Landlord and tenant — Construction of rent review clause in lease of office premises — Conflicting decisions considered by Vice-Chancellor — Another case on the question whether, in determining the rack rental value for the purpose of the clause, the hypothetical lease should be assumed to include or exclude the rent review provisions contained in the actual lease — Construction of the ‘rent exclusion provision’ — The material words in the present lease, which provided for five-yearly reviews, were that the hypothetical lease should be a lease ‘containing the same provisions (other than as to the yearly rent)’ as in the actual lease — Considering the matter first without reference to authority, the Vice-Chancellor rejected as offending against common sense a wholly literal construction to the effect that all provisions relating to rent (such as the proviso for re-entry on non-payment) should be ignored — Further, a construction requiring the valuer to ignore both the actual rent payable before the review and the provisions for future reviews conferred a windfall on the landlord going beyond the adjustment of rental values in line with the market which was the underlying purpose of a rent review clause — Accordingly, apart from authority, and in the absence of any clear words indicating the parties’ intention to enter into an unusual bargain, the correct construction in the present case was that the hypothetical letting was to be on the terms of the actual lease, excluding only the rent payable before the review date but including the provisions for five-yearly rent reviews — Examining the authorities, there was a conflict between, on the one hand, the Pearl Assurance case, the Datastream case and the MFI case, which approached the construction on the basis of the underlying commercial purpose of the clauses, and, on the other hand, the National Westminster Bank, Pugh, and Equity & Law Life cases, which did not adopt that approach, although in all these cases there were differences in the particular wording of the clauses — Subject to a clearly expressed intention (as in the Pugh case) that the rent review provisions were to be disregarded, it was proper to give effect to the underlying commercial purpose of a rent review clause and to require future rent reviews to be taken into account in the hypothetical letting — There was an urgent need for certainty in this field and it was most desirable that there should be an early decision of the Court of Appeal to resolve the conflict of judicial approach — Declaration in favour of tenants
This was an
originating summons in which the plaintiffs, the British Gas Corporation,
sought a declaration as to the correct construction of the rent review clause
in a lease of office premises at 152 Grosvenor Road, London SW1, of which they
were the tenants, the defendant landlords being the Universities Superannuation
Scheme Ltd.
John Colyer QC
and Kirk Reynolds (instructed by the Director of Legal Services, British Gas
Corporation) appeared on behalf of the plaintiffs; Michael Barnes QC and David
Elvin (instructed by Coward Chance) represented the defendants.
Giving
judgment, SIR NICOLAS BROWNE-WILKINSON V-C said: This is yet another case
raising the question whether or not a valuer, in fixing the new rent under a
rent review clause in a lease, should take into account the fact that the lease
in question contains provisions for further rent reviews in the future.
Shortly
stated, the problem arises in this way. For very many years now, in the overwhelming
majority of cases landlords granting long terms of years have insisted on the
insertion of a rent review clause in the lease whereby the rent payable is
periodically adjusted to reflect changes in the value of money and property.
The most common machinery is to provide for the new rent to be fixed by a
valuer as being the rack rental which would be obtainable in the market at the
review date if the demised premises were to be let on that date. Such rent
review clauses usually lay down the formula by reference to which such rack
rental is to be fixed by the valuer. The formula commonly takes the form that
the valuer is to assume a hypothetical letting of the premises on the open
market on the terms of the actual lease but subject to certain artificial
variations. A very common variation is that the valuer is to assume that the
hypothetical letting is on the terms of a lease containing the same provisions
as the actual lease ‘other than as to rent’ or ‘other than those relating to
rent’ or ‘other than the amount of rent hereby reserved’. I will call such
words ‘the rent exclusion provision’. The question is whether in any particular
case the effect of the rent exclusion provision is to require the valuer to
ignore the fact that the actual lease contains provisions for future rent
review, on the footing that the rent review clause is itself a provision
relating to rent. The answer to that question may be of great financial
importance. In the present case I was told that, if the valuer had to disregard
future reviews of rent, the new rent might be as much as 20% greater than the
rent which would be fixed if the future reviews are taken into account.
The present
case concerns a lease of very substantial office premises granted by the
predecessor in title of the defendant to the plaintiff for a term of 35 years
from March 25 1980. The rent reserved (defined in the lease as ‘the Yearly
Rent’) was a peppercorn until July 1 1980 and ‘thereafter throughout the
remainder of the term the rent of £1,150,000.00 per annum (and so in proportion
for any lesser period) or such other rent as may from time to time be
substituted therefor pursuant to the provisions of the Second Schedule . . . ‘.
