Landlord and tenant — Rent review clause — Whether upwards only — Construction of documents
By a deed of lease the respondent tenant
held a nine-year term of premises with an option for three further three-year
terms. Under the initial term there were two rent reviews. The provisions for
the rent review applied if the option to take the additional terms was
exercised. By clause 3.1 of the second schedule to the lease, the tenant was to
pay during the term of the lease rent at a specified rate ‘or where increased
in accordance with the express provisions of this Lease at the increased rent’.
The Court of Appeal of New Zealand held that the clause meant that at review
the rent could be less than the current rent. The appellant landlord appealed
contending that on its proper construction the lease had the effect that the
rent payable in the event of a rent review was not to be less than the current
rent.
application for a declaration was dismissed. Where parties to a formal document
have used ordinary words, the parties must be taken to have used those words
according to their ordinary meaning. If their meaning is clear and unambiguous,
effect must be given to them because that is what the parties are taken to have
agreed to by their contract. It is not the function of the court to search for
ambiguity. Unless the context shows that the ordinary meaning cannot be given
to the words or that there is an ambiguity, the ordinary meaning of the words
which have been used in the document must prevail. Clause 3.1 was clear and
unambiguous; the tenant is to pay the current rent or an increased rent
following a review.
The following cases are referred to in
this report.
Australian Mutual Provident Society v National Mutual Life
Association of Australasia Ltd [1995] 1 NZLR 581
Australian Provident Society v Bridgemans Art Deco Ltd
(1995) 3 NZ ConvC 192
Board of Trustees of the National
Provident Fund v
Shortland Securities Ltd [1996] 1 NZLR 45
This was an appeal by Melanesian Mission
Trust Board from a decision of the Court of Appeal of New Zealand allowing an
appeal by the respondent, Australian Mutual Provident Society, who had sought a
declaration in the High Court as to the construction of a deed of lease.
JRF Fardell and J Long (instructed by
Dipp Lupton Broomhead) appeared for the appellant; Ian Millard and Bruce Scott
(instructed by Clifford Chance) represented the respondent.
Giving the judgment of the Board, LORD
HOPE OF CRAIGHEAD said: This is an appeal against a judgment of the Court
of Appeal of New Zealand (Richardson P and Gault J; Henry J dissenting) on the
interpretation of a clause relating to the rent payable under a lease of
commercial premises. The proceedings which are the subject of this appeal were
heard together with an appeal from a decision of Doogue J in Australian
Provident Society v Bridgemans Art Deco Ltd (1995) 3 NZ ConvC 192,
149. Both cases raised the same issue in regard to a deed of lease which in
each case was in all relevant respects in identical terms. This was whether the
lease on its proper construction had the effect that the rent payable in the event
of a rent review was to be not less than the then current rent. The Court of
Appeal delivered a single set of judgments in respect of each case, in which
this question was answered in favour of the lessee. Both cases were then the
subject of a further appeal to their lordships’ Board, but the dispute between
the Australian Mutual Provident Society (‘AMP’) and Bridgemans Art Deco Ltd has
been resolved and the appeal in that case was abandoned. Their lordships are
now concerned only with the action between AMP and Melanesian Mission Trust
Board (‘MMT’).
On March 5 1990 MMT, who were to be the
lessor, and AMP, who were to be the lessee, entered into an agreement to lease
for commercial premises to be constructed at Parnell, Auckland, on November 25
1991. Following completion of the building, the parties executed a formal deed
of lease for the premises. The lease was to be for a term of nine years, on the
termination of which the lessee was to be entitled to have a further lease for
three further terms each amounting to three years. During the initial term
there were to be two rent review dates; namely August 14 1994 and August 14
1997. In the event of their exercising their option to have a further lease of
the premises for a further term, AMP were entitled to have the amount of rent
payable for that further term to be determined under the same procedure as that
which was to apply in the event of a dispute about the amount of the rent upon
the occasion of a rent review during the initial term.
