by Steven Fogel
Colin Bell invites debate about fitting-out assumptions and rent-free periods in “Back to the drawing board”(*). The climate is right for re-appraising the internal consistency of rent-review clauses. If the parties want their review to reflect reality then the premises should be valued as they stand, with due credit given for tenants’ works. The fitting-out assumption may be dangerous if there are provisions to ensure fair allowance for rent concessions.
Rent-review clauses deem premises to be “fit” or “fitted out” because, as Colin Bell points out, landlords do not want tenants to claim at review that the notional tenant would press for compensation for not receiving a rent-free period for fitting-out. However, forms of rent-review clauses grow in size as knowledge deepens. As new provisions are added, it is necessary to take stock of the internal consistency of these forms. While the assumption that premises are “fit” may once have been an understandable means of preventing argument about rent-free periods, the wording pays reconsideration now that rent concessions are dealt with in a more sophisticated way.
Tenants have rightly observed (as Mr Bell mentions) that earlier versions of the assumption which deemed the premises “fit” were dangerous because “fit” might mean “free from defect” or that the landlord has complied with its covenants when this might not be the case in reality. While this article seeks to view the assumption in a wider context it is worth mentioning that the Court of Appeal in Orchid Lodge v Extel [1] NPC 35 — where a license to assign stipulated that the rent under the lease would be reviewed by reference to the authorised use of the premises and contained an acknowledgement from the assignee that the premises were “fit for use and occupation therefore” — held that these words did not require the assumption of a higher standard of fitting-out than actually existed; indeed, such an assumption would contradict the improvements “disregard” specified in the lease.
Draftsman’s treatment of rent concessions
It is nowadays widely recognised that rent concessions are given for a variety of reasons, not just to enable fitting-out. The challenge is to find a form of words which, while making the level of reviewed rent responsive to market facts (ie by establishing the real market rent after deducting the value of rent concessions), does not allow the rent at review to be distorted by reason of the hypothetical context in which it is determined.
An example of good modern drafting practice is to deem that the bidding tenant has derived the benefit of rent concessions before the notional letting at review. Requiring evidence of rent concessions to be “disregarded” (the approach of the clause quoted by Mr Bell) is widely considered a dangerous practice from the viewpoint of both landlord and tenant. A “disregard” interferes with honest valuation. There seems only to be a case for using a disregard where the tenant received a major concession at the outset; here the concession may need to be amortised over the whole of the duration of the lease.
The “fitting-out” assumption of itself presents tenants with problems, but these problems, considered in the next section, are highlighted when a rent concession assumption is included.
The fully-fitted trap
Questions which the tenant faced with a fitting-out assumption might ask are:
(1) Does the fitted-out assumption mean that the tenant’s own detachable fittings must be regarded as remaining at the premises? Clearly, yes. The use of the vacant possession assumption would mean that items classifiable as the tenant’s property (eg because they are not fixed to the premises) are deemed to have been removed. While the landlord is not seeking a rent element referable to those items, he does not want the rental value of the premises to be undermined by any notional removal of the tenant’s property. However, the landlord can achieve this objective by adding an assumption that no works done at the premises have diminished the rental value. He does not need to go so far as incorporating the fitted-out assumption.
(2) Should the tenant who is deemed to take fitted-out premises at review pay a “premium rent” for the privilege? Mr Bell puts this question and explains that it arises because the tenant would be unconcerned with the need to finance and write down costs if the premises were notionally “fitted-out”. However, the position is not so bad for the tenant as first appears. Most review clauses, including that from which Mr Bell quotes, specify that the effect on rent of qualifying improvements are to be disregarded. So, if the tenant has actually financed fitting-out works then it might be expected that the rental element attributable to those works should be deducted from the rental value.
(3) What exactly does “fitted-out” mean? If the tenant carried out fitting-out works five or more years ago, then does use of the fitting-out assumption imply that the fittings in place at the review date are of an updated standard ideally suited to the style of the highest bidding notional tenant? If so claimed, then the benefit of the disregard is cancelled. Yet there may be saving factors. The assumption that the premises are “fitted-out” will prevail not only at review but be repeated in the rent-review clause contained in the notional lease. If the style of the fitting-out is one which would quickly date, then the hypothetical tenant may reduce his bid to take account of the burden which awaits him at subsequent reviews. The tenant will probably ask the court to apply a presumption of reality to the expression “fitting-out” to require that the notional mirrors the actual standard.
(4) If the actual tenant did not carry out the initial fitting-out works and paid a premium rent for the convenience of the landlord’s works, is it fair to the tenant that the premium element should be “refreshed” at each review? No more is it fair, perhaps, than that the tenant should enjoy compensation for his notional deprivation of a rent-free period at each review.
The premium rent and the discount for the absence of a rent concession are factors brought into existence by the hypothetical grant of a new lease at the review date. Although these factors pull in opposite directions it is not safe to assume they are self-cancelling.
An assumption too many?
It follows that the reference to fitting-out should be dropped and reliance placed on assumptions that rent concessions have already been enjoyed and that no depreciating works have been carried out. The premises should be valued as they stand. To stop the notional lessee seeking compensation for the lack of a rent-free period, this will be deemed already to have been received. But if the notional lessee would lower his bid to compensate for the cost of financing new fitting-out works badly needed, then this would be taken into account. It would not be cancelled by an artificial implication of a higher standard of fitting than in fact exists.
If the tenant cannot persuade the landlord to drop the fitting-out assumption, then the use of clear words and, possibly, schedules, plans and photography should specify the standard up to which the premises are to be assumed at review to be fitted out.
(*) Estates Gazette, March 9 1991 p 96.
