Rent review update

Citation

Smith, P.F. (1998), "Rent review update", Journal of Property Valuation and Investment, Vol. 16 No. 5. https://doi.org/10.1108/jpvi.1998.11216eab.001

Rent review update

Rent review update

Keywords Law, Rent review, Tenants

In the following article we give a digest and some analysis where appropriate of the main cases reported in the field of rent review between July 1997 and June 1998.

Upwards-only reviews

It is in the interests of tenants, especially in a falling market, to persuade the courts that a rent review clause is capable of being construed as being downwards as well as upwards, for obvious reasons. As usual, the question is one of construction of the particular clause, as shown by the result in Standard Life Assurance v. Unipath Ltd [1997] 38 EG 152. The landlords held the reversion of leases dated 4 November 1974. The tenants were assignees of the leases. The original leases reserved an annual "lease rent" of £95,300 for the first five years, thereafter £95,300 or such increased sum as might be substituted. There were five yearly reviews, which only the landlord was entitled to initiate. The rent had been reviewed to some £539,200 in 1989. In 1994, an annual rent of £412,071 was determined on arbitration, and the question of construction arose, whether the rent review clause allowed for a downwards revision of the rent. The Court of Appeal held that the first-instance judge had been correct to hold that it did not. The originally reviewed rent of £539,200 continued to be payable as a result.

The terms of the rent review clause referred to "increased" and to "further increased". These considerations went against any idea of an intention to have an upwards and downwards review. A submission by the tenant that, unless the relevant words clearly specified that the rent should be capable of being reviewed upwards only, the rent review was to be considered to be upwards or downwards, was rejected. As a matter of construction, the parties in this case intended the clause to be a ratchet clause. Moreover, that the rent review could only be triggered by the landlord, who was unlikely to do so if he thought that the rent would be reduced, was a further pointer away from the clause allowing for a downwards revision of the rent.

This case is mentioned as showing that questions of construction are not to be resolved by resort to presumptions. Thus the court refused to presume in this case that the purpose of the clause was to reflect changes in the value of money and real increases in the value of property during a long term ­ in view of the indications of an intention to provide for a ratchet clause mentioned above. In any case, as observed by Aldous LJ, if the parties had intended to provide for a two-way rent review, they could easily have done so in the rent review clause itself. Stuart Smith LJ pointed out that the words "lease rent", used in this case, were expressly stated to be the initial rent for the first five years of the term, and then, for the remainder of it, the yearly rent of £95,300 or such increased sum as might be substituted under the rent review process. Once the 1989 review had been terminated, the sum of £539,200 was the "lease rent" and it was in relation to that latter sum which the rent review clause affected in 1994. Peter Gibson LJ dissented as to the construction of the clause, holding that the tenant's construction was consistent with the language of the clause as a whole whereas that of the landlord was not, on the facts.

Rectification so as to produce upwards-only review

The courts seem to be rather less unsympathetic to claims to insert words into rent review clauses ­ if they can be persuaded that without them the clause could not work ­ than they might have been in the past. Thus in Great Bear Investments Ltd v. Solon Co-Operative Housing Services Ltd [1997] EGCS 177, Mr AG Steinfield QC was prepared to insert certain words into a rent review clause so as to render it an upwards-only clause.

According to the brief report to hand, the tenant under the rent review clause, which provided for four-yearly reviews except that the first review was to be five years from the commencement date of the lease, had to pay by way of additional rent a sum equal to the difference between the reviewed rent and the rent actually paid for the period commencing on the relevant review date. The landlords, realising that no express provision had been made for an upwards-only revision in what appeared to be a falling market, persuaded the High Court to insert words into the descriptive words of the new rent, which preceded those just mentioned. The relevant clause thus provided for a rent equal to the rent previously payable under the lease or under the rent review clause, whichever was the higher (emphasis supplied). Note was taken of the fact that the rent review provision itself made no provision for a refund to the tenant if there was determined a level of rent lower than the current passing rent immediately before such a determination. It appears that the court thought that it was not in fact acceding to a claim to rectification.

Instead, it seems to have described the process by which the underlined words were inserted into the lease as "rectification by construction". It seems to have taken the view that a mistake had clearly been made: and that any reader of the actual clause would have concluded that an error had been made. Without the inserted words, the clause would have been unworkable.

