing the premises. The tender was rejected by the primary judge, on the basis that it was presented belatedly in the proceedings, without the lessor having an opportunity to challenge it: Tcpt, 29/09/10, p 13(20). The lessee sought to renew the tender in this Court, challenging the rejection by the primary judge. 20The Court rejected the tender in the course of the appeal. Without considering whether the material established that which it was tendered to establish, the material is in any event irrelevant. The issue in dispute concerns the construction of the lease, entered into in April 1996. As the lease was a contract wholly in writing, that issue cannot be resolved by reference to what one of the parties did on the premises, between five and six years later. 21Returning to the point of construction, it may be noted that, pursuant to clause 17.7, the payment by the lessor of $45,000 was contingent only upon receipt by it of the duly executed lease and the bank guarantee. Although the sum was expressed to be the lessor's contribution to the lessee's fitout of the premises, there was no requirement in the lease that the lessee carry out any particular fit out or refurbishment of the premises, at any particular expense, or to any particular standard. Indeed, at the outset there was no obligation to refurbish at all, the lessee merely being "permitted" to refurbish and reposition certain partitioning, belonging to the lessor: clause 17.5. On the other hand, the lessee was obliged to keep the premises in good and substantial repair, order and condition (clause 5.1) and "at intervals of not less than 5 years and from time to time if necessary or reasonably required by the lessor" to redecorate the premises, which included the cleaning of the whole of the interior, painting, staining or polishing internal surfaces and replacing carpets and floor tiles which had been worn or damaged beyond fair wear and tear: clause 5.2(a). The lease being for a period of five years, this provided an express obligation on the lessee to incur expenditure on the premises no later than the end of the lease and, if the option to renew were taken up, by the time that occurred. Thus, in circumstances where the lessor was prepared to make a substantial contribution to the fit out of the premises at the commencement of the lease, and where the lessee had contractual obligations of repair and refurbishment at the end of the lease, it is by no means absurd to envisage a further payment being made at the commencement of the option period. 22The issue thus presented should be resolved in favour of the lessee: clause 17.7 was, on the proper reading of the contract, included within the new lease which resulted from exercising the option. The issue was identified in those terms; there was no separate argument that clause 17.7 might have been included in the new lease, in a formal sense, but, properly construed, did not give rise to an obligation to make a payment, because there was no fit out anticipated at the commencement of the option period. That argument was only raised in an attempt to demonstrate that the inclusion of such a clause was absurd and required a different reading of clause 16.1. In any event, for the reasons given below, the proper construction of the lease has no consequences for the outcome of the appeal. Deduction from payments of rent 23The lessee did not sue to recover the $45,000 and, indeed, has never sought to do so. As the payment was due in April 2001, enforcement of the debt is long since statute-barred. The reason that the lessee took no proceedings was that it had recovered the amount by way of deduction from the rental payments. According to the applicant's chronology, the deductions occurred between 16 February and 16 May 2003 and thus well before the lessee vacated the premises, shortly after the expiry of the new lease period, in July 2004. 24The obligation to pay rent was contained in clause 3.1, which provided as follows: "The Lessee will during the Term pay to the Lessor free of all deductions in each year the rent and other payments (if any) specified calculated and payable in the manner provided in Schedule Two hereto." 25Apart from requiring that the rent be paid in equal monthly instalments in advance, and subject to what appears at [30] below, Schedule Two provided no assistance in construing clause 3.1. For the lessee to have justified the deductions it made from the payments of rent, in order to recoup the $45,000 said by it to be owing under the lease, clause 3.1 must be read to say that the rent would be provided free of some deductions. To make good that reading, the lessee sought to rely on English authorities. 26The position in England is summarised in K Gray and SF Gray, Elements of Land Law (5 th ed, OUP, 2009) at 4.3.57: "At common law the tenant has a right of recoupment from future rent in respect of the cost of repairs covenanted, but not executed, by the landlord. The right, of ancient derivation, affords the tenant a significant remedy where the landlord is in breach of any covenant (whether express or implied) to repair the demised premises. In Lee-Parker v Izzet [1971] 1 WLR 1688 at 1693F-G Goff J confirmed that the tenant may execute the covenanted repairs himself and then deduct the cost of these repairs from future payments of rent. The tenant who takes advantage of this right has pro tanto a defence to any action by the landlord for arrears of rent .... The tenant's right may ... be excluded - as happens increasingly frequently - by a covenant in which the tenant undertakes to pay rent 'without any deduction or setoff whatsoever'." 