Landlord and Tenant Act 1954, Part II–Appeal from decision of Goulding J approving terms proposed for grant of new tenancy to solicitor tenants in the City of London–Terms proposed involved a transfer from landlords to tenants, with an adjustment of rent to compensate for the shift, of a proportion of the financial risks of servicing, maintaining and repairing the building of which the demised premises formed part–Scheme designed to recoup from the contributions of the various tenants the whole financial burden imposed on the landlords of compliance with their covenants to provide services and to maintain the structure of and decorate the building–The ‘clear lease’ basis for shortterm lettings–Held by the Court of Appeal that the proposed variation of terms introduced a radical change in the balance of rights and responsibilities–The case had to be considered under section 35, rather than under section 34, of the 1954 Act–Short-term tenants, such as appellants, were not adequately compensated by a small reduction in rent for the assumption of the financial risks implicit in the maintenance of the structure of an office block–Tenants would be made insurers of landlords against unknown contingencies of undefined costs–Tenants’ appeal allowed, but leave given to landlords to appeal to House of Lords
This was an
appeal by the members of the firm of Ince & Co, solicitors, who occupied as
tenants the fifth floor of Knollys House, Byward Street and Seething Lane in
the City of London, from a decision of Goulding J which was reported at (1979)
24 9 EG 1065. Goulding J, in determining the tenants’ application for a new
lease of the premises occupied by them, approved the terms of a draft lease
proposed by the landlords which embodied variations, to which the tenants
objected, in the provisions of the previous tenancy. The landlords were the
City of London Real Property Co Ltd, the respondents to the present appeal.
Derek Wood QC
and Jonathan Gaunt (instructed by Ince & Co) appeared on behalf of the
appellants; Ronald Bernstein QC and Benjamin Levy (instructed by Nabarro
Nathanson) represented the respondents.
Giving the
first judgment at the invitation of Buckley LJ, SHAW LJ said: This is an appeal
by the plaintiff tenants from a decision of Goulding J given on December 18
1978 in determining their application for the grant of a new tenancy of
business premises on terms proposed by the landlord but not agreed to by the
tenants. They contend that those terms imposed upon them burdens and risks
which had hitherto been borne by the landlord, and that although the new rent
made allowance for this shift of burden and risk, the learned judge was wrong
in approving those terms in that he failed, in so doing, to give due effect to
the requirements of section 35 of the Landlord and Tenant Act 1954.
The premises
in question comprise the fifth floor of an office building of modern
construction, having been completed in 1962. The owner landlord is a property
company of good standing. The plaintiff tenants are a firm of solicitors of
high repute. They were granted a lease of the relevant premises for a term of
five years from March 25 1972. The rent reserved was £65,421 per annum, and
there were in addition certain charges for services such as the heating of the
demised premises and the lighting of the general parts of the building. The
effective rent for office floor space was £9.39 per sq ft.
The new lease
sought is one which it is agreed shall expire on March 24 1982; it is also
agreed that if the terms of that lease were made to correspond substantially to
those of the lease which was current when the plaintiffs’ application came to
be determined, the rent per sq ft should be £10.50. The landlord is not,
however, willing to reproduce those terms in the new lease. Hitherto the
landlord has borne the burden of keeping the general building in repair and
servicing it, and has been responsible for any damage to the structure. The
incidence of these liabilities, practical and financial, has of course been
reflected in the rents reserved in the lettings of different parts of Knollys
House; but the respective tenants have had to bear a determinate finite
liability while the landlord has carried a contingent liability without any
finite limit, save perhaps the cost of restoration in the event of total
destruction of the building. The landlord now wishes to transfer this
contingent and immeasurable liability to tenants in appropriate proportions. To
offset this shift of burden the landlord proposes a rent of £10 per sq ft
instead of £10.50 per sq ft. It is agreed by valuation experts on both sides
that so far as the liability in question can be translated into monetary terms,
50p per sq ft appears to be the right figure to measure the additional
liability cast on the tenants. Whether over any given period in which tenants
are called upon to pay for repairs and services affecting the general building
they will have to provide a sum less than or more than the saving in rent must,
however, remain a matter of conjecture and speculation. In the long term the
concession of 50p per sq ft may provide a true approximation. In the short term
the odds must be uncertain either way.
The landlord’s
attitude in this regard derives from business reasons manifested in the
contemporary property market. The disposal of office buildings in which the
landlords receive ‘clear rents’ from the various lettings under what are called
‘clear leases’ is not only facilitated but is made more profitable than in
situations where the landlord carries the primary liability for the
maintenance, repair and servicing of the general structure and can look to the
tenants for contribution only in regard to part of the expenditure thereby
incurred.
