Landlord and tenant — Rent review — Arbitration — Open market rent defined as best yearly rent after expiry of a rent-free period — Whether deduction should be made for incentive period from rent payable after expiration of rent-free period to arrive at open market rent
An arbitrator
made an award pursuant to the provisions of a rent review clause in a lease of
office premises at 1 and 2 Broadgate, London EC2, owned by the applicant
landlord and let to the respondent tenant. For the purposes of the rent review,
the open market rent was defined as ‘the best yearly rent which would
reasonably be expected to become payable after the expiry of a rent-free period
of such length as would be negotiated in the open market between a willing
landlord and a willing tenant upon a letting of the Premises . . .’. The
arbitrator concluded that, when analysing comparable transactions, the
‘additional’ or ‘inducement’ rent-free period (additional to any period for
fitting out) may be amortised and a suitable deduction made from the ‘face’
rent payable at the expiration of the rent-free period. He applied a factor on
a discounted cash-flow basis to reflect the ‘incentive’ rent-free period of 24
months amortised over 10 years at 6%. That was done on the basis that the
fitting-out period was to be ignored, but the inducement rent-free period
should be taken into account. He determined the open market rent of the
premises at £5,281,365 pa for 1 Broadgate and £3,931,795 pa for 2 Broadgate;
alternatively, if he was held to be incorrect and no regard should be had to
inducement rent-free periods, £7,033,316 pa for no 1 and £5,236,046 pa for no
2. The landlord appealed the award by notice of motion under section 1 of the
Arbitration Act 1979, contending that the arbitrator erred in law in making
deductions from the ‘face’ rent in arriving at the open market; the tenant
cross-appealed the arbitrator’s decision that the rent review clause was not
onerous.
definition of ‘open market rent’ in the lease requires the arbitrator to find
the rent which will actually be payable when such rent-free period as would
have been negotiated shall have expired. In looking at comparables, the
arbitrator does not take the rent reserved as being the true rent of the
comparable premises, but is entitled to adjust such rents to arrive at the true
rent. This the arbitrator appears to have done in arriving at the ‘headline’ or
‘face’ rent. However, there was no warrant in terms of the rent review clause
for the arbitrator applying some further adjustment to the rent. The tenant’s
contention that the arbitrator wrongly failed to make a deduction to reflect
the onerous nature of the rent review clause was dismissed on the ground that
it was a question of fact and not law, and therefore was not appealable. The
judge gave a certificate under section 1(7)(b) of the Arbitration Act 1979, but
refused leave to appeal.
The following
cases are referred to in this report.
British
Gas Corporation v Universities Superannuation
Scheme Ltd [1986] 1 WLR 398; [1986] 1 All ER 978; (1986) 52 P&CR 111;
[1986] 1 EGLR 120; 277 EG 980
British
Gas plc v Dollar Land Holdings plc [1992] 1
EGLR 135; [1992] 12 EG 141
This was the
hearing of notices of motion under section 1 of the Arbitration Act 1979
seeking to appeal an award of an arbitrator in rent review proceedings between
the applicant landlord, Broadgate Square plc, and the respondent tenant, Lehman
Brothers Ltd.
Kim Lewison QC
(instructed by Herbert Smith) appeared for the landlord; David Neuberger QC
(instructed by Freshfields) represented the tenant.
Giving
judgment, HARMAN J said: I have before me four notices of originating
motion, two on behalf of a landlord, Broadgate Square plc, and two on behalf of
a tenant, Lehman Brothers Ltd. All arise out of an award by an arbitrator on a
rent review clause. They were entered pursuant to a consent of the parties by
notices by the landlord of April 28 1993 and by the tenant on May 4. The matter
involves extremely large sums of money and obviously is, to the parties, of
considerable commercial importance. The clause is a specific one, I think
frequently called a one-off clause, which was before the arbitrator on the rent
review hearing. The award contains extracts from the lease. The lease itself is
not appended to or incorporated expressly by reference in the award.
Accordingly, when it was submitted to me that I should look at the terms of the
lease itself, I held that under Ord 73 and the practice note set out at p1266 of
the current White Book, only documents incorporated in or expressly appended to
the award are proper for the court to look at, and I ruled that I should not
look further at the lease than the extracts of it in the award.
