Rent review update 2010

Citation

Dowden, M. (2011), "Rent review update 2010", Journal of Property Investment & Finance, Vol. 29 No. 1. https://doi.org/10.1108/jpif.2011.11229aab.001

Rent review update 2010

Article Type: Law briefing From: Journal of Property Investment & Finance, Volume 29, Issue 1

Rent review provisions specify the dates during the term at which the reviewed rent is to be assessed. They direct the parties or the third-party valuer to apply the relevant assumptions and disregards to a hypothetical letting at the specified review date, taking into account comparable evidence of the market at that date. However, rent review clauses have long recognised and catered for the fact that reviews are rarely settled on the specified date, and that the process may not be even initiated by then. The process might be initiated months or even years later.

The ruling in Idealview v. Bello (2009) EWHC 2808 (QB) highlights the risk for tenants who assume that delay in the rent review process means that the landlord’s right to a review, backdated to the original review date, is lost. A 1994 rent review was triggered by landlord’s notice in 2006. The premises had been assigned in 2005. The review, which produced a significant and backdated increase in rent, was upheld because:

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  Delay did not amount to abandonment by the landlord of its right to implement the review.

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  The tenant did not participate in the arbitration. It raised its question about time being of the essence only in court. The judge considered that the tenant ought to have raised the point before the arbitrator.

The tenant also argued that the landlord’s claim to a backdated rent review should be subject to limitation. The Court of Appeal agreed with the High Court’s rejection of that argument. There was nothing to make time of the essence for the review, and as the House of Lords found in Scottish & Newcastle v. Raguz (2009) 1 All ER 763 the back payment becomes due on the date specified for payment once the review has been determined.

To protect itself against a delayed rent review a tenant may serve notice specifying a date by which the landlord must refer the review to third party determination, and providing that the review will not be operable if the landlord fails to meet that deadline. Consequently, even where the clause imposes no time limit, it is open to the tenant to make time of the essence (Barclays Bank v. Savile Estates (2002) 2 EGLR 16)).

The first step, though, is to ascertain whether the procedure set out in the lease provides a sufficient “contra-indication” to the principle that time is not of the essence for rent review.

Initiating the rent review

The rent review clause should state who could initiate the review process; it will usually be either the landlord alone or both parties.

Some leases do not require a formal procedure to be followed and merely need one party to write to the other initiating the review. The lease may provide that the rent should be determined as soon as possible. Alternatively, more stringent requirements may be imposed such as the form of notice or counter-notice to be used, as well as time limits for service.

Where the provisions are linked, either expressly or by implication, to time limits or deadlines, it is necessary for both parties to establish whether time is “of the essence”. This is particularly significant where:

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  the landlord must initiate review by a particular date, or lose the right to a review for that period; and

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  the tenant is required to respond by counter-notice to a landlord’s notice, failing which the rent proposed in the landlord’s notice becomes payable (Starmark Enterprises v. CPL Distribution (2002) 4 All ER 264)

The form of notice

Notice must usually be given in writing. If the lease is silent, Law of Property Act 1925, s 196(1) applies requiring a written notice or counter-notice.

The notice may need to be in a particular form and if this is the case, the wording of the lease must be strictly followed. The effect of errors in notices is determined by the Mannai principle – whether a reasonably minded recipient would be left in doubt as to what was intended by the notice (Mannai Investment v. Eagle Star Insurance (1997) 3 All ER 352)

A rent review notice, whether it is from the landlord to formally initiate the rent review procedure or from the tenant in the form of a counter-notice formally objecting to the landlord’s proposed new rent, must clearly communicate its purpose.

Where the lease provides for the landlord to specify a rental figure in his notice, there is no implied duty for the sum requested to be reasonable. But, where a landlord states that a particular figure is in his opinion the true open market value of the property, this must be correct. If the figure is later found to be totally wrong, the notice itself may be held to be invalid. The opinion should be based on comparables in the market or professional advice (Davstone (Holdings) v. Al-Rifai (1976) 32 P & CR 18).

Unfortunately, there are no general principles that can be easily applied. Much turns on the precise wording of the relevant lease and the notice.