The deed of lease which the parties
entered into on November 25 1991 was based on the standard form of commercial
lease published by the Building Owners and Managers Association of New Zealand
(‘BOMA’). Among the schedules which formed part of the lease were the first schedule
which contained particulars of the lease, and the second schedule which set out
the covenants, terms, conditions and provisions which were to be incorporated
in it. The short point of construction raised by this appeal relates to clause
3.1 in section 3 of the second schedule, which deals with rent, the lessee’s
contribution to operating expenses and rent review. Clause 3.1 is in these
terms:
The Lessee shall pay to the Lessor during
the term of this Lease rent (hereinafter called ‘Base Rent’) at the rate
specified in Item 9 of the First Schedule or where increased in accordance with
the express provisions of this Lease at the increased rent.
The phrase ‘term of this Lease’ is
defined in item 6 of the first schedule as meaning the initial term of nine years.
In item 9 of the first schedule the annual base rent is defined as meaning the
sum of A$499,126.62 pa plus GST. It is not in doubt that the lessee’s
obligation was to pay that sum as the base rent for the first three years of
the initial term until the date of the first rent review. The question is
whether the effect of clause 3.1 is that the base rent cannot fall below the
amount specified in item 9 of the first schedule during the first nine years or
whether it is free to move up or down according to the state of the market at
each review date.
In the Court of Appeal the view of the
majority was that the intention to be ascribed to the parties in respect of the
review of rent was that the current market rent arrived at by the review
mechanism was to result in the determination of a new base rent, which was to
apply from the review date in substitution for the figure specified in item 9
of the first schedule or for any figure substituted for it under a previous
rent review. Thus the rent was to be free to move up or down according to the
state of the market at each review date. In his dissenting judgment Henry J
said that the clause, on its own, was clear and unambiguous. Its effect was
that the lessee was obliged to pay the sum stipulated in item 9 or a higher sum
if there had been an increase in accordance with the express provisions of the
lease. He was not persuaded that there was an unacceptable conflict between
that interpretation of clause 3.1 and the other provisions of the lease, or
that an absurd result would be produced if their ordinary meaning was to be
given to the concluding words of that clause.
Their lordships have come to be of the
opinion that the view which was reached by Henry J is to be preferred to that
of the majority of the judges in the Court of Appeal. Their reasons for
reaching this opinion can be stated briefly. But out of respect for the careful
judgments in the
to their lordships in their consideration of this matter, it is appropriate
that they should mention the conclusions which they have reached on the various
issues which have been raised about the meaning of the clause in its whole
context.
It is not necessary in this case to say
much about the circumstances which provided the background to this contract or
the commercial purpose of the transaction. It was of a kind which is familiar
to those who engage in the practice of letting commercial property. On the one
hand, there was the lessor, MMT, whose primary interest in the transaction was
to obtain a return on the money which it had invested in the construction of
the building. On the other, there was the lessee, AMP, whose interests lay in securing
terms for the letting of the property which did not exceed those generally
available in the market for similar premises. From the point of view of the
investor the most attractive form of lease is one which ensures that the return
on the amount invested will be increased if market rent were to rise but will
not diminish if market rents were to fall. Its purpose is best served by a
system of periodic rent reviews together with a provision, commonly referred to
as a ‘ratchet clause’, which will ensure that the rent payable after any review
will never be less than the rent payable prior to the review date. The lessee’s
purpose will be best served by provisions which will enable the rent to be
adjusted either way at each review date. The balance which requires to be
struck between these competing interests is a matter for negotiation in each
case. The result of that negotiation is then set out in the formal contract,
which supersedes the negotiations and to which one must then turn in order to
discover what was agreed.