There is in the short report no suggestion that the tenants took unfair or unconscionable advantage of the landlord's error, the usual basis for inserting new words not in the original lease. In addition, the clause would seem to have been workable, albeit to the landlords' disadvantage, if a downwards as well as an upwards revision of rent had been possible ­ the fact that no refund was expressly allowed of rents paid down to the date of a downwards revision of rent need not necessarily baffle us as the clause was not a model of good drafting anyway. This ruling, with respect, seemed all too ready to insert words which did not essentially have to be there in the absence of fraud or estoppel and we question its result.

Effect of lessor's election not to pursue a review

The problem posed by Wakefield (Tower Hill Trinity Square) Trust v. Janson Green Properties Ltd [1998] EGCS 95 was as to the effect on a second rent review process of a landlord having on the occasion of the first review written to his tenant that he would not be seeking to implement a rent review of premises held on a 152-year lease of office premises. Unfortunately, the report of the case does not give sufficient information to be able to indicate a general answer to the question. In this case, the Chancery Division ruled that the landlord had not abandoned for all purposes its right to have the market rent for the first review date in 1991 determined by arbitration, when the second rent review took place during 1996. It would have been different if the landlord had been guilty of delay and inaction. In this case, however, the landlord had informed the tenant of his decision not to pursue any increase in the rent payable in 1991, once advised that the rent level which might be arrived at by an arbitration would not exceed the then current level of passing rent of £200,000.

In the end result, the landlord obtained a declaration to the effect that it was still possible to operate a proviso in the rent review provisions (which seemingly stated that the market rent reviewed was not to in any circumstances to be less than the market rent immediately before the rent review) by obtaining a determination of the market rent for the first review period. This would then enable a determination to be made, as required in the rent review clause, of 20 per cent of the market rent determined at the first rent review. Presumably, then, if the landlord was thereby able to secure a new rent above the £200,000 passing rent as at 1996, he would secure this increase. The effect of his decision in 1991 was effective only in relation to the first rent review. The court seems to have refused to construe the actions of the landlord in writing to the tenant in 1991 as not amounting to waiver. If so, and since no consideration passed from the tenant for the landlord's unilateral decision, it is difficult to see what other conclusion could have been reached in this case. Its result goes to show the power placed in a landlord's hands by upwards-only rent review clauses, whose abrogation (owing to their potential unfairness to lessees) should be considered by Parliament.

Land or buildings on land?

If a reviewed rent has to be computed on the basis of land as a vacant site, rather than as including the land and buildings put there by the tenant, it is obvious that the level of rent will be likely to be much reduced. The issue has been litigated on at least two reported occasions. In Ipswich Town Football Club Co. Ltd v. Ipswich Borough Council [1988] 2 EGLR 146, the Chancery Division held that the land-only basis of review must be taken. The opposite conclusion was reached by the Privy Council in Goh Eng Wah v. Yap Phooi Yin [1988] 2 EGLR 148. In the recent case of Braid v. Walsall Metropolitan BC [1998] EGCS 41, it appears that the Court of Appeal, on considering the lease before it as a whole, reached the same conclusion as that of the Chancery Division.

In February 1973, when the lease, whose duration is not specified in the brief report, was granted, the land concerned was vacant. The premises clause of the lease defined the premises as including land and buildings. The rent review clause required the new rent should be such higher sum or sums assessed as the "reasonable rent for the land for the appropriate period". There were three reviews at 20-year intervals. It is not clear whether at the start of the 20-year period from 25 March 1992, the land had been developed, but the tenant by assignment of 1983 asked a declaration that for that period and the next period from 25 March 2012, the rent should be assessed so as to disregard buildings and structures now or later standing on the land.

The Court of Appeal held that as a matter of construction of this lease, the clear indication, from the demised premises clause, was that the land as undeveloped was in contemplation and not any subsequent buildings. This is about all one can get from the report. It is worth noting that in the Goh Eng Wah case there was an actual reference to a specific building, a theatre, in the demising clause. In the Ipswich case the land alone was referred to in that clause, much as in the present case.