27In respect of the last statement, the authors place reliance on Electricity Supply Nominees Ltd v IAF Group Ltd [1993] 1 WLR 1059 at 1064B-C; Debonair Nominees Pty Ltd v J & K Berry Nominees Pty Ltd (2000) 77 SASR 261 at 271, and Batiste v Lenin [2002] NSWSC 233; 10 BPR 19441 at [105] (see below). 28Gray and Gray also refer to the equitable right of set off, as arising where the tenant has put up with damaging consequences of a landlord's breach, rather than expending his or her own funds in remedying such a breach: at 4.3.58. There must, however, be a "close reciprocity" between the effect of the breach and the obligation to pay rent: Muscat v Smith [2003] 1 WLR 2853 at [9], [30] (Sedley LJ); referring to British Anzani (Felixstowe) Ltd v International Marine Management (UK) Ltd [1980] 1 QB 137 at 153-4 (Forbes J). The authors accept that the equitable right can be contractually excluded, but "only by clear words", noting that a covenant to pay rent "without any deduction" was not sufficiently clear to have that effect, referring to the judgments in Connaught Restaurants Ltd v Indoor Leisure Ltd [1994] 1 WLR 501 at 509A-C and 510E-G (Waite LJ); Edlington Properties Ltd v JH Fenner & Co Ltd [2006] 1 WLR 1583 at [71]-[75] (Neuberger LJ, Pillard, Scott and Baker LJJ agreeing); Grant v NZMC Ltd [1989] 1 NZLR 8 at 13; Batshita International (Pte) Ltd v Lim [1997] SLR 241 at [12] (Yong Pung How CJ, Karthigesu and LP Thean JJA); cf Courage Ltd v Crehan [1999] ECC 455 (Morritt, Schiemann and Mance LJJ) at [61]-[72]. 29To speak of a right of "set off" appears to invoke a procedural right as a defendant in court proceedings. However, the cases extend that language to the antecedent question of whether a tenant has a right of recoupment for amounts expended, as against its obligation to pay rent, or has a right of abatement or reduction in the payment of rent on account of the debt supposedly owing by the landlord. If viewed prospectively, the question will be whether, if the full rent is not paid, the tenant will be in default under the lease and may suffer consequences. These will not necessarily involve legal proceedings: a landlord may, for example, have a right to distrain on the tenant's goods or the tenant may lose a right to renew the lease under an option requiring that it not be in default when the option is sought to be exercised. 30It is not necessary for present purposes to determine whether the language used in the lease would entitle the landlord to demand timely payment of the full amount of the rent in circumstances where, in breach of its own obligations under the lease, the landlord had allowed the premises to fall into such disrepair that they were uninhabitable, or unusable for the purposes for which the lease was granted. Further, there may be circumstances in which a payment made by a tenant of an amount properly payable by the landlord may be treated as a means of fulfilling the obligation to pay rent. The issue, not addressed in the present case, would then be whether such a conclusion could stand in the face of a specific provision requiring that, for example, the lessee "shall pay all rent by order on the lessee's bankers directing payment thereof to the credit of the account of the manager at such bank and branch thereof as is from time to time nominated by the lessor": Schedule 2, Part C of the present lease. 31In Batiste v Lenin , Bryson J stated at [105]: "My view is that on the literal and true meaning of the covenant to pay rent without deduction, there is no room for reliance on the right of recoupment referred to in Lee-Parker v Izzett . In my opinion the literal meaning of 'without deduction' makes this clear, and looking further to the purpose of using those words, there is no other purpose available than to prevent the lessee from relying on rights or claims to be entitled to set off, recoup or otherwise withhold payment of part of the rent. In the ordinary use of language to recoup another obligation out of rent is to make a deduction from the rent, and if the use of the words 'without deduction' did not achieve this result I cannot see what they would achieve, as the ordinary obligation of a debtor is to pay the whole debt." 32These remarks were made without reference to the decision of the English Court of Appeal in Connaught Restaurants , or the judgment in Grant v NZMC Ltd . It is not necessary to determine in these proceedings whether his Honour was correct in considering that the words "without deduction" excluded common law and equitable rights of recoupment in all circumstances. Indeed, because his Honour had found that the lessor was not under an obligation to carry out such work as would render the premises habitable, the remarks set out above were obiter. On appeal, Sheller JA (Giles and Santow JJA agreeing) was prepared to accept that had the lessor been under an obligation to restore and repair, but refused to do so, and the lessee had carried out the work at its own expense, it would have been entitled to recoup itself from future rent: Batiste v Lenin [2002] NSWCA 316 at [47]. 