The dispute between Australian
Provident Society v Bridgemans Art Deco Ltd, which has now been
settled, arose when the lessor took no steps to initiate a rent review to take
effect from the first review date. The lessor was satisfied that no increase in
rent would result, and it took the view that it was entitled to continue to
receive rent at the rate which was current under the lease up to that date. AMP
sought a declaration in the High Court that the lessor was obliged to undertake
a review of the rent and an order for specific performance with a declaration
that the rent could reduce on review and, in the alternative, relief by
rectification of the lease or under section 7 of the Contractual Mistakes Act
1977. Doogue J refused relief and held that the correct construction of the
relevant provisions precluded any reduction of the rent on review. The Court of
Appeal allowed AMP’s appeal against that decision and granted a declaration and
order in the form sought in the prayer for relief. The dispute in the present
case arose after MMT had initiated a rent review and an issue arose in the
course of the review as to whether the review could result in a reduction of
the rent. This issue was referred by the High Court to the Court of Appeal for
determination at the same time as the appeal in the other case, as the same
question of interpretation was involved. In this case also the lessee’s
argument was successful before the Court of Appeal.
The approach which must be taken to the
construction of a clause in a formal document of this kind is well settled. The
intention of the parties is to be discovered from the words used in the
document. Where ordinary words have been used they must be taken to have been
used according to the ordinary meaning of these words. If their meaning is
clear and unambiguous, effect must be given to them because that is what the
parties are taken to have agreed to by their contract. Various rules may be
invoked to assist interpretation in the event that there is an ambiguity. But
it is not the function of the court, when construing a document, to search for
an ambiguity. Nor should the rules which exist to resolve ambiguities be
invoked in order to create an ambiguity which, according to the ordinary
meaning of the words, is not there. So the starting point is to examine the
words used in order to see whether they are clear and unambiguous. It is of
course legitimate to look at the document as a whole and to examine the context
in which these words have been used, as the context may affect the meaning of
the words. But unless the context shows that the ordinary meaning cannot be
given to them or that there is an ambiguity, the ordinary meaning of the words
which have been used in the document must prevail.
The preamble to the deed of lease states
that:
… the Lessor hereby leases to the Lessee
and the Lessee hereby takes on lease the premises described in Item 5 of the
First Schedule for the term and at the rental and subject to the covenants
conditions agreements and restrictions hereinafter set out in the Schedules
forming part of this Lease.
Clause 3.1 then sets out the covenant of
the lessee to pay rent to the lessor. The rent payable by the lessee is defined
in that clause as ‘the Base Rent’. The remaining clauses in section 3 of the
second schedule deal with the manner of payment of the base rent, the lessee’s
contribution to operating expenses of the building and the manner of payment of
that contribution, with rent reviews, with interest on overdue rent or other
moneys and with the payment by the lessee to the lessor of sums payable by the
lessor as GST under the Goods and Services Tax Act 1985. These remaining
clauses are all ancillary to the primary obligation of the lessee, which is to
pay the rent which for its part the lessor has the right to receive under
clause 3.1.
The definition of the expression ‘Base
Rent’ falls into two parts. The starting point is the rate specified in item 9
of the first schedule. This is the first part of the definition. The second
part consists of the words ‘or where increased in accordance with the express
provisions of this Lease at the increased rent’. The word ‘increased’ which is
used here is susceptible of only one meaning. It indicates that the amount of
the ‘increased rent’ cannot be less than the amount which was previously
payable. No mention is made anywhere in this clause of an amount which is less
than the rate specified in item 9 in the first schedule. So, if effect is given
to all the words used in this clause according to their ordinary meaning, the
lessee’s obligation is to pay rent at the rates specified in item 9 or at a
rate which has been increased in accordance with the express provisions of the
contract. The lessee would be in breach of this clause if it were to pay rent at
a rate which was less than that specified in item 9 or, if that amount has been
increased following a rent review, the amount of any increased rent.
Various points were made about this
clause by Mr Ian Millard on AMP’s behalf, in an attempt to demonstrate that
some other meaning should be given to it or that it was at least ambiguous. The
use of the word ‘rent’ rather than ‘rate’ at the end of the clause was said to
be inelegant, in view of the previous reference to the ‘rate’ specified in item
9 of the first schedule. It was said that, as the second part of the definition
of ‘Base Rent’ did not expressly prohibit a decrease in the rent, sense could
be made of the clause irrespective of whether the result of a rent review was
that the rent should go up or down. And it was suggested that the purpose of
the second part of the definition was to enable any increased amount demanded
by the lessor under clause 3.7 for GST to be recovered from the lessee.