The rent
review clause itself, as with so many such clauses, is one where the longer you
look at it the less clear becomes its meaning. I will read it, quoting from p2
of the award under the rubric 5:
‘Open Market
Rent’ means the best yearly rent which would reasonably be expected to become
payable in respect of the premises after the expiry of a rent free period of
such length as would be negotiated in the open market between a willing
landlord and a willing tenant upon a letting of the Premises as a whole by a
willing lessor to a willing lessee in the open market at the relevant Review
Date for a term of ten years or a term equal to the residue then unexpired of
the Term (whichever is the longer) with vacant possession without fine or
premium . . .
I think that
both the extremely able and learned counsel who have argued this matter before
me agreed in the end that the clause contains tautologies and unhappinesses.
The arbitrator himself plainly found the matter difficult and he asked for a
legal assessor, who sat with him on the first day, having read the skeleton
arguments presented by leading counsel to the arbitrator and heard that
argument, and on the last day also, when points which the assessor wanted dealt
with were put to counsel for both sides. As a result the assessor, Mr Joseph Harper
QC, one of Her Majesty’s counsel, gave an opinion which, although it runs to 12
pages, is comparatively short and clear to read. I
He sets out
the questions of law as to the true construction of the clause, as to the
meaning of the rent-free period point, as it was defined. He refers to the
current market conditions, which I think must be a reference to the market
conditions as at December 1991, which is the relevant date for the rent review
terms, and he refers to various authorities, notably the decision of Sir
Nicolas Browne-Wilkinson V-C in British Gas Corporation v Universities
Superannuation Scheme Ltd [1986] 1 WLR 398* at p403 A-C, and finds (as I
consider entirely correctly) that clear words in a rent review should be given
effect to, but that subject to special circumstances it is proper to give
effect to the underlying commercial purposes of a rent review clause and to
construe the words so as to give effect to that purpose.
*Editor’s
note: Also reported at [1986] 1 EGLR 120.
Mr Harper
concludes, and it was accepted by both sides as correct, at para 9:
In my
opinion, an arbitrator should if possible give effect to the literal meaning of
the words used in the rent review clause.
He then went
on to say that he was of the view that it is possible to do so in the present
case without arriving at an absurd result. He then considers the terms of the
clause which I have read. He observes at para 11 that the formula, that is the
terms of the rent review clause, says nothing whatever about comparables. It
relates to ‘the Premises’ which are, as he says, the demised premises, and it
is said that the formula is telling the arbitrator that he must direct his
attention to achieving such a rent as would be payable for these, that is the
demised premises, after the expiry of the hypothetically market negotiated
rent-free period. That would be the new rent which will be payable from day one
of the review period.
It was pointed
out in argument, in considering this opinion, that the new rent as defined by
the clause as an open market rent is not in fact the rent payable passing
between these two parties, because the rent passing between them is, in the
case of one of the two buildings in Broadgate, 90.275% of the open market rent,
and the other 90 point (some other slight fractional difference)% of the open
market rent. That seems to me an entirely passing point which in no way affects
the soundness of the legal advice tendered.
He went on in
para 12 to say:
Accordingly,
what an arbitrator does when evaluating comparable transactions on the present
review is a matter for the valuer’s art. It is not a matter touched by this
formula. In particular therefore the arbitrator is not compelled, in respect
of such comparables, to ‘look only at the rent payable after the expiry of
any rent free period’. He has a free hand.
That advice being
tendered, the arbitrator had to conclude what he believed was the true effect
of this clause. He held at p5, para 11(a) of the award:
When
analysing comparable transactions, regard may be had to rent free periods
granted in the market over and above rent free periods granted for fitting out
that, when analysing such transactions the ‘additional’ or ‘inducement’ rent
free period may be amortised and a suitable deduction be made from the ‘face’
rent. The amortised deduction shall only relate to rent free periods granted in
excess of rent free periods for fitting out.
I can pass
over the next point. He then held at (c):
That the ‘open
market rent’ as defined in the Third Schedule is £5,281,365 per annum
and
(d) if the award at (a) is held to be incorrect no
regard should be had to any rent free periods or inducements, then I would have
awarded an open market rent of £7,033,300 per annum.
Finally, it
was held:
That if it is
held that the Respondent’s secondary contention is correct and regard should be
had to all rent free periods and inducements, including those granted
for fitting out then I would have awarded an ‘open market rent’ of £4,874,323
per annum.