Serving the notice

The starting point is to check the lease and in particular whether the rent review clause specifies how service should be carried out. If the rent review clause is silent on the point, the general service provisions in the lease should be followed. Some leases state that service should be in compliance with a statutory provision, the most common being Law of Property Act 1925, s 196.

Tenants must be particularly alert to clauses that direct or permit service by leaving a notice at the relevant business premises. Service can be validly affected even if the notice is never received by a person with management responsibility or authority. An extreme case was Warborough Investments v. Central Midland Estates (2006) EWHC 2622 (Ch). The lease permitted personal service by leaving the notice at the business premises (a supermarket). The landlord’s director (the aptly named Mr Upward) arranged for service by a certificated bailiff whose report said: “Handed notice to girl behind customer service desk”. The notice seems to have got no further. Nonetheless, the notice was held to have been validly served.

When is time of the essence?

Many older forms of rent review clause require service of notices, either from the landlord to trigger the review process or from the tenant to object to the figure proposed by the landlord and to refer the review to third-party determination. Where those provisions are linked, either expressly or by implication, to time limits or deadlines it is necessary to establish whether time is “of the essence”. If time is of the essence, the consequences can be severe. For the landlord, missing a deadline can mean losing the right to operate the rent review. For the tenant, failure to serve a counter-notice in time can result in the rent increasing to the figure first proposed by the landlord – even if that figure was pitched unrealistically high as a starting point for negotiation.

The general presumption is that time is not of the essence for a rent review clause. However, that presumption can be rebutted if there are “sufficient contra-indications” in the wording, structure or context of the particular clause (United Scientific Holdings v. Burnley Borough Council (1977) 2 All ER 62).

The general presumption that time is not of the essence may be displaced:

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  Where the parties have expressly stated that time is to be of the essence. It is important to check the whole document. An express provision for time to be of the essence in relation to one clause is an indication that time is not intended to be of the essence in relation to other time stipulations for which there is no such provision.

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  Where the language of the rent review clause is sufficiently emphatic to show that time limits were intended to be strict. The court has accepted that wording such as “notice shall be served on or before [a particular date] but not at any other time” is enough to cause time to be of the essence (First Property Growth Partnership LP v. Royal & Sun Alliance Property Services (2003) 1 All ER 533).

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  Where the rent review clause contains other indications that are consistent only with time being of the essence. Deciding between two previous conflicting decisions the Court of Appeal found that time was of the essence where a clause set a deadline for service of a tenant’s counter-notice and spelled out the consequences of the tenant failing to meet that deadline. In those circumstances a tenant who misses the deadline for objecting to the rent figure proposed by the landlord is likely to be stuck with that figure (Starmark Enterprises v. CPL Distribution (2002) 4 All ER 264.

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  Where the lease contains other provisions showing that the parties intended the rent review timetable to be strictly observed. This most commonly arises where there is a clear interrelationship between the rent review clause and a tenant’s break clause. In United Scientific, one example given was “where the tenant had a right to break by notice given by a specified date which was later than the last date for serving the landlord’s trigger notice”. Time limits for the operation of break clauses are strictly applied so the parties must be taken to have meant the tenant to know what the reviewed rent would be before deciding whether to exercise the break option. To give business efficacy to that arrangement, the time limit for the rent review notice must also be strict.

Back payments

If the revised rent has not been agreed by the review date, the rent continues to be payable at the old rate until the new rent is agreed or determined. Once the new figure is agreed, the likelihood is that the landlord will be owed an additional sum representing the extra amount payable over and above the previous rent payable from the review date up to the date of determination. The rent review clause may provide for this payment to be made either when the new rent is determined or on the next rent payment date.

Interest

Most leases contain express provision requiring payment of interest on the backdated sum. In the absence of such a clause there is no implied term that interest is payable although where the rent is determined by an arbitrator, they will have the power to award interest.

Take care when agreeing interest provisions on behalf of tenants to ensure that the interest is only calculated on the shortfall due on each rent payment day. The interest rate should not be a penalty rate as this may incentivise landlords to delay the review.

What is valued?