33In the present case, the lessee having made deductions from the rent to the amount of $45,000, which it claimed to be owed by the lessor, the lessor took no steps for more than six years to recover that amount. Had it taken proceedings, the question identified above would have required resolution: any debt now being statute barred, the question does not arise and need not be considered further. Reliance on guarantee 34The result in this case must turn upon the lessor's claim to be entitled to call upon the guarantee. The guarantee was given pursuant to clause 15 of the lease, which provided: "15.1 Prior to the commencement of this lease the lessee shall cause a bank guarantee irrevocable up until and including the date of expiry of the Term for the sum stated in item 15 of the reference schedule in favour of the Lessor to be provided to the Lessor to secure the Lessor against any failure by the Lessee to comply with the conditions of this Lease relating to the care or repair of the demised premises or the payment of rent, charges or any other moneys payable by the Lessee under this Lease. 15.2 In the event of such failure the Lessor shall be entitled without further notice to the Lessee to forthwith call up such guarantee wholly or in part and to apply any moneys paid thereunder to any loss or damage sustained by the Lessor ... without prejudice to the Lessor's right to full reimbursement from the Lessee for such loss or damage sustained and the Lessor's right to claim payment for any deficiency." 35The amount identified in item 15 of the reference schedule was $45,000. The "Term" was defined in the lease to mean the period commencing on the date set out in item 6 of the reference schedule and expiring on the date set out in item 7, the latter date being 15 April 2001. When the lease was renewed, it was assumed that the guarantee would continue in satisfaction of clause 15, and the termination date would presumably have been 15 April 2004, though that was not specified. Although a guarantee which was irrevocable only until the expiry of the term of the lease might have been of limited benefit to the lessor, nothing turns on that possibility because the guarantee, as provided, was not limited to a specific time; rather it stated: "This Guarantee is to continue until the earlier of: i) this Guarantee is returned to the Bank at its offices at 20 Bond Street, Sydney; or ii) payment to the Beneficiary by the Bank of the whole of such sum or such part as the Beneficiary may require." 36The bond was held by the beneficiary (the lessor) and had not been returned prior to the commencement of these proceedings; nor had any payment been made under it. The obligation of the bank was contained in an unconditional undertaking to pay on demand: "Should the Bank be notified in writing at its office at 20 Bond Street, Sydney such notice purporting to be signed for and on behalf of the Beneficiary, that the Beneficiary desires payment to be made of the whole or any part or parts of that sum, the Bank will make such payment or payments to the Beneficiary forthwith without further reference to the Customer [the lessee] and notwithstanding any notice given by the Customer to the Bank not to pay the same." 37The rights of the lessor to claim under the guarantee are not contained in the guarantee itself, but must be identified in the lease. The issue is whether the lessor is entitled now to make a claim under the guarantee for payment of rent, whether such amount was owing or not and whether the lessor retains (given the expiry of the limitation period) any right to sue for the outstanding amount. Before resolving this issue, a number of subsidiary points need to be disposed of. First, it was submitted to the primary judge that the guarantee came to an end with the termination of the lease. In its terms it did not, as his Honour held at [28]. Nor, despite the wording of clause 15.1, was the guarantee revocable upon termination of the lease. Even if it had been, it was not revoked. Finally, although relief was sought by way of injunction against the bank, the lessee does not require such relief if relief is available against the lessor. 38The real issue is, therefore, whether the lessor could properly be injuncted from making a demand on the bank pursuant to the guarantee. As suggested by Austin J in Reed Construction Services Pty Ltd v Kheng Seng (Australia) Pty Ltd (1999) 15 BCL 158 at 164-165, the question may properly be identified as whether there was a negative stipulation, expressed or implied in the lease, precluding the lessor from calling upon the guarantee in the present circumstances. This approach was approved by a Full Court of the Federal Court (French, Jacobson and Graham JJ) in Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd [2008] FCAFC 136; 249 ALR 458 at [77], referring at [78] also to Fletcher Construction Australia Ltd v Varnsdorf Pty Ltd [1998] 3 VR 812 (Charles, Callaway and Batt JJA) . As noted by Callaway JA in the latter case (at 826): "There are broadly two reasons why the beneficiary may have stipulated for a guarantee. One is to provide security. If it has a valid claim and there are difficulties about recovering from the party in default, it has recourse against the bank. The second reason ... is to allocate the risk as to who shall be out of pocket pending resolution of a dispute." 