In the light of the recent Broadgate Square case, reported in last week’s issue, Richard Porter and Michael Langdon offer advice to landlords seeking to achieve headline rents.
Readers will be aware of the decisions by the Court of Appeal on November 17 in the cases of Co-operative Wholesale Society Ltd v National Westminster Bank plc; Broadgate Square plc v Lehmann Brothers Ltd; Scottish Amicable Life Assurance Society v Middleton Potts & Co; and Prudential Nominees Ltd v Greenham Trading Ltd [5] 01 EG 111. They will also be aware that, pending any appeals to the House of Lords, only the landlord in the Broadgate Square case was left in receipt of a headline rent.
In the current state of the law, what advice should be tendered to a landlord seeking to achieve a headline rent? The initial reaction may be simply to advise him to follow the wording of the Broadgate Square lease. There must, however, be some doubts as to whether the same result would be achieved – and not only because, as a general rule of construction, the meaning of any clause will depend on the interpretation of the language used in the context of the whole document and all the material circumstances.
Background
Until relatively recently rent-free periods usually reflected the time that it would take for the tenant to fit out the premises or (if he were going to sublet) to market them. No such time would be needed at the beginning of a rent review period and it was generally accepted as reasonable that, at a rent review date, it should be assumed that the premises were ready for immediate occupation and use so that the benefit of the initial rent-free period would not be repeated at each review. The market then changed and landlords started to offer much longer rent-free periods (or other inducements) to persuade a new tenant to take a lease. Because of the effect on the value of the reversion, landlords preferred to forgo receipt of a greater (headline) rent for a period rather than receive a lower rent (the true market rent) from the commencement of the lease.
This change in the market has led to problems in construing attempts in rent review clauses to deal with rent-free periods and other inducements and, in particular, whether they are intended to make the hypothetical transaction to allow for any traditional fitting-out period or to the recently introduced longer period as well. The latter construction will obviously benefit the landlord by giving him a headline rent; it is not surprising that the question has been extensively argued before the courts and elsewhere, because a large amount of money is at stake. Perhaps the whole issue is another example of the problems that often arise when, for any reason, a rent review clause purports to disregard the true state of the market.
Basic approach taken by the courts
British Gas Corporation v Universities Superannuation Scheme Ltd [6] 1 EGLR 120. Sir Nicolas Browne-Wilkinson said that, in the absence of clear words or surrounding circumstances:
the lease should be construed so as to give effect to the basic purpose of the rent review clause anfer 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 . . .
On the other hand, the courts have acknowledged that it is always open to the parties to agree any deal they choose, including one which provides for payment of a headline rent, and indeed if they do so it is not open to the tenant to complain because in changed market conditions it is more onerous than anyone would have foreseen.
In three of the cases mentioned above, adopting this approach and applying it to the particular words used in those leases, the Court of Appeal was able to find (for different reasons and on different wording in each case) that the parties had not intended the hypothetical transaction giving rise to the reviewed rent to provide for any inducement other than a rent-free period directly related to fitting-out, albeit perhaps with a degree of tentativeness in the Scottish Amicable case, where Hoffmann LJ said: “I think that the language of the clause can bear this construction”, ie that the rent-free period was attributable to the letting being a new one and thus related only to fitting-out. Despite this, in the Broadgate case the court felt constrained to construe the clause in that lease on a basis which entitled the landlord to obtain a headline rent on review and it is interesting to consider the differences in wording which may have driven it to this conclusion.
The Broadgate Square lease
The open market rent was defined as:
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 . . .
In his judgment given in the Court of Appeal, Hoffmann LJ said he agreed with Harman J that:
these words leave no escape from the conclusion that the open market rent is to be the headline rent. Unlike the previous case, the rent-free period is not deemed to have expired before the parties negotiate. The rent to be applied to the whole term is the rent which would become payable after the expiry of such rent-free period as would be negotiated on the review date, ie the headline rent. The reference to the rent-free period being of ‘such length as would be negotiated in the open market’ makes it impossible to confine the words to rent-free periods attributable to the tenant having to move in.
It is, however, apparent from Harman J’s judgment at first instance that he did not find the clause particularly easy to construe. He said:
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.
It may also be relevant to remember that the arbitrator’s award contained only extracts from the lease and Harman J held initially that, under the relevant rules of court, he should not look further at the lease than the extracts of it in the award.
Amount of the headline rent
In determining the amount of the headline rent an arbitrator will have to look at comparables which show other premises let in similar areas and in similar conditions, but his evaluation of comparable transactions is a matter for the valuer’s art. He has to adjust them “according to the art or magic of valuers in reaching the true rent. . . .”
The onerous provision
In the Broadgate Square case at first instance the tenant argued that the arbitrator had made an error of law in not making a deduction from his valuation to reflect the fact that the hypothetical rent review clause was on the same terms as the actual clause and was on an onerous basis. Harman J, however, held that whether a clause is onerous and, if so, whether it produces a discount on the rent are both questions of fact and so were not capable of being appealed. It should, incidentally, be remembered that, although the onerous provision argument is useful to a tenant, it certainly does not follow that any discount which may be allowed should be as great as the difference between a headline rent and a true market rent, and in most cases it will not be.
It is to be hoped that further guidance will be forthcoming from the House of Lords. In the meantime, it does seem possible that another landlord, using the same wording as in the Broadgate Square lease, might not be as fortunate. A judge who is able to consider every term of the lease in slightly different circumstances might come to a different conclusion. Another arbitrator might wave a different wand over comparables and might also come to a different conclusion on the onerous provision point.
Michael Langdon is a partner in the property litigation group and Richard Porter a consultant to the property group at city solicitor McKenna & Co.