The starting point in construing a rent review in a commercial lease is an assumption that the rental value is to be that of the whole of the demised premises as they exist at the review date. This is in line with the “presumption of reality”. The assumption may be displaced by the wording in the lease itself, which in the factual and business context gives a sufficiently clear indication of a contrary intention. The court may not, however, have regard to subjective evidence of intention at the relevant time or of the course of negotiation between the parties.

In Airways Aero Associations v. Wycombe District Council [2010] All ER (D) 132 (Jul), the High Court held that reference in a rent review clause to “the airfield” (which was not a defined term), rather than “the demised premises” did not mean that it was intended that only part of the demised premises should be valued at review. The lease was of a small civil airport. The tenant contended that the use of the word airfield required the valuer to determine a rent for an area less than the whole site, excluding the hangars and other buildings.

The terminology used in the lease did not denote an intention to refer to different parts of the site, but was largely indiscriminate. The various uses of the terms “airfield” and “aerodrome”, which were not specially defined, did not indicate any clear demarcation between different areas of the site. The two terms had closely similar meanings and were essentially alternatives for each other. The use of terms other than “the demised premises” in bespoke clauses, did not suggest a careful distinction from the demised premises, but only that the draftsmen used language he considered appropriate to the subject matter of the lease, rather than the generic language of the standard clauses in the lease.

Nor was there anything in the relevant factual context suggesting that the parties wished to draw a distinction for the purposes of rent review.

The presumption of reality may be departed from where the premises are unusual in location, extent, configuration or use so that it is difficult to find comparable evidence for rent review purposes. Rent may then be fixed by reference to hypothetical premises, which must be described carefully.

Directing the valuer as to the location of the hypothetical premises can be difficult. In Dukeminster (Ebbgate) v. Somerfield (1997) 2 EGLR 125 the premises were assumed to be within a specified radius, which included commercial areas of Bristol and remote rural parts of mid-Wales.

Hypothetical premises can also be relevant where the landlord or tenant is to construct a new building in the context of a pre-let. Clear direction is required as to the property to be valued at review (e.g. just the land, or the land plus building) and as to the assumed specification of the building (Coors Holdings v. Dow Properties (2007) All ER (D) 43 (Mar)).

Rent review – onerous provisions

Points scored and gloated over when negotiating a lease can bite back when the rent comes up for review. In a weak market the presence of “onerous” provisions in a lease can entirely wipe out the uplift in rent that would be achieved by a more reasonably pitched lease. In a rising market any well-advised tenant seeking to limit rent increases at review will argue for a discount to reflect unfair or burdensome terms.

The purpose of rent review is to adjust the rent payable to reflect changes in market conditions during the term of the lease. Since the relevant market conditions are those that would inform the terms of a new letting at the review date, rent reviews are carried out as a fictional new letting of the actual premises to a “hypothetical tenant” whose rent bid represents the rent reasonably obtainable in the open market for a lease of those premises. To ensure that the fictional letting is not distorted by the presence or business goodwill of the actual tenant, or by any breach of covenant on its part, the valuer is required to make a number of assumptions and disregards. The extent of those assumptions and disregards should be strictly limited. The valuer is required wherever practicable to stick closely to reality. If the valuer is required, by clear wording, to depart too far from the real terms binding on the actual tenant, there is a significant risk that the tenant could be required to pay a higher rent than is justified. Consequently, as well as terms that are onerous in themselves, tenants must look out for directions to the rent review valuer that require too great a departure from reality.

While some terms are always regarded as onerous, others shift their status and effect depending on prevailing market conditions. This note highlights terms most likely to be used by tenants to argue for a discount at review in the present weak market conditions.

Restrictions on use

The more flexible the use permitted by the lease, the more attractive the premises would be to the hypothetical tenant, because that tenant would be able to accommodate changes to its business. A lease that allows flexibility in use is also easier to assign or underlet. The result is that the hypothetical tenant’s rent bid is likely to be significantly higher than for a lease that limits use to a narrow range, as that in turn limits the range of potential tenants and assignees.