Mr Kim Lewison
QC, for the landlords, in attacking this award, went on to look particularly at
the reasoning of the arbitrator set out at pp 15 and 16 of the award, notably
the phrases below line 20, that:
It has been
customary for many years for landlords to grant rent-free periods to assist
tenants against the cost of fitting-out work. However, the situation has now
changed and landlords are granting relief for periods in excess of the norm and
that extra relief is seen to take the form of an inducement.
He then refers
to any ‘normal period’. He referred further to p22 of the award. He accepts Mr
Harper’s opinion at line 13 on p22:
As Mr Harper’s
Opinion clearly illustrates, the word ‘premises’ as used in the clause is
defined on page 4 of the lease as the demised premises. There is nothing in the
clause to direct me on the treatment of comparables and, indeed, I would not
expect there to be anything. I therefore reject Mr Cullen’s
— who was
leading counsel for the tenant below —
submission in
paragraph 11(c) of his Statement of Claim. The review clause is merely making
clear that the hypothetical tenant of the premises would not be able to claim a
rent-free period at the review date.
and that
sentence was attacked by Mr Lewison as unfounded. He goes on to say in the next
paragraph:
. . . Mr
Harper’s Opinion hits the point squarely on the head, and in answer to Mr
Harper’s first question, both counsel agreed that the word ‘premises’ . . .
meant ‘the demised premises’ and nothing else. In my view, the correct way to
treat the clause is to ignore rent-free periods granted for fitting out but to
make a deduction for rent-free periods that can be looked upon as taking the
form of an inducement.
That was
attacked as wholly unsupported by anything in the clause. The clause made no
distinction between rent-free periods granted for fitting out and rent-free
periods granted as an inducement. He went on to record that:
Counsel
agreed that the hypothetical tenant did not have the benefit of a rent free
period and that the rent would become payable from day 1, the review date. Any
rent free period that might have run would have been deemed to have expired
immediately before the grant of the hypothetical lease.
He then goes
on at considerable, though not unnecessary, length, through the matter and
comes to his conclusions where he sets out a section beginning ’14 CONCLUSIONS
AND VALUATION’. He refers to his conclusions on the legal issues, accepts the
respondent’s secondary contention that allowance should be made for rent-free
periods over and above that achieved in the market for fitting out. He takes
the appropriate period for fitting out to be six months and an additional
rent-free period to have been amortised on a discounted cash-flow basis. I can
pass over the next paragraph.
He refers to
three transactions which he says he relied upon and he then comes to what he
states as:
my valuation
of the ‘headline’ or ‘face’ rent of each building is as follows: . . .
and he reaches
the conclusion that 1 Broadgate, the prime office amount of the space, by far
the larger amount, is to be valued at £38 per sq ft. Various other rents for
ancillary smaller parts of the building are added in, producing a total figure
of £7,033,316 pa. For 2 Broadgate, a somewhat similar process is gone through to
produce a figure of £5,236,046 pa.
The
arbitrator, having thus said that he has found the headline or face rent, then
goes on to a further series of steps and these are the steps that are said by
Mr Lewison to be illegitimate within the rent review process as determined by
this clause. The arbitrator says that he has:
applied a
factor on a discounted cash flow basis to reflect an ‘incentive’ rent free
period of twenty-four months amortised over ten years at 6%
and he arrives
at figures which I have already said are the figures that
£3,931,795 pa for 2 Broadgate. He does that on the basis that the respondent’s
secondary contention, that is that the fitting-out rent-free period should be
ignored but the inducement rent-free period should be taken into account, was
correct. He then goes on to find a yet further variation on the respondent’s
primary contention.
Having said
all that, I go back to the open market rent definition in the third schedule to
the lease itself.
— The ‘Open
Market rent’ should be the best yearly rent which would reasonably be expected
to become payable in respect of the premises. That rent is to be fixed after
the expiry of a rent free period of such length as would be negotiated in the
open market between a willing landlord and a willing tenant upon a letting of
the Premises as a whole by a willing lessor to a willing lessee in the open
market at the relevant review date . . .
So that in
finding the best yearly rent reasonably expected to become payable the
arbitrator is to find the rent which will actually be payable when such
rent-free period as would have been negotiated shall have expired. That rent he
can reach only by looking at comparables which show other premises let in
adjacent or similar areas of the City of London, in similar conditions to
these.