The reason is
obvious enough. If all outgoings in respect of an office building are covered
by the tenants’ obligations, the income which accrues to the landlord from the
property is subject to no fluctuation in the costs of outgoings. The ‘clear
lease’ removes any speculative element. Investment in a building let under
clear leases is thus rendered more secure and attractive. Its capital value is
correspondingly enhanced and it is rendered more saleable, especially to
pension funds and other investment institutions.
Owners of
office blocks are turning more and more to the type of letting envisaged in the
expression ‘clear lease.’ So long as
there is a scarcity of superior office accommodation in the City of London and
its environs, tenants will continue to accept the form of letting which imposes
on them a share of the burden which has in the past normally fallen upon the
landlord or reversioner.
Mr Bernstein
QC, who has argued this appeal on behalf of the respondent landlord, produced
impressive statistics in support of the proposition that recent new lettings
have been on a ‘clear lease’ basis; and he has submitted that inasmuch as the
rents reserved are less than they would have been if the old system had been
pursued, and less by a figure which, it is common ground, represents, as far as
can be ascertained,
tenants to complain, let alone to resist, the landlord’s proposals.
This may well
be true in the case of a new letting. In general an owner of property is
entitled to dispose of it on such terms as he chooses, if a tenant can be
found. Where, however, a prospective letting lies in the penumbra of some
statutory provision, the position is not so plain; a careful examination of
that provision may reveal that the landlord’s liberty of disposition can and
should be qualified even where it may appear superficially that a new burden on
an existing tenant is compensated for by a relaxation in regard to the rent
reserved. Is there a true offset of burden and benefit or may it be that there
is not a real equivalence between the one and the other?
In the present
case Mr Bernstein has contended that as it is universally accepted that the
tenants’ projected new burden is represented in money terms by 50p per sq ft of
the tenants’ office space, and as it is agreed also that the rent has been
reduced correspondingly, the tenants suffer no detriment by reason of this
departure from the terms of their original lease. He further submitted that the
court has no greater responsibility in such circumstances than to apply the
provisions of section 34 of the 1954 Act to the situation thus simply depicted.
That section provides that:
The rent
payable under a tenancy granted by order of the court under this Part of this
Act shall be such as may be agreed between the landlord and the tenant or as,
in default of such agreement, may be determined by the court to be that at
which, having regard to the terms of the tenancy (other than those relating to
rent), the holding might reasonably be expected to be let in the open market by
a willing lessor.
This argument
would suffice to identify and to delimit the court’s function if the amount of
the rent was the only factor in issue between the parties; but what is
proposed, and what Goulding J approved, was a collateral variation of the
obligations of the tenants in regard to general maintenance, repairs and
servicing.
This, in my
opinion, necessarily attracts the application of section 35 which reads:
The terms of
a tenancy granted by order of the court under this Part of this Act (other than
terms as to the duration thereof and as to the rent payable thereunder) shall
be such as may be agreed between the landlord and the tenant or as, in default
of such agreement, may be determined by the court; and in determining those
terms the court shall have regard to the terms of the current tenancy and to
all relevant circumstances.
The learned
judge considered this in applying the first of the three tests he enunciated.
He posed the question, ‘Has the party demanding a variation of the terms of his
current tenancy shown a reason for doing so?’
He went on to cite a passage from the judgment of Widgery LJ in Cardshops
Ltd v Davies [1971] 1 WLR 591 at p 596, where it is stated:
Section 35 .
. . shows that the terms of the new tenancy must be fixed having regard (inter
alia) to the terms of the current tenancy; and a departure from the terms
of the current tenancy is something which . . . requires to have a reason
attributed to it.
One need
hardly add that the reason put forward must have validity in the circumstances
to which it relates. In the present case the landlord avers that the value of
Knollys House as an investment would be greatly augmented (by one or two
million pounds) if it was entirely let on clear leases, and that, with the
court’s approval where necessary, such a situation could be achieved within a
relatively short period. From the landlord’s standpoint this is a powerful
reason. In the world of property and commerce there could hardly be a stronger
one.