Where the lease provides that the tenant cannot change its use without the landlord’s consent, there is no statutory direction that consent will not be unreasonably withheld. The landlord’s right to refuse consent is unfettered unless the clause expressly limits the landlord’s discretion. Where the landlord has an absolute right to withhold consent there is likely to be an adverse effect on rental value. However, where the lease expressly provides that consent must not be unreasonably withheld, the landlord will arguably be entitled to value the premises on the most profitable use for which consent could not be unreasonably withheld.

The landlord should not link the user clause to the tenant’s business. A lease provided that the premises could not be used otherwise than as offices in connection with the tenant’s business of consulting engineer. This confined the class of hypothetical tenant to consulting engineers and diminished the rent by just over 30 per cent (Plinth Property Investments v. Mott, Hay & Anderson (1979) 1 EGLR 17).

Repair, reinstate, rebuild

A covenant to “when necessary rebuild, reconstruct or replace” the premises has been found onerous, justifying a 27.5 per cent discount, because it extended beyond the usual covenant to keep the premises in good repair. The effect of an onerous repairing obligation on review will depend upon the length of the lease term and the nature and location of the premises. A full repairing lease in an historic city might not be considered to be onerous if comparable properties are let on the same basis. The landlord could justifiably refuse to soften the tenant’s repairing liabilities without losing out on review. On the other hand, allowances of between 20-25 per cent have resulted from arbitration where the building is run-down and a tenant can be required to rebuild. This issue is very likely to arise at rent review given the demonstrable market shift towards shorter lease terms, with BPF/IPD figures indicating that average lease terms are now 5.6 years (Norwich Union Life Insurance Society v. British Railways Board (1987) 2 EGLR 137).

Alterations

The more difficult it is for a tenant to carry out alterations, the greater the risk of a discount at rent review. Severe restrictions on alterations mean that premises cannot readily be adapted to changing business needs through the term of the lease. They also restrict the tenant’s ability to assign the lease. An absolute (or unduly restrictive) ban is highly likely to have a negative effect on rent review. Where the tenant is prohibited from making external alterations to retail premises, the landlord should ensure that the shop front is excluded from the restriction. If the lease contains a covenant against tenant’s improvements without the landlord’s consent, it will be subject to the statutory proviso that such consent is not to be unreasonably withheld (even if it is not expressly stated).

Keep open covenants

Keep open covenants are fairly common in multi-let retail properties, but they are potentially onerous because they oblige the tenant to keep premises open and trading regardless of economic conditions. In practice, the courts have leaned against enforcing such covenants by specific performance. Damages are available, but only if and to the extent that the landlord can show damage to its reversion. Despite the difficulties of enforcing keep open covenants, they continue to be regarded as onerous and have been used to justify a discount of up to 20 per cent at review (Co-operative v. Argyll Stores (1997) 3 All ER 297).

Break clauses

Many break clauses can provide that before the lease can be terminated, the tenant must have complied with its covenants. This precondition will be strictly interpreted by the courts and it could be difficult for the tenant to operate a break clause. In such a case, the tenant will argue that the availability of the break either represents no real benefit, or that its benefit is greatly reduced so it should not be open to the landlord to gain an increased rent at review to reflect the benefit that a freely exercisable break would give to the tenant (Fitzroy House v. The Financial Times (2006) 2 All ER 776).

The hypothetical term

Factors other than tenants’ covenants could affect review. A particularly difficult issue is the hypothetical term on review. Wording that benefits the tenant could secure a deduction of between 5-10 per cent at review. On the other hand, positive wording for the landlord could increase the rental value by up to 5 per cent. The starting point is the “presumption in favour of reality”, which prompts the valuer to assume that the hypothetical lease will be granted for a term equal to the residue of the actual lease. This is to ensure that the rent is assessed for a term that equates to the time that the actual tenant has left in the premises. However, there are circumstances (e.g. a penultimate or last day rent review) where the presumption in favour of reality would produce an absurd result, so the clause must specify the term that the valuer is to assume.