The second schedule, para 1(a), provides that the landlord may give the tenant
a review notice in which event the yearly rent payable as from the review date
‘shall be the higher of (i) the Yearly Rent payable immediately before such
Review Date and (ii) the rack rental value of the Demised Premises at the
relevant Review Date’. ‘The Review Dates’ are defined as the dates of
commencement of the 6th, 11th, 16th, 21st, 26th and 31st years of the term, ie
at five-yearly intervals. Para 3 of the second schedule provides as follows:
Rack rental
value of the Demised Premises means such rent as may be agreed or determined as
hereinafter provided to be the best yearly rent at which the Demised Premises
could reasonably be expected to let in the open market by a willing landlord to
a willing tenant for a term equal to the term hereby granted by means of a
lease containing the same provisions (other than as to the yearly rent) as are
herein contained on the following assumptions . . .
A review
having been required by the landlord at the first review date (March 25 1985)
and the parties having failed to agree the new rent, under the terms of the
lease the new rent has to be fixed by an independent valuer. The question is
whether such valuer in assessing the ‘rack rental value’ should assume a
hypothetical letting on terms which include provisions for review of the rent
every five years.
The question
is one of construction. Accordingly I will first consider the matter apart from
authority and then turn to see whether I am precluded by the decided cases from
giving effect to my own views.
Despite the
definition of ‘the Yearly Rent’ to which I have referred, the draftsman of the
lease was not careful in his use of the terminology. In various clauses he uses
the phrases ‘yearly rent’ (ie without capital letters) and ‘the rents hereby
reserved’ (in the plural). It is common ground that such variations in
terminology disclose no method and can be ignored. The question therefore turns
entirely on the words ‘containing the same provisions (other than as to the
yearly rent)’ in para 3 of Schedule 2 construed in the context of the lease as
a whole and the surrounding circumstances. There is no evidence of any special
circumstances applying to this case which might affect the question of
construction.
Counsel agreed
that there were three possible constructions of the rent exclusion provision in
this case, viz:
(1) that it requires the
valuer to ignore all provisions relating to rent in the lease;
(2) that it requires the
valuer to ignore those provisions which relate to the quantification of rent,
ie the rent payable immediately before the relevant review date and the
provisions for future rent reviews; and
(3) that it requires the
valuer to ignore the rent actually payable before the review date only, ie he
must take into account the provisions for future reviews of the rent.
The first of
these constructions is the only one that the words literally bear. But the
result of such a literal construction is so surprising as to offend common
sense. The covenant for payment of rent is a ‘provision . . . as to the yearly
rent’. So is the right of re-entry reserved for non-payment of rent.
Accordingly, if the literal construction were right, the valuer would be faced
with the wholly unrealistic (and I would have thought impossible) task of
fixing the open market rental for a large office block on terms which contained
no covenant for payment of rent nor any right of re-entry in the event of
non-payment of rent. Mr Barnes, for the landlord, to my mind rightly did not
contend for this fully literal construction.
Once one
departs from the literal meaning of the words, one is necessarily implying some
limitation into the words actually used in the lease. The only question is
whether such implication should be that inherent in construction (2) or
construction (3) above. At this stage, in my judgment, one is necessarily
forced to seek to discover the underlying purpose of the provisions for rent
review so as to give effect to that purpose.
There is
really no dispute that the general purpose of a provision for rent review is to
enable the landlord to obtain from time to time the market rental which the
premises would command if let on the same terms on the open market at the
review dates. The purpose is to reflect the changes in the value of money and
real increases in the value of the property during a long term. Such being the
purpose, in the absence of special circumstances it would in my judgment be
wayward to impute to the parties an intention that the landlord should get a
rent which was additionally inflated by a factor which has no reference either
to changes in the value of money or in the value of the property but is
referable to a factor which has no existence as between the actual landlord and
the actual tenant, ie the additional rent which could be obtained if there were
no provisions for rent review. Of course, the lease may be expressed in words
so clear that there is no room for giving effect to such underlying purpose.
Again, there may be special surrounding circumstances which indicate that the
parties did intend to reach such an unusual bargain. But in the absence of such
clear words or surrounding circumstances, in my judgment the lease should be
construed so as to give effect to the basic purpose of the rent review clause
and not so as to confer on the landlord a windfall benefit which he could never
obtain on the market if he were actually letting the premises at the review
date, viz a letting on terms which contain provisions for rent review at a rent
appropriate to a letting which did not contain such a provision.
Therefore,
apart from authority I would hold that on the true construction of para 3 the
rack rental value has to be fixed on the basis that the hypothetical letting is
on the terms of the actual lease excluding only the rent actually quantified
and payable before the review date but including the provisions for five-yearly
rent review.