In looking at
the comparables the arbitrator obviously does not have to take the rent
reserved in the allegedly comparable lease as being the true rent of the
comparable premises. As Mr Harper said, he had to adjust that according to the
art or magic of valuers in reaching the true rent which is agreed by that
lease. If it were the fact that someone had signed a lease agreeing to pay a
rent of £100 per sq ft for some floors of an office block for a term of five
years, but made that agreement and became the tenant for that term only in
consideration of a payment of £50m down as an inducement to the tenant to take
that lease, naturally the arbitrator in looking at these premises, which might
be nearby and might be very similar physically to the demised premises which he
is required to value, would say that the reserved rent of £100 per sq ft is not
the true rent for these premises at all. The arbitrator, in exercising his own
skill and judgment, would be entitled to hold that the comparable premises are
a good physical comparable, but that the rent gave him no guide to the open
market rent which the premises would fetch were the rent, that I ventured to
call in argument ‘a straight rent’, that is a rent payable from day one
throughout the term without regard to fancy inducements by way of large
payments, to take on a lease. Quite clearly on the hypothesis I have given the
reserved rent of £100 per sq ft is no guide to the letting value. That is what
the arbitrator was told he was entitled to consider by Mr Harper and as part of
the art of valuation he must take the various alleged comparables and find what
they truly represent as straight rents, in order to reach what is the true open
market rent as defined here. That is the valuation exercise which the
arbitrator had to perform.
It follows
that upon that having been done he reaches a figure, and that figure he appears
to have reached when he says he has found what he has defined earlier as the
rent reserved by the lease by the words ‘the ‘headline’ or ‘face’ rent of each
building is as follows’. It seems to me that Mr Lewison is right when he says
that there is no warrant in the terms of this clause for the arbitrator
applying some further adjustment to the rent which he has found, is in fact the
best yearly rent reasonably expected to become payable for a term of 10 years
or the surviving part of the lease, because once he has found that figure by
considering and adjusting the comparables, bearing in mind that this is to be
the amount payable after the expiry of such rent-free period as may be
negotiated, that is indeed the open market rent. It seems to me that the
arbitrator, in his attempt to reach some figure between the top and the bottom,
has taken the finding of the true rent to be reserved and adjusted it down. I
am well aware that the true rent to be reserved is not the rent to be payable,
but that is, in my view, entirely of assistance to Mr Lewison, who observed to
me, and in my view correctly, that it is a non sequitur to say that
because the actual tenant has no rent-free period the hypothetical tenant has
no rent-free period. There are many other differences and no exact
correspondence between reality and hypothesis upon this set of terms. One such
difference is the reduction of the open market rent to about 10% below the
figure to reach the rent, which is actually payable and reserved, as opposed to
that which is to be assessed as the open market rent. Another is the fact that
the premises are described as being in a particular state up to a particular
specification, although that will not be in fact the state of specification in
which the premises are because considerable work has been done to them, so that
the arbitrator is not assessing the premises as they stand, but assessing them
upon an assumed basis. Both those points seem to me to justify Mr Lewison’s
submission that there is no exact correspondence between reality and hypothesis
in this case and the fact that there is no rent-free period here, in actuality,
does not require the hypothesis to have a rent-free period inserted in for the
purpose of discounting the rent which would otherwise be reached.
The rent, as
Mr Lewison pointed out, is payable in respect of the premises after the expiry
of a rent-free period. The formula must be there pointing to the rent which is
that actually payable and not then reduced by some discounted cash-flow
calculation to a discounted figure. It seems to me that there is an error of
law disclosed by the arbitrator’s award, although, as it seems to me, he was
advised by his legal assessor correctly in what he should have done. Upon that
basis, it seems to me that the right answer is that I should allow the
landlord’s appeal against the arbitrator’s award and dismiss the tenant’s, as
it were (although not technically), cross-appeal contending that the rent
should be fixed in accordance with the tenant’s primary submission at the
lowest of the three amounts fixed by the arbitrator as possible choices.