One may
therefore pass to the second test propounded by Goulding J, which I would
respectfully adopt, namely: ‘Will the party resisting the change be in
principle adequately compensated by the consequential adjustment of open market
rent under section 34?’ I read the passages
in his judgment dealing with what I consider to be the crucial question in this
appeal. He said:
Secondly, the
tenants can in principle be adequately compensated for the proposed change of
terms by a diminution of the open market rent to be fixed under section 34 of
the Act. The tenants’ own expert witness, Mr Baker, found no difficulty in
agreeing a figure for that purpose. He was very conscious of the tenants’
objection to the uncertainties of the comprehensive service charge and to their
lack of control of the landlord’s future expenditure. Nevertheless he was
satisfied that the agreed rent reduction of 50p per sq ft, or £4,950 in all,
was a fair compensation in all the circumstances. If I have understood
correctly the figures produced by Mr Treagus, the landlord’s chief surveyor and
one of its directors, the acceptance of the landlord’s terms would increase the
service charge by about £2,700 per annum on the basis of figures relating to a
year which ended in March 1978. The remaining £2,250 (approximately) per annum
can be regarded as compensation, and is agreed to be a fair compensation, for
the transfer of uncertainties from the landlord to the tenants in respect of
the three years to end in March 1982.
It is here
that, regretfully, I find myself parting company with the learned judge. The
advantage conferred on the landlord by a clear lease is the freedom from
factors which are of uncertain outcome and which elude absolute quantification
and lend themselves to what at best is a conjectural assessment, however
informed the source. That freedom removes an element of risk from the
landlord’s financial situation; but the element of risk is not obliterated. It
is transferred to the tenant. In the outcome, the diminution in the rent,
though ‘fair compensation’ when in prospect, may prove in actuality to be
wholly inadequate as the years go by. If the risk is disadvantageous and
therefore unacceptable to the landlord at a commensurable rent why should it be
more acceptable and less disadvantageous to the tenants, albeit at a reduced
rent? This is the more so since they are
not in the business of property management and property dealing. The status of
an individual landlord is, in these days, generally of longer duration than
that of a particular tenant. This is especially the case with office lettings,
which are often for successive relatively short terms. A landlord can spread
the risk of deterioration, dilapidation and depreciation over a longer period
and possibly over several properties; tenants have neither the opportunity nor
the interest to do so. A risk which is normally acceptable to a landlord as an
incident of his ownership of property may be oppressive and intolerable to a
tenant whose interest in the premises he occupies is coextensive with his
tenure and will not survive it. As for the general building of which those
premises form part, he has only a very limited interest which does not extend
to responsibility for its overall maintenance.
It is, I
think, unnecessary to discuss the detail of the terms by which the landlord
seeks to achieve a clear lease. In general terms the plan is that subject to
certain safeguards against abuse the landlord retains the practical
responsibility for deciding what is required in the nature of repair,
restoration, renewal and services. While the cost is to be defrayed by the
sitting tenants throughout Knollys House, the figures involved are those
certified by the landlord’s accountant subject in the case of dispute to a
final determination by a surveyor or engineer nominated as provided in the
lease.
The third test
in Goulding J’s analysis was whether the proposed change would materially
impair the security of the tenants in carrying on their business or profession.
In the circumstances of this case I do not think that the proposed change has
any impact on that aspect of the tenants’ situation. I respectfully agree with
the learned judge in this regard.
Having
enunciated the tests and applied them, he then considered, following the
language of section 33 of the Act, whether the clear lease propounded by the
landlord was ‘reasonable in all the circumstances.’ He sums the matter up thus:
So I come to
the final and comprehensive question, whether the proposed variation of terms
is fair and reasonable as between
to condense in words the dialogue of the intracranial jury room. On the main
question of introducing a clear lease I can only say that, weighing the
landlord’s reasons against the tenants’ objections, taking into account the terms
of the current tenancy, and remembering the compensating diminution of fixed
rent, I think it fair and reasonable to adopt the landlord’s terms, and I
cannot see that any other elements of the case point to an opposite conclusion.
If the
landlord’s proposals survive the three individual tests prescribed in the
course of the judgment below, it is true that the outcome is then, to use the
words of the learned judge, ‘in the realm of pure discretion.’ Perhaps it is rather a matter of impression.
Whichever it may be, this court would not, and should not on a matter of
discretion, interfere in any other than an extreme case where the court of
first instance had palpably misdirected itself. This is not remotely the
position in the present case. The learned judge, in the course of a pellucid
judgment, has arrayed the arguments, devised the proper tests and considered
their individual effect. None the less, I do not think that in the present case
the ultimate stage which calls for the exercise of discretion considering the
overall reasonableness of the landlord’s proposals is reached, for they fail to
pass the second test.
In my judgment
the landlord’s terms introduce a radical change in the balance of rights and
responsibilities, of advantage and detriment, of security and risk. The tenants
are justified in rejecting them in so far as they seek to achieve a clear
lease. The objections are not to be dismissed as captious and they should be
met. I would accordingly allow the appeal.