39The issue was dealt with by the primary judge by reference to the Limitation Act , as it applied between the lessor and the bank: at [31]. Reference was then made to the decision of the High Court in Wood Hall Ltd v The Pipeline Authority [1979] HCA 21; 141 CLR 443. His Honour continued: "As a general proposition and subject to exceptions which do not apply here then unless terms of an underlying contract are incorporated into the performance bond or guarantee a bond beneficiary or obligee ought to be able to call on it holding the proceeds as security until any underlying dispute between obligee and other contracting parties is determined." 40His Honour recognised, there would remain a question of entitlement as between the lessee and the lessor which formed part of the case which he was determining. Accordingly, he accepted that "it would be wrong to hold that the lessor could call upon on the bond leaving it to the lessee to bring some claim based upon unjust enrichment or implied contractual terms to recover money in the circumstances where I have already decided entitlement": at [32]. Precisely what this passage meant, however, is not clear, as his Honour had previously identified the question to be whether the lessor could call on the bond "notwithstanding that a claim by it against the [lessee] for arrears of rent is barred by the Limitation Act 1969 ": at [29]. It appears that the right of the lessor to claim under the guarantee having once been triggered by a "failure" by the lessee to make timely payment of rent, thereafter lasted forever. 41That reasoning gives rise to curious consequences. There would, presumably, be a negative stipulation implied in the lease that the lessor could not retain the proceeds of the bond in circumstances where the lessee had never been in arrears in payment of rent. It would also follow, arguably, that if the rent had been paid late, thus triggering a "failure" for the purposes of clause 15.2, the lessor would not be entitled to retain any amount obtained from the guarantor once the full payment had been made by the lessee. That would be so because, although there had been a failure, there was, at the later point in time, no amount owing and payable by the lessee to the lessor. However, if that reasoning be correct, it is necessary to distinguish the case where there has been a failure, but there is no amount owing and payable because the limitation period expired before any claim was made on the guarantor and the case where a claim was made and answered after the expiration of the limitation period; in the latter case it would be necessary to explain why the lessor should be entitled to retain money which, when obtained, was not owing and payable by the lessee. 42Clause 15 is inconsistent with the result proposed by the primary judge. Clause 15.1 requires that the basis of the demand under the guarantee is that there is an amount by way of "rent ... payable by the Lessee under this Lease". Assuming, for present purposes, that there was such an amount payable in 2003, when deductions were improperly made, that amount is no longer "payable" in the sense of being recoverable at law. Further, clause 15.2 envisages that, in the case of a shortfall, the lessor will retain a right to "full reimbursement" from the lessee and a right "to claim payment for any deficiency". This language is consistent with the need for an enforceable right at the time a demand is made under the guarantee. 43Furthermore, while it is the failure to pay rent which triggers the lessor's entitlement to call up the guarantee, the entitlement extends only "to apply any moneys paid thereunder to any loss or damage sustained by the Lessor". This is the language of legal entitlement, not loss or damage which the lessor may claim without any legal right to recoupment. The lessor's approach is tantamount to treating the guarantee, not as security against default in the performance of a contractual obligation, nor as a mechanism for recovery pending resolution of a contractual dispute, but as a freestanding entitlement. This approach is not consistent with the analysis in Fletcher Construction and Clough Engineering . 44The purpose of the guarantee, as reflected in clause 15 of the lease, is to provide security to the lessor in respect of its legal entitlements. To the extent of the guarantee, it is protected against the insolvency of the lessee and is relieved of the obligation to bring proceedings to enforce its entitlements: see at [37] above. It is not, however, absolved from the need to establish those entitlements if its right to call on the guarantee, or to retain moneys paid to it thereunder, is challenged by the lessee. 