I should also
consider the point raised by Mr David Neuberger QC, for the tenant, that in any
event the arbitrator has made an error of law in that at p58 of the award the
arbitrator dealt with a point raised before him under the title ‘The ‘onerous’
rent review clause’. He referred there to a deduction of 10% made by a valuer
from his valuation to reflect the fact that the hypothetical rent review clause
was drawn in the same terms as the actual clause and is on an onerous basis.
The arbitrator held:
I do not
regard the clause as onerous and reject this point.
He went on:
If my legal
interpretation is held to have been incorrect, [as I have held] and no
allowance or deduction should be made for rent free periods, I would still reject
Mr Hyder’s submission for a deduction
— he then adds
the words:
for it might
introduce an element of double counting.
Mr Neuberger
observed that the phrase ‘it might introduce an element of double counting’ is
a thoroughly unsatisfactory one. First, to say that it might do so leaves one
entirely uncertain whether it in fact does, or in fact does not, and one is
left wondering what the effect is. Second, the reference to double counting is
entirely obscure. What could be double counting is, to my mind, very difficult
to perceive. None the less, Mr Lewison said that it was not his business to try
to deal with every step in the reasoning. I was confined by the Act to
considering whether there was a question of law arising out of the award on
which I could confirm, set aside or vary the award: see section 1(2) of the
1979 Act. In particular, he observed, whether a term is onerous must be a
question of fact. It is a question of comparative exercise in judgment, is this
term inflicting an excessive burden, because almost every term inflicts a
burden and that cannot be the sense of ‘onerous’ in this phrase. It must be
that the term is more burdensome than normal similar terms. It must be a
question of comparisons, and that plainly must be a question of fact, said Mr
Lewison, and I agree. Mr Lewison submitted further that whether, if the term
were onerous, it would in fact produce a discount on the rent is also a
question of fact. There are many onerous covenants, that is covenants which are
more restrictive than usual covenants, which, although more restrictive, will
not in practice,
they will or not is a matter of evidence and a matter of assessment by an
expert valuer and must be a question of fact. The arbitrator rejected the
proposition that there should be a discount for the onerous, as it was called,
clause on both views of the law and on that footing no question of law is
raised by this part of the award.
Mr Neuberger
submitted that the extremely unsatisfactory nature of the last phrase in the
last sentence of that paragraph ought to raise such doubts in my mind that it
would be proper to exercise the jurisdiction under section 1(5) where the court
may order an arbitrator to state the reasons for his award in sufficient detail
to enable the court to deal with it. I follow that there are doubts about the
meaning of that phrase, but I remain convinced that the arbitrator, who is the
sole judge of fact and who should not be interfered with by the court on
questions of fact, has on matters which are primarily factual on both bases of
legal view held that the clause is not onerous, and upon that basis I do not
think that I ought to intervene and send the award back for further findings in
that way.
I have
therefore come to the conclusion that on all the questions raised before me the
landlords succeed and obviously, consequentially, that the tenant’s claim
fails. On that basis I will make such precise order as counsel agree.
Following submissions
by counsel on certificate and leave to appeal, HARMAN J said: It seems
to me that the sums of money in this case, which when capitalised on any
reasonable application of years’ purchase must run into tens of millions, are
such that it is impossible not to accept that there are special reasons for
allowing an appeal by certificate under section 1(7)(b) of the
Arbitration Act 1979. It does not seem to me that there is any general public
importance in the question of construction of this somewhat obscure clause. No
doubt some of the phrases in it are used in other clauses, but that is not a
sufficient general interest, in my view. If it were a clause from a precedent
book, which it could be said had been used in dozens of leases up and down the
City, there might be a general public importance, but that is not the case.
I therefore
propose to grant a certificate that there is a question of law arising upon the
first part, the landlord’s appeal in this matter. It seems to me that the
second part of this matter, as to whether the clause was ‘an onerous clause’,
is purely raising questions of fact, it does not raise any question of law and
no certificate from me ought to be granted upon that question.
I then have to
turn to whether I should give leave to appeal on this matter, and it seems to
me I am, perhaps not very surprisingly, clear that the decision to which I have
come is correct and does not really warrant going to the Court of Appeal,
although it does raise questions of special interest to the parties. I
therefore think the right thing to do is to follow my brother Knox J in British
Gas plc v Dollar Land Holdings plc*, grant a certificate on the
point I have identified, but refuse leave to appeal.
*Editor’s
note: Reported at [1992] 1 EGLR 135.