No obligation to hold review

In connection with the question of the extent to which a landlord may be obliged to initiate a rent review, even if it is to his advantage in a falling market to refrain from so doing, reference may be made to the Privy Council decision of Sunflower Services Ltd v. Unisys New Zealand Ltd 74 P&CR 113. The ratchet clause in this case provided that no determination of a reviewed rent could reduce the base rent payable by the lessee below the base rent payable prior to the rent review date. The parties entered into a deed of variation under which the lessor undertook to waive the ratchet clause in relation to the then next review, as at 1 August 1991. There was no express obligation by the landlord to hold a rent review. The Privy Council concluded that the fact that the deed of variation referred to a review "to be effective from" a specified date did not enable the court to imply that the landlord had an obligation to initiate that review by serving a trigger notice. Thus if he thought that by initiating a review, he would start a process which would lead to the determination of a lower rent than that passing at the relevant review date in 1991, the landlord could simply refrain from serving that notice. This result shows that the court will not read words into any agreement which are not specified by the parties where it is not essential to give a proper meaning to their agreement.

Reasonable construction of clause

As might be expected, the courts try to reach a construction which they regard as giving a "commercial" or "reasonable" sense or meaning to ambiguous words of a rent review clause, especially when it comes to valuation of the premises for review purposes. It is surprising at times that parties forget this principle. If it had been remembered, one wonders if the case of Dukeminster (Ebbgate House One) Ltd v. Somerfield Properties Co. Ltd [1997] 40 EG 157 would have got as far as it did.

The landlords demised a "mega" retail warehouse of some 250,000 square feet to the tenants in 1989. The term was for 25 years. There were five-yearly rent reviews. At the date of the lease there were no comparable "mega" warehouses. It appears that there were, within a 35-mile radius of the situs of the demised premises, which was Ross-on-Wye, a number of 50,000 square feet retail warehouses, in such diverse places as North Bristol, where rents were high, and Stroud, to name but two places from the list mentioned in the case. With a view to allowing the landlord to "gear" the reviewed rent of the "mega" warehouse to that of the smaller warehouses in the area, the disputed rent review clause allowed him to elect to have the rent determined as follows. The new rent could be determined with reference to notional premises, viz., "a warehouse unit within a 35-mile radius of Ross-on-Wye".

Not surprisingly, the landlord claimed that this clause allowed him to select as the basis of comparison for rent review purposes the rent of a 50,000 square foot warehouse in North Bristol, for reasons given. The Court of Appeal refused to agree with this construction. They adopted the general principle that any rent review clause must be given a commercial meaning, or at least a reasonable one, which expressions they seem to have used interchangeably. The clause in this case must be construed so that the notional warehouse must be situated within a location comparable to the site of the premises in Ross-on-Wye.

Any clause in a lease is to be construed, unless it clearly provides to the contrary, as governed by the context in which it appears. The Court of Appeal followed this approach when they said that all rent review provisions operated in the real world and not in a world of fantasy.

Length of notional term

In accordance with the principle of reality, it is assumed, if the rent review clause of a lease is silent, that the length of the term of the hypothetical lease, for the purposes of ascertaining an open market rent, is to be the residue of the actual term as unexpired: see Lynnthorpe Enterprises Ltd v. Sidney Smith (Chelsea) Ltd [1990] 2 EGLR 131. Dillon LJ there referred to the guidelines of Sir Nicholas Browne-Wilkinson VC (as he then was) in British Gas Corporation v. Universities Superannuation Scheme [1986] 1 WLR 398. He added at [1990] 1 EGLR 131, p. 132B:

The burden of the guidelines is that the court will have regard, if the language used in the rent review clause permits, to the underlying purpose of a rent review clause and will therefore be disposed to construe the rent review clause as requiring the notional letting to be a letting on the same terms (other than as to quantum of rent) as those still subsisting between the parties to the actual existing lease.