45The lessor does not assert that it has an extant right to recover the unpaid rent from the lessee, the claim being barred by ss 24(1) and 63 of the Limitation Act . (Section 24(1) imposes a six year period on a cause of action to recover "arrears of income", the word "income" being defined to include rent: s 11.) The lessee contends that a claim on the bank under the guarantee would also be statute barred, because the cause of action referred to in s 24(1) "includes a cause of action to recover the arrears from any person, whether as principal surety or otherwise": s 24(4). It is not necessary to decide this point. In a case such as the present, where the lessor had no legal entitlement at the time it sought to call on the guarantee, the lessee was entitled to an order restraining it from calling on the guarantee. Conclusions 46The lessee was entitled to payment of $45,000, pursuant to clause 17.7 on exercising the option to renew. Assuming it was not, however, entitled to recoup the unpaid debt from the rent payments, its conduct in that regard would have given rise to a debt owing to the lessor. At least for a period of six years thereafter, there would have been mutual debts in the same amount. There was no suggestion that, if the lessor had sued within the limitation period, the lessee (also within the limitation period), would not have been entitled either to set off its debt by way of a defence under s 22 of the Civil Procedure Act 2005 (NSW), or to cross-claim for the $45,000 in an action for unpaid rent. Similarly, if the lessor had called on the guarantee within the limitation period, the lessee could have brought an action for unjust enrichment or moneys had and received on the basis that there was, at the relevant time, no outstanding balance owing by it to the lessor. 47It would be a surprising result if, there never having been an outstanding balance owing to it from the lessor, since 2004, it could call on the guarantee in respect of its statute barred debt and retain the proceeds, in circumstances where the lessee could not rely on its statute barred debt by way of set-off or cross-claim. 48The lessee is entitled to an order prohibiting the lessor from calling on the guarantee, that step not yet having been taken, as a result of interim relief granted below. As there is no other basis upon which it is suggested that a claim might be made under the guarantee, the lessor should be required to deliver the original bank guarantee to the lessee. It is neither necessary nor appropriate to make an order, as sought in the notice of appeal, restraining Macquarie Bank. 49The lessee is entitled to its costs, both in this Court and in the Court below. 50The Court should make the following orders: (1) Grant leave to appeal and direct that, within 7 days, the applicant file a notice of appeal in the terms of the draft notice contained in the white folder. (2) Allow the appeal and set aside orders made by Windeyer AJ on 21 October 2010. (3) Order that the first respondent be permanently restrained from making any demand in writing on Macquarie Bank Ltd pursuant to the guarantee given on 15 April 1996 numbered 323/03 96. (4) Order that the first respondent forthwith deliver the original of the bank guarantee referred to in the previous order to the appellant at its address for service in these proceedings. (5) Order that the first respondent pay the appellant's costs of the proceedings in this Court and in the Court below. 51CAMPBELL JA : I have had the advantage of reading the draft judgment of Basten JA in this matter. Subject to the following remarks, I agree with it. 52An equitable set-off can sometimes justify a tenant in not paying rent. The common law also recognised that sometimes, if a tenant had expended its own money in making good a breach of covenant by the landlord, the tenant had a right to recoup that expenditure by not paying rent. The basis on which the common law recognised the right of recoupment was that the payment by the tenant was regarded as money paid to the use of the landlord, that discharged pro tanto the tenant's obligation to pay rent: Batiste v Lenin [2002] NSWCA 316 at [47]. 53Basten JA at [29] notes that the expression "set off" appears to invoke a procedural right as a defendant to court proceedings. So far as equitable set-off is concerned that appearance is deceptive. Rather, an equitable set-off can be asserted as soon as circumstances subsist which support the equitable set-off, and regardless of whether proceedings have been brought at that time. This can occur because equitable set-off operates to bind the conscience of the primary claimant, preventing the primary claimant from insisting on satisfaction for the primary claim without giving credit for the claim made against the primary claimant by the other party. Thus, if the other party had an equitable set-off which completely extinguished the claim of the primary claimant, the existence of the equitable set-off could give the other party a right to prevent the primary claimant from exercising any self-help remedy based upon its supposed entitlement under the primary claim. 