Does authority
preclude me from reaching this result?
In my judgment it does not. The authorities were recently reviewed by
Warner J in Datastream International Ltd v Oakeep (1985) 277 EG
66*; I gratefully adopt his analysis. I add to the cases there considered the
recent judgment of Hoffmann J in MFI Properties Ltd v BICC Group
Pension Trust Ltd (as yet unreported)† , decided since the conclusion of
the argument in this case. In the latter case, the words of the rent exclusion
provision were ‘other than those relating to rent’: Hoffmann J held that in
fixing the hypothetical rent the provision for rent review had to be taken into
account by the valuer. His reasoning closely accords with my own and I
gratefully adopt it.
*Editor’s
note: See p 98 ante.
† Editor’s
note: Now reported at p 115 ante and (1986) 277 EG 862.
Although each
of the decided cases is a decision on the construction of the lease in question
(and therefore not directly authority on the meaning of the lease I have to
construe), they do disclose a marked difference of approach to the construction
of these clauses. On the one side are Vinelott J (in Pearl Assurance plc
v Shaw (1984) 274 EG 490), Warner J (in the Datastream case) and
Hoffmann J (in the MFI case) who, like myself, treat the literal
construction or any intermediate construction as offending commercial common
sense and therefore give effect to the underlying commercial purpose. On the
other side are those cases in which either the words were given their literal
meaning (see National Westminster Bank plc v Arthur Young McClelland
Moores & Co (1984) 273 EG 402) or the judge rejected the view that one
should approach the construction of a rent review clause on the basis that it
is intended only to give effect to the normal commercial reason for including a
rent review clause: ibid; Pugh v Smiths Industries Ltd (1982) 264
EG 823, [1982] 2 EGLR 120; Equity & Law Life Assurance Society plc v
Bodfield Ltd (1985) 276 EG 1157*. I am far from suggesting that the Pugh
case and the Equity & Law Life case were wrongly decided. In the
former, the words used in the rent exclusion provision were so clear that
imputed intention could not override them and the literal construction did not
produce an absurdity. In the latter, the other terms of the lease in question
were very unusual. But neither Goulding J nor Peter Gibson J thought it right
to give any effect to the underlying commercial purpose of such clauses.
*Editor’s
note: Also reported at [1985] 2 EGLR 144.
In these
circumstances, there are in my judgment conflicting decisions as to the correct
approach to the construction of these clauses. I am accordingly free to adopt
the approach I prefer. In my judgment the correct approach is as follows:
(a) words in a rent
exclusion provision which require all provisions as to rent to be
disregarded produce a result so manifestly contrary to commercial common sense
that they cannot be given literal effect;
(b) other clear words which
require the rent review provision (as opposed to all provisions as to rent) to
be disregarded (such as those in the Pugh case) must be given effect to,
however wayward the result; and
(c) subject to (b), in the
absence of special circumstances it is proper to give effect to the underlying
commercial purpose of a rent review clause and to construe the words so as to
give effect to that purpose by requiring future rent reviews to be taken into
account in fixing the open market rental under the hypothetical letting.
I am conscious
that such an approach is perilously close to seeking to lay down mechanistic
rules of construction as opposed to principles of construction. But there is an
urgent need to produce certainty in this field. Every year thousands of rents
are coming up for review on the basis of clauses such as the one before me:
witness the growing tide of litigation raising the point. Landlords, tenants
and their valuers need to know what is the right basis of valuation without
recourse to lawyers let alone to the courts. The question cannot be left to
turn on the terms of each lease without the basic approach being certain. It is
in my judgment most desirable that this, or some other case, should at an early
stage be taken to the Court of Appeal so as to resolve the conflicting judicial
approaches that have emerged.
Finally, I
must deal specifically with the submissions which Mr Barnes made on the basis
of the existing authorities. He submitted that a distinction should be drawn
between those cases where the rent exclusion provision (as in this case)
excluded provisions as to rent on the one hand and, on the other, cases
where the rent exclusion provision excluded the amount of rent (as in
the Datastream case). He submitted that in the former case the rent
review provisions had to be disregarded whereas in the latter they did not. In
my judgment such narrow semantic distinctions are both legally and commercially
undesirable. Moreover, since Mr Barnes made the submission, it has become
inconsistent with the decision of Hoffmann J in the MFI Properties case.
Once one departs from the truly literal construction (which Mr Barnes did not
contend for), in my judgment there is no alternative, save in special
circumstances, but to give effect to the underlying commercial purpose of the
clause.
I will
therefore make the declaration asked for in the originating summons.