In the course
of the hearing of the appeal, Mr Wood, on behalf of the appellant tenants,
submitted a modified version of the landlord’s proposals which his clients were
prepared to agree. I would set aside the order of the court below and
substitute an order incorporating the form devised on behalf of the tenants.
Brightman LJ,
who also sat on this appeal, is unable to be present this morning and I go on
to read his judgment.
BRIGHTMAN LJ
in his judgment (read by Shaw LJ) said: I agree that this appeal should be
allowed. In so doing I differ with considerable hesitation from the carefully
reasoned judgment of Goulding J.
The form taken
by the draft lease annexed to the order under appeal is as follows, so far as
relevant. The term of the lease is three years from March 1979. There are expressed
to be three rents: first, a fixed rent of £100,700 a year. Secondly, by way of
further or additional rent, a proportionate part of certain insurance premiums
paid from time to time by the lessors in respect of the building of which the
demised premises form part. This is called an insurance rent. Thirdly, by way
of further or additional rent, a service charge calculated and payable in the
manner set out in the first schedule. Clause 2 contains a covenant by the
lessees to keep the interior of the demised premises in repair and decorated.
Clause 3 contains a number of covenants on the part of the lessors which can be
summarised as follows: (1) to provide heating; (2) to clean the common parts;
(3) to keep the exterior and interior of the building in repair, other than the
demised premises; and (4) to provide the services mentioned in paragraphs 1 to
11 of Part I of the Second Schedule; this is subclause (1) (iv), and I shall
have to refer to it later.
The function
of the First Schedule is exclusively to calculate the service charge, as indeed
the opening words of the First Schedule proclaim. Put shortly, the schedule
provides that the service charge is to consist of the fair and reasonable
proportion, to be certified by the lessor’s surveyor, of the total of five
items: item (a), the actual or estimated cost in any year of the term of
providing the services mentioned in paragraphs 1–11 of Part I of the Second
Schedule; these are the services which the lessors covenanted to provide in
clause 3(1)(iv) of the body of the lease; item (b), a management fee, upon
which nothing turns; item (c), certain VAT, upon which nothing turns; item
(d)(i), an amount, to be revised annually by the lessors at their discretion,
towards the estimated cost of replacing lifts, boilers and other equipment on
the basis of certain life expectancies; and item (d)(ii), a similar annual
amount towards the estimated cost of the decoration of the exterior and common
parts of the interior of the building calculated on the footing that such work
will be carried out at the end of specified periods. Paragraphs 1 to 11 of the
Second Schedule, Part I, which represent item (a) above, comprise various items
of routine expenditure but most importantly include also ‘repairing,
maintaining, cleaning, painting and decorating the structure exterior
and common parts of the building . . . plant and equipment . . . and all drains
pipes wires’ etc.
The scheme of
the draft, therefore, is to impose on the landlord the obligation to provide
all the services to the building and to repair, maintain and decorate the
building, both externally and internally (except the demised premises); but to
entitle the lessors to recover, as additional rent, a proportion of the money
which is spent on services and on external and internal repairs, plus a yearly
sum which can best be described as estimated provision for depreciation of
lifts, boilers and other equipment and for external and internal decorations.
The service rent so collected from the tenant, though gauged by reference to
actual or estimated expenditure, becomes in the hands of the lessors their
absolute property to deal with as they please. If all leases are on the same
basis, which is not yet the case, the effect will be to extract from the
tenants in each year sums which are calculated to recover or recoup the whole
financial burden of the lessors’ compliance with the covenants of the lease, in
order to leave the fixed rent in the hands of the lessors as clear profit
exonerated from the burden of all outgoings.
The scheme of
the Landlord and Tenant Act 1954, in the case of the renewal of tenancies
within the Act, is to give the court jurisdiction to determine, in default of
agreement between landlord and tenant, the duration of the new tenancy, the
rent payable under the new tenancy, and the other terms of the new tenancy.