In their lordships’ view there is no real
substance in any of these points. The cases to which they were referred show
that practice has varied in regard to the words at the end of clause 3.01. In Australian
Mutual Provident Society v National Mutual Life Association of
Australasia Ltd [1995] 1 NZLR 581 the word used at the end of this clause
was ‘rate’. In Board of Trustees of the National Provident Fund v Shortland
Securities Ltd [1996] 1 NZLR 45 the word at the end of the clause was
‘rent’. There is little to choose between these words and, whichever is chosen,
the result is perfectly intelligible. The use of the word ‘rent’ may be said to
reflect the fact that the purpose of the review procedure in clause 3.5 is to
determine the current market rent with a view to an adjustment of the amount of
the rent currently payable. The absence of an express prohibition against any
decrease does not mean that decreases in rent are permitted. It is absence of a
provision for a reduction in rent rather than a prohibition against such
a reduction which is the critical feature of the clause, as its function is to
define the extent of the lessee’s covenant in regard to the base rent. The
recovery of GST by the lessor is an entirely separate matter. The amount
recoverable under clause 3.7 must be related to the amount of the payments made
by the lessee under the lease, including the amount
the lease, is deemed to be part of the rent for the purposes of clause 9.1 so
as to be recoverable by distress. But it does not fall within the expression
‘Base Rent’ for the purposes of clause 3.1.
Then it was said that the second part of
the definition had been added out of an abundance of caution, so as to ensure
that an increase in the rent resulting from a rent review would be recoverable.
On this view it was sufficient to rely on the provisions of clause 3.5 in order
to identify the amount payable. The amount resulting from the rent review,
whether it represented an increase on or a decrease from the rent previously payable,
would then be substituted for that specified in item 9 of the first schedule.
But their lordships can find no justification for reading the clause in this
way. Nor can they agree with the majority of the Court of Appeal that this part
of the clause, assuming that it was intended to refer to the result of rent
reviews, is superfluous. Effect must be given wherever possible to all the
words which the parties have included in their contract. There is no
indication, taking the clause on its own, that any of the words used in it are
superfluous. The purpose of the clause as a whole is clear and unambiguous. It
is to define the extent of a lessee’s obligation to pay rent. It is designed to
ensure that the amount paid by the lessee is the amount specified in item 9 of
the first schedule or a higher amount if the provisions of the lease about rent
reviews so require. As Mr JRF Fardell said, its effect is the same as that of
an express ratchet clause with the result that, in the event of a rent review,
the rent will never be less than the base rent payable immediately prior to the
review date.
This interpretation of clause 3.1 was
said to be inconsistent with section 7 of the second schedule, which provides
for an abatement of the rent in the event of damage or destruction of the
premises. The argument was that, as the provisions of this section provide for
a proportion of the rent to be suspended until the premises have been repaired
and reinstated or the lessee has taken repossession of the premises, the definition
of the base rent must be read as allowing for the rent to be decreased as well
as increased. But this argument involves a misreading of the provisions of
section 7. What the clauses in this section are designed to provide is for a
proportion of rent to be suspended in the events referred to in that section,
not to adjust the amount of the rent payable for the whole premises. These
provisions have no part to play in the calculation of the base rent for the
purposes of clause 3.1.
In their lordships’ view the whole matter
is put beyond doubt when regard is had to the terms of clause 3.5 which deal
with rent reviews, and they are compared with those of clause 2.3 which deal
with the position in regard to rent if the lessee desires to have a further
lease of the premises for a further term of three years. Clause 3.5(a)(i)
provides:
At any time not earlier than 4 months
prior to each successive date stated in Item 12 of the First Schedule (each of
such dates being called ‘the review date’), the Lessor shall notify the Lessee
in writing of the Lessor’s assessment of the current market rent to apply from
that particular review date in respect of each part of the Premises.
Clause 2.3(b) and (c) are in these terms:
(b) The Lessor shall not less than two
(2) months prior to the termination date give a written notice to the Lessee
stating the amount of Base Rent which the Lessor considers to be the current
market rent of the premises as at the date of commencement of the further term.