54This has been accepted in this court in Roadshow Entertainment v (ACN 053 006 269) Pty Ltd Receiver & Manager Appointed (1997) 42 NSWLR 462 (Gleeson CJ, Handley JA and Brownie AJA). There, Roadshow had purported to terminate a contract by reason of the repudiation of the other party. The question at issue was whether Roadshow was disentitled to terminate the contract because it was itself in breach of a contractual obligation to make certain payments to the other party. It had not made the payments in question, but in circumstances where it was justified in withholding the payments because there were circumstances entitling it to an equitable set-off. The Court held that Roadshow was entitled to terminate, saying, at 481: "Equitable set-off is a substantive defence: see S R Derham, Set-Off , 2nd ed (1996) at 56-65. As Goff LJ said in Federal Commerce & Navigation Co Ltd v Molena Alpha Inc [1978] QB 927 at 982, a defence of equitable set-off may be set up 'not merely as a means of preventing ... judgment, or, at any rate, execution, but also as an immediate answer to ... liability to pay'. This must be correct because an equitable set-off impeaches the title of the other party to the legal demand against which it is asserted. When 'the circumstances which support an equitable set-off exist, it is unconscionable for the creditor to regard the debtor as being indebted': Derham (at 60). The debtor can therefore claim that the payment demanded was never due: see Tomlinson v Cut Price Deli Pty Ltd (1992) 38 FCR 490 at 494-495, per Drummond J and the cases there cited. Roadshow was therefore entitled in equity to withhold the payments otherwise due on 31 October and 30 November and for that additional reason its conduct did not prevent it from rescinding the contract for fundamental breach." 55That decision has been followed by a differently constituted Court of Appeal (Sheppard AJA, Mason P and Handley JA agreeing) in Concrete Constructions v Dalma Formwork [1999] NSWCA 16 at [21]-[22]. The decision in Tomlinson v Cut Price Deli at 494-495, approved by this court in Roadshow , held that a landlord was not entitled to retake possession of leased premises when the tenant had failed to pay money contractually due, but had a claim for damages for misleading and deceptive conduct in an amount greater than the unpaid money. 56Other support for equitable set-off not being confined to being a procedural right is found in P W Young, C Croft & M Smith, On Equity (2009) at [15.390], and in R Derham "Equitable set-off: a critique of Muscat v Smith" (2006) 122 Law Quarterly Review 469 at 470-471. 57While I recognise that there are some United Kingdom cases, including in the Court of Appeal of England and Wales, that take a different view, those United Kingdom cases are not binding on this court (or any other Australian court): Cook v Cook (1986) 162 CLR 376 at 389, 394; Tillman v Attorney General for the State of New South Wales [2007] NSWCA 327; (2007) 178 A Crim R 133 at [99]. It is unnecessary to go further into the question of whether equitable set-off is purely procedural because the answer does not affect the outcome of the case. 58The lessor argued that the lessee's covenant to pay the rent "free of all deductions" needed to be construed in the context of other provisions of the lease including: - a clause making time of the essence for payment of rent; - a clause providing that the Lessee should not "without the written consent of the Lessor reduce or diminish directly or indirectly the rent" and - the provisions of the lease requiring the provision of the Bank Guarantee (which provided an alternate source from which the lessor could recover money if the lessee were to breach a covenant). 59The lessor argued that these provisions had the effect that events later than the time at which the lessee made its promises in the lease could not give rise to a right of equitable set-off entitling the lessee to pay less than the full rent. The argument was to the effect that the lease needed to be construed as at the date it was made, there was a clear promise to pay the rent without reducing it by a cent, that promise was not stated to be dependent on the lessor performing any of its covenants, and in light of that promise it would not be unconscionable for the lessor later to require the lessee to do what it had promised to do, even if the lessor were in breach of one of its own promises. In other words, any breach by the lessor (such as of its covenant to pay the $45,000) would not "impeach" the claim of the lessor to be paid the full amount of rent that the lessee had agreed to pay, and thus no right of equitable set-off would arise. It is not necessary to decide whether that argument is correct because, even if the lessee had never had a right to set off its right to be paid $45,000 against its obligation to pay the rent, by the time the lessor sought to call upon the bank guarantee the expiry of the limitation period had had the effect that the lessor's claim to be paid the rent had become statute barred. That had the effect that the bank guarantee secured no obligation, and thus could not be called on. 60After judgment in this matter was reserved the parties requested and were granted leave to make submissions concerning the recent decision of the Full Federal Court in Norman; in the matter of Forest Enterprises Ltd v FEA Plantation Ltd [2011] FCAFC 99. Norman discusses several authorities relating to whether a covenant in a lease to pay the rent "without any deductions whatsoever" prevents a right of equitable set-off from arising from events occurring after the lease is entered. However, that discussion is obiter. The effect of such a provision in a lease remains an open question so far as Australian intermediate appellate courts are concerned. 61I agree with the orders proposed by Basten JA. ********** DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 15 February 2012