The appropriate length of the hypothetical term can shift dramatically as market conditions change. Office leases drafted in the 1980s and into the early 1990s on “institutionally acceptable” terms would often direct the valuer to assume a hypothetical term of up to 20-25 years. Structural changes in the property sector since then mean that such assumed terms are unrealistically long. Where the wording of the rent review clause leaves the valuer no choice but to assume so long a hypothetical term, the rent achievable at review will be discounted (Canary Wharf v. Telegraph Group [2003] 3 EGLR 31).

Challenging an arbitrator’s decision

An arbitrator’s decision can be challenged on the ground of “serious irregularity” under Arbitration Act 1996, s 68. Successful challenges are rare, but they do happen. If the court finds that there was a serious irregularity then the remainder of the section accords it discretion to:

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  send the arbitration back to the arbitral tribunal;

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  set it aside whether in whole or in part; or

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  declare the award to be of no effect.

The tribunal must act fairly and impartially between the parties, which includes the obligation to provide a reasonable opportunity to the parties to put their own case and to answer their opponents’ cases.

Metropolitan Property Realizations v. Atmore [2008] was an application to Sales J in the Chancery Division for the remission of a rent review to the single arbitrator for serious irregularity under s 68(2)(d). The complaint was that the arbitrator had failed in his award to deal with a matter that was essential to his decision.

Metropolitan was tenant of a sub-lease of property comprising shop units on the ground floor and residential apartments on the first floor. Atmore was its landlord. The lease provided for a rent review every 21 years. That meant a review in September 2006.

Clause 1(d) of the lease provided that the rent to be set by the arbitrator was to be: “the amount which shall in his opinion represent a fair yearly rent … at the relevant date having regard to rent values then current for property let without a premium with vacant possession and to the provisions of this Lease (other than the rent hereby reserved)”.

The arbitration had been a “paper” arbitration, meaning that instead of oral representations the arbitrator came to his decision on the basis of written representations, in this case by each party’s respective chartered surveyor. Metropolitan’s surveyor’s calculation of the fair yearly rent involved the application of a discount from the amount of rent that a notional tenant could expect to receive from its sub-tenants.

That would mean that the amount the notional tenant would receive as rent, from his sub-tenants, would be more than the amount he would have to pay his landlord, so leaving him with a profit. Otherwise, no tenant would be willing to enter into a notional lease in the present market conditions.

The landlord’s surveyor’s calculation contained no such reduction. He assessed a yearly rental value for each flat and for each shop unit. From the total he made a deduction for the management charge, a deduction for the possibility that some of the shop units and flats might not be let for the period up to the next rent review, and then inserted an additional sum to reflect that the rent would be static for 21 years. His total came to £118,000, which was the amount that the arbitrator awarded.

Sales J accepted Metropolitan’s contention that the arbitrator’s failure to discount for a profit for the notional tenant constituted a serious irregularity under s 68(2)(d). He rejected Atmore’s submission that Metropolitan had not expressly set out that argument at the time of the arbitration. He ruled that even in those circumstances the arbitrator should have reasoned through his award in a logical manner and satisfied himself that his calculation reflected the commercial approach he had adopted for the calculation. Indeed that approach had assumed that a notional tenant would take a notional lease at a rate at which there would be some profit left over for him. He failed to do so. Accordingly, he had not dealt with the basic issue asked of him. Sales J identified the substantial injustice which s 68 requires as being both the lack of rationally sustainable award and the high rent to which the tenant would now be locked in for 21 years.

Although Metropolitian shows that successful challenge is possible, the threshold for judicial intervention is extremely high. Substantial injustice must be shown. A mistake by the arbitral tribunal is not sufficient unless it is of essential importance to the overall decision, so that without the error the tribunal might well have reached a different view.

A breach of the principles of natural justice, of the requirement to act fairly, is treated as a serious irregularity affecting the proceedings. The arbitrators cannot decide a case on a point that was not raised or argued without having heard from each party on that point.

The arbitral tribunal does not need to deal in its award with all the issues raised, provided that it has dealt with the essential issues.

Generally, the arbitral tribunal does not need to set out each step by which it came to its decision. However, it appears from Metropolitan that where there is only one decision to be made, or where that decision involves a mathematical calculation based on market factors then such reasoning is likely to be required because those are essential issues.

Malcolm DowdenLexisPSL