(c) The Lessee shall within one (1) month
of the date of receipt of the Lessor’s notice given under paragraph (b) of this
Clause or within such other period as may be agreed notify the Lessor in
writing that either:
(i) The Lessee accepts the Lessor’s
statement of Base Rent for the first period of the further term;
or
(ii) The Lessee rejects the Lessor’s
statement of Base Rent and requests that the Base Rent be determined in
accordance with the procedure set out in Clause 3.5(b).
It can be seen that during the initial
term the initiative in regard to rent review lies with the lessor. The Court of
Appeal held that the word ‘shall’ in clause 3.5(a)(i) must be read as imposing
an obligation on the lessor to initiate a rent review. This led them to the
view that the provision for rent review during the initial term had been
inserted into the lease in the interests of the lessee as well as of the
lessor. On this approach, assuming that the lessor was obliged to initiate the
process even in a situation where it was clear from the outset that the current
market rent was less than the rent currently payable, it would seem odd if
clause 3.1 allowed the rent to be increased if the current market rent was
above that currently payable but did not allow for it to be decreased if it was
less. But in their lordships’ opinion the function of the word ‘shall’, as used
repeatedly throughout clause 3.5, is merely to identify the course of action
which the lessor or the lessee must follow in order to obtain the results for
which the clause provides. It does not oblige either party to seek these
results. What it does is to lay down the route which must be followed if these
results are to be achieved. In that sense, and in that sense only, it is
mandatory because if the procedure is not followed any right to achieve these
results will be forfeited. There is no machinery available to the lessee either
to initiate a rent review or to compel the lessor to do so. As Henry J pointed
out, the absence of such machinery is inexplicable if the lessee was to have
the right to have the rent reviewed. But it is consistent with a reduction in
rent during the initial period not having been contemplated.
The position is quite different in the
event of the lessee seeking a renewal of the lease for a further term under
clause 2.3. Here provisions have been included which are expressed in favour of
the lessee. The lessee is to have the option, according to a strict timetable
of procedure, to have the amount of the base rent determined so that the amount
specified in item 9 of the first schedule will conform to the current market
rent of the premises as at the date of commencement of the further term. The
structure of clause 2.3 is in sharp contrast to that of clause 3.5. Its effect
is worked through the definitions in the first schedule by the variations to
that schedule which are set out in clause 2.4.
Their lordships find here a clear
demonstration of the point that, where provisions are included in the lease in
favour of the lessee, the lease is careful to spell them out in express terms.
If it had been the intention that the lessee was to have a similar right to
initiate a rent review during the initial period as that which is given by
clause 2.3(c) one would have expected that to be stated expressly. As it is,
the effect of these various provisions is that the lessor was guaranteed a
minimum return by way of contractual rent for the first nine years, after which
the rental return was to be free to move according to the rents prevailing in
the open market. There is no reason to think that this was an arrangement which
was not within the contemplation of the parties when they entered into the
contract.
A number of other points were made which
their lordships do not find it necessary to discuss in detail. They are content
to adopt the observations of Henry J on these matters. At the end of the day
the solution to the problem raised in this case lies in the clear and
unambiguous language of clause 3.1. None of the other provisions in the lease
to which their lordships were referred are inconsistent with the plain meaning
of the words used in this clause, which is that the measure of the lessee’s
obligation to pay rent is the amount specified in item 9 of the first schedule
or any increase in that amount which may result from a rent review under clause
3.5. Except in the case of damage to or destruction of the premises, for which
special provision is made by section 7 of the second schedule, there is no
provision in the lease which would enable the lessee to fulfil its obligation
to pay the base rent during the initial period by tendering less than the
amount defined by this clause.
Their lordships will humbly advise Her
Majesty that the appeal should be allowed, that the application for a
declaration should be dismissed and that the remaining issues including that of
rectification be referred back to the High Court for determination. The
respondent must pay the appellant’s costs in the Court of Appeal and before
their Lordships’ Board.