This is achieved by sections 33, 34 and 35 respectively. The test to be applied
under each section is different. As it is impossible to determine the proper
rent payable under a tenancy until the other terms of the tenancy have been
determined, it follows that the parties must agree, or the court must
determine, the duration of the tenancy, and the terms other than duration and
rent, before determining rent. In other words, the court must perform its
function under sections 33 and 35 before it approaches its task under section
34. The case was argued below as if the provisions governing the payment of the
service rent were terms which fell to be determined pursuant to section 35 of
the Act on the basis that they were ‘terms of a tenancy other than terms as to
the duration thereof and as to the rent payable thereunder.’ If such provisions fall within section 35,
the court is required in reaching its determination to ‘have regard to the
terms of the current tenancy and to all relevant circumstances.’ This approach lets in arguments based on a
comparison between the old lease and the proposed new lease and allows the
tenant to challenge the justification for transferring the financial
responsibility for the building as a whole from the shoulders of the lessors to
the shoulders of the lessees. If, however, the service rent is part of ‘the
rent payable under the tenancy,’ then the matter has to be determined under
section 34. Under this section the court would have to decide whether the fixed
rent, the insurance rent and the service rent constitute rents ‘at which,
having regard to the terms of the tenancy (other than those relating to rent)
the holding might reasonably be expected to be let in the open market by a
willing lessor,’ disregarding certain features which are not relevant to the
instant case.
The learned
judge appreciated the existence of what I may term the section 34 argument, but
as the point had not been taken he expressed no conclusion on its validity. The
point
with under the Act unless this court first comes to the conclusion whether the
proper section to apply to the service charge, which is the main bone of contention,
is section 34 or section 35.
I agree
entirely with my Lord, Shaw LJ, that this case has to be considered under
section 35 and not under section 34, because the substantial issue is not the
amount or calculation of the rent but the incidence of certain unusual
financial burdens which will have the effect of controlling the rent.
Approaching the case on this basis, and applying the three tests enunciated by
Goulding J, I entirely agree with Shaw LJ that a short-term tenant such as the
appellants, is not adequately compensated by a small reduction in rent for the
assumption of the financial risks implicit in the maintenance of the structure
of an office block. Those risks are proper to be borne by the owner of the
inheritance or of a long term of years but are not appropriate to be borne by
one who is in possession for three years and has no further interest save a
limited statutory security of tenure. Such risks are indeterminate in amount
and could prove to be wholly out of proportion to the very limited interest
held by a short-term tenant. No doubt they can be quantified annually when
averaged over a number of years, and better still when averaged over a number
of properties. But they are not capable of being fairly allowed for, by way of
a reduction of rent, when the tenancy has only a few years to run. The tenant
in such a case would be made the insurer of the landlord against unknown
contingencies of undefined cost. I wholly agree with the approach of Shaw LJ,
and I respectfully adopt the entirety of his reasoning. I would accordingly
allow the appeal.
Agreeing,
BUCKLEY LJ said: I concur in the view that this case falls to be considered
under section 35 of the Landlord and Tenant Act 1954 rather than under section
34. Section 35 requires the court, in determining what the terms of a new
tenancy granted by order of the court shall be, to have regard to the terms of
the current tenancy. If the intention of the legislature had been merely that
the sitting tenant should have a pre-emptive right to a tenancy on such terms
as could be negotiated on the open market between a willing lessor and a
willing lessee at the relevant time for a lease of the holding with vacant
possession, that intention would have been easily and clearly expressed, but
not in the language of section 35: the terms of the current tenancy would be
irrelevant.
The section
does not require the new tenancy to be on the same terms as the current
tenancy. All relevant circumstances must be considered, but the section makes
clear that the terms of the current tenancy are relevant. This must be, in my
opinion, because the legislature intended that, in the absence of relevant
circumstances leading to some other conclusion, the new tenancy should, mutatis
mutandis, be on similar terms to the existing tenancy. Any departure from those
terms requires explanation, that is to say justification: Cardshops Ltd
v Davies [1971] 1 WLR 591 at p 596.
The effect of
the proposed modification of the terms of the existing tenancy in the present
case is to make the lessee an insurer of the lessor against risks connected
with the structure of the building which under the terms of the existing lease
have to be borne by the lessor. They are risks which are inherent in the
ownership of the building. The reduction in the rental which is said to
compensate the lessee for assuming these risks is far from being an indemnity
against them. The lessee might find himself at any time unexpectedly and
unforeseeably saddled with very heavy capital expenditure for which the reduction
in rent would by no means compensate him, except possibly in the very long run;
but, as has already been pointed out, a particular tenant may fill that role
only for a relatively short period and compensation which is only compensation
on a very long-term basis would be no comfort to him.
The proposed
alterations in the terms of the lease, in my judgment, alter the mutual
relations of the lessor and the lessee so drastically, and so adversely to the
lessee, that the court could not in the exercise of its discretion properly
impose them on the lessee under the Act in the absence of some more cogent
reason than can be discovered in this case.
For these
reasons, and for those already given by my Lords, I agree that this appeal
should be allowed.
The appeal was
allowed with costs in the Court of Appeal and with costs below subsequent to
the adjournment into court. The terms of the order to be agreed by counsel.
Leave given to appeal to the House of Lords.