In the end, the question of the length of the hypothetical term to be assumed after review is one of construction. Clear and unambiguous language is required to displace the assumption just mentioned, as it reflects reality and is not artificial. Thus it is no great surprise that in St Martin's Property Investments Ltd v. CIB Properties Ltd [1997] EGCS 99, Judge Gilliland QC, sitting as a judge of the Chancery Division of the High Court, refused to hold that the hypothetical term of a hypothetical lease of business premises was any more than the 25 years which remained, at the rent review date, as the unexpired residue of the actual lease. The rent review clause in this lease, which was for 35 years from 24 June 1986, stated that the reviewed rent was to be "for a term equal in duration to the original term hereby granted". The High Court, in relation to the first rent review (as at 24 June 1996) took these words to be clear and unambiguous. Even if they had not been, Judge Gilliland QC, would have given effect to "the commercial purpose of the term" ­ presumably a slip for the commercial purpose of the rent review clause. Hence, there was no ground for acceding to the landlords' submission that the term to be assumed for the purposes of the first rent review in 1996 was to be a period of 35 years.

The principle of reality also meant that the High Court refused to re-write the rent review clause so as to alter the rent review dates (since the hypothetical lease was assumed to last for 25 years and not for a notional 35 years). The only ground on which the court could alter the terms of a lease was if the required open market valuation could not be made, which was not the case on the facts. Hence, the court also refused to alter the break clauses in the lease by replacing the names of the actual tenants with those of an hypothetical tenant.

It is not likely that the court would be persuaded in an ordinary case that the tenant is to face a valuation of an open market rent on the basis of assuming a term which he is not any longer entitled to. In special cases it may be that the residue of the term for the purposes of rent review must be taken as intended to be longer that the actual term granted. Thus in Toyota (GB) Ltd v. Legal & General Assurance (Pensions Management) Ltd [1989] 2 EGLR 123, the Court of Appeal accepted that it was not possible to hold that the term to be valued for rent review purposes was the unexpired residue of one year of the actual term held by the tenant. The total grant to the tenant consisted of two leases, an occupational lease for an initial period of 16 years and a reversionary lease of 34 years commencing on the same date, 25 March 1989, as the first term ended. As a matter of reality, the tenant enjoyed a complete span of years, not just an initial period of 16 years. But in the Toyota case the tenant presumably expected to pay for the whole span and the landlord shared this expectation. In the case under consideration, the landlord was trying to persuade the court to force the tenant to pay for something, a 35-year unexpired term, which was no longer in existence. The court was as reluctant to give the landlord a windfall benefit in the present case as it had been unwilling to make the assumption that the two leases were unconnected in the Toyota case.

Length of notional sub-lease

As has just been noted, it is ordinarily assumed that the length, as one of the terms of the hypothetical lease after a rent review, will be the same, as far as possible, as those of the actual existing lease (for a further example of this principle see British Gas plc v. Dollar Land Holdings plc [1992] 1 EGLR 135 where it was held that the term of the hypothetical lease in that case was the remainder of the existing lease, so reflecting the reality of the case). This assumption may be displaced, if the court concludes that the lease does not contain standard terms or if the context requires, or both. This process is what took place in Brown v. Gloucester City Council [1998] 16 EG 137 and the contrast with the result in the previous case should be noted, bearing in mind, however, that in the present case the court was dealing with the notional length of sub-leases, not a head lease, and with land which was assumed to be in a different state (developed land) to the land originally let (vacant land). On 15 March 1989, the landlord council granted the tenant a 125-year lease of 4.55 acres of vacant land, with terms aimed at encouraging the tenants to develop the land. The initial rent was £3,340 with five-yearly rent reviews. The rent at review was the passing rent or, if greater, 10 per cent of the rack-rental value. The latter was defined in relation to a "notional building site coverage" of a specified area, to be regarded as five separate building units. The rack-rental value was the aggregate of the rents at which such buildings might reasonably be expected to be let on the open market "upon such other terms as are herein contained". The tenant persuaded the High Court that the term of the hypothetical sub-leases of each building should correspond to that of the residue of the actual lease, which, at the 1994 rent review, was 120 years. The land had not, at the time of the first review, been developed.

The Court of Appeal allowed the appeal, holding that the expression "terms of the lease" should be narrowly construed, owing to the context of this lease. The term of the hypothetical sub-leases should therefore be such term as the landlord might reasonably be expected to grant and the tenant might reasonably be expected to take in all the circumstances.

Millett LJ pointed out that the subject-matter of the actual lease and of the hypothetical lease were not the same, since the original lease was of vacant land at a ground rent. The tenant was expected, although not obliged, to develop the land, and was given an incentive to do so, being able to keep 90 per cent of the rack-rent obtainable by building on the land. The rent review clause was designed to operate whether or not the land had been developed, so that the landlords were not prejudiced by the tenant's failure to develop the site.

Millett LJ also said that if the land had been developed and the buildings sub-let to these tenants, the evidence showed that they would have not in fact have been sub-let for the whole unexpired period of the original term. Even if they were vacant, they would not have been so available, without a substantial discount from the rent; but the landlord was not prepared to allow this merely so that the tenant could have a long lease. Thus a discounted rent was not the rent at which the demised premises might reasonably be expected to be let within the rent review clause. The assumption made in the High Court would have allowed the tenant to be assumed to enjoy 90 per cent of a rack rent on buildings let for a commercial period while the landlord had 10 per cent of a reduced rent. The rent review clause could not be assumed to have so capricious an operation. Hence the construction of the particular clause adopted in the present case.

The formulation that the hypothetical lease was to be for such term as the landlord might reasonably be expected to grant and the tenant might reasonably be expected to take in all the circumstances was, as noted by Millett LJ, adopted by Chadwick J in a different context in Prudential Assurance Co. Ltd v. Salisbury's Handbags Ltd [1992] 1 EGLR 153.

The facts and context of the present case and the principle there adopted were specific to its own rent review clause and circumstances, for the reasons already given, notably that the purpose of the lease was to encourage the tenants to develop the land concerned. The assumption is that the hypothetical lease is of the same kind and subject-matter as the original lease. The rent review clause being designed to protect the landlord's rental income from inflation in money values, the usual assumption is that the terms of the hypothetical lease will in the words of Millett LJ, p. 139, "replicate so far as possible the terms and conditions of the original lease" and be for the unexpired residue of that lease.

Section 12 of the Arbitration Act 1996

One of the aims of s 12 of the Arbitration Act 1996, which contains the court's power to extend the time for service of, inter alia, rent review notices, was to restrict the circumstances in which the court had power to act, no doubt with the aim of discouraging litigation. The decision of Clarke J in Fox & Widley v. Guram [1998] 03 EG 142 is a good illustration of the narrow operation of this new provision, and a warning against laxity by tenants in receipt of a landlord's notice specifying a new rent.

The rent review clause at issue in this case entitled the landlords by written notice to specify a sum, their statement of the new market rental, at any time before a date six calendar months prior to the review. There was also a provision for agreement between the parties, not in issue in this case. The tenants could serve a counter-notice on the landlords not later than three months after the landlords' notice (time expressly being of the essence at least in relation to this counter-notice). The effect of service of such a notice would be to refer the matter to arbitration.

In fact, the landlords served a notice in time but giving the wrong day for the rent review (25 May not 23 May). Nothing much arose out of this trifling error. In their notice, the landlords specified a rent of £14,000. The tenants did not serve a counter notice on time, or indeed at all, and asked the court for leave under s 12(3)(a) or (b) of the 1996 Act for leave to extend the time for service of a counter-notice. They failed to persuade the High Court to grant leave.

Under s 12(3)(a), it was held that while the court would take into account the underlying commercial purpose of the time provision, the circumstances in this case could not fairly be said, within the Act, to have been outside the reasonable contemplation of the parties when they agreed the relevant part of the rent review clause. As regards s 12(3)(b), Clarke J held that the conduct of these landlords did not make it unjust to hold the tenants to the strict terms of the rent review clause. Nothing in the statement of the £14,000 figure, for example, had this effect ­ the landlords were simply overstating their case, which the court did not regard as wrong in itself. In addition, the tenants had had every opportunity to serve their counter-notice but failed to do so.

It is worth noting that Clarke J also held, following Templeman LJ (as he then was) in Amalgamated Estates Ltd v. Joystretch Manufacturing Ltd [1981] 1 EGLR 96, 99A, that there was no (implied) requirement that, in a rent review notice of the kind at stake in this case, the landlord will supply only a bona fide and genuine pre-estimate of the open market rental value. It was pointed out that if the landlord suggested a preposterous figure, the tenant had the right to serve a counter-notice.

As regards s 12, the narrow view of the High Court will come as no surprise: the aim of the Act seems to be to discourage taking points of law and seeking time-extensions, at least in a case where the applicant has, as in this case, seemingly been the author of his own misfortunes. It is likely that the ruling would have been the same under the 1979 Act. As to the supposed duty on a landlord not to overstate his case in specifying a new rent, it would be surely asking too much of landlords to require them not to err on the side of generosity of a specified figure in a case where this is their inclination as a result of self-interest. The question of what might arise if a rent review clause allowed a landlord's specification notice but no express right in the tenant to challenge it did not arise in this case. If tenants agree to landlord's rent review notices being able to specify a new rent, then it is perhaps unlikely they will not also insert challenge provisions. The problem for the tenant in this case was that time had been expressed to be of the essence in relation to his counter-notice ­ an avoidable difficulty, no doubt.

Natural justice in arbitrations

Owing to the fact that a rent review arbitration is a quasi-judicial process, an arbitrator is bound by the rules of natural justice, including an obligation to allow the parties the chance to make further submissions if the arbitrator intends to take a new point not raised by them. However, in Ravenseft Properties Ltd v. Boots Properties Ltd [1997] CLY No. 403, the Chancery Division held that this rule was not infringed on the facts.

It appears from the short report that the landlord of a shop which had a double frontage let the premises to the tenant on a 63-year lease from March 1968. The rent for the year ending in March 1996 was £90,700. It seems that there may have been annual rent reviews, since the report says that the parties could not agree on the rent for the next following year, which the arbitrator ultimately decided was £95,000. The experts for the landlord and tenant produced differing valuations and the arbitrator in his reasoned award stated that he preferred the valuations of the tenant's expert. In addition, however, he considered that the fact that the shop had a double front merited an uplift in the rent, not, as advocated by the tenant's expert, a mere 5 per cent but rather a figure of some 20 per cent. The tenant claimed that the arbitrator had failed in breach of the rules of natural justice to give him the opportunity to make submissions about his approach to the uplift question.

Tuckey J refused to accede to the tenant's arguments. He accepted that matters which were likely to form the subject of an arbitrator's decision ought to be exposed to the submissions and comments of the parties. Some matters were not objectionable, as where the arbitrator relied on his own expertise. That was different to the case where an arbitrator relied in his decision on a point not raised by the parties, or adopted an approach not explored in the parties' submissions.

This case fell on the unobjectionable side of the line. The arbitrator's decision to adopt a 20 per cent uplift was merely a matter of quantification. It was described as being pure valuation based on the arbitrator's own experience. No new point had been taken, and there had been no breach of the rules of natural justice.

The report notes that the High Court referred to the judgment of Bingham J (as he then was) in Zermalt Holdings SA Ltd v. Nu-Life Upholstery Repairs Ltd [1985] 2 EGLR 14. Bingham J there upheld a challenge to an arbitration award because the arbitrator declined to adopt an approach ("equated zone A") to valuation accepted by both parties to the dispute, and adopted one of his own, which he did not put in advance of the award to the parties for their comments. A citation from the judgment of Bingham J at p 15L is not inappropriate:

The rules of natural justice do require, even in an arbitration conducted by an expert, that matters which are likely to form the subject of decision, in so far as they are specific matters, should be exposed for the comments and submissions of the parties. If an arbitrator is impressed by a point that has never been raised by either side, then it is his duty to put it to them so that they have an opportunity to comment. If he feels that the proper approach is not one that has been explored or advanced in evidence or submission then again it is his duty to give the parties a chance to comment. If he is to any extent relying on his own personal experience in a specific way that again is something he should mention so that it can be explored. It is not right that a decision should be based on specific matters which the parties have never had the chance to deal with, nor is it right that a party should first learn of adverse points in the decision against him.

In the present case, in contrast to the position in the Zermalt Holdings decision, the arbitrator was not doing anything different to that suggested by the parties: an uplift had been accepted in relation to the premises. He simply, as the learned judge noted, took a different view of the facts and of the evaluation of the facts to one of the parties' experts.

P.F. Smith