A recently reported rent review case makes
fascinating reading since it sheds interesting light on the way in which
property investment could take place in the heady days of the property boom of
the late 1980s. It also reveals all too clearly the dramatic effect which the
precise wording of a lease can have on its value to an investor.
Dukeminster
(Ebbgate House One) Ltd v Somerfield Property Co
Ltd [1996] 16/3 RRLR 76 concerned the rent review of a large retail
distribution warehouse located in Ross on Wye. The premises had been let, in
1989, on a 25-year lease subject to five-yearly reviews. The rent review clause
required the rent to be reviewed either to the current open market rental value
of the actual premises or, at the election of the landlord, to a rent geared to
the rent of a notional unit. The notional unit was defined as ‘a warehouse unit
within a 35-mile radius of Ross on Wye’ having, among other stated
characteristics, a total gross internal area of 4,645m2 (50,000 sq
ft). The essence of the dispute between the parties was whether this wording
entitled the landlord to select the location of the notional unit so as to tie
the rent of the subject premises to the highest rents in that area, namely
north Bristol.
Somewhat
surprisingly, the landlords had originally intended to argue their case simply
on the basis of rectification, contending that the wording of the lease should
be changed so as to reflect the clear agreement of the parties that the
reviewed rent be geared to the highest rents in the 35-mile circle. Only at the
instigation of the court did they also argue that the clause, as it stood,
already carried that meaning. As things turned out this was just as well, since
the court rejected the claim for rectification but upheld their contention on
the meaning of the provision!
The premises
were originally owned by the defendants (then known as Gateway Properties Ltd);
in autumn 1988 it was decided to market them on a sale-and-leaseback
arrangement. In order to fetch the highest possible capital sum, it was
obviously necessary to set the initial rent at an attractive level and to offer
a good prospect of that income being sustained. Hence, despite being the
prospective tenants, the defendants and their advisers went to considerable
lengths to adopt a marketing strategy in which it was clearly suggested that,
because any reviewed rent could be geared to rents in north Bristol, the rather
high initial rent could be justified by reference to rents currently being
achieved in that area. The plaintiffs eventually paid a capital sum of just
over £9m for a 999-year lease subject to a 25-year underlease granted at an
annual rent of £855,000 (some £3.50 per sq ft).
point
As already
explained, the plaintiff landlords had originally accepted that the rent review
clause as drafted was meaningless since it did not specify where within the
35-mile radius the notional warehouse was located. At the prompting of the
court they then argued that the wording carried the obvious meaning that the
unit could be located anywhere within that area.
The tenants’
view was that this was quite wrong and that one of two other meanings should be
given to the clause. First, the provision could mean that the notional unit was
to be in Ross on Wye but that the rent for that unit was to be arrived at by
looking at comparables within the radius and then adjusting them. Alternatively
the clause could be interpreted as requiring the notional unit to be anywhere
within the designated area but for the rent then to be adjusted so as to end up
with a rent for a notional unit in Ross on Wye.
Although
both sides alleged that the other’s interpretation produced a commercially
untenable result, the judge, Mr Michael Hart QC, did not think that either had
made out such a case. Although the fact that the plaintiffs’ borrowing costs
exceeded the amount of the initial rent suggested that they needed an increase
in that rent at the first review, the judge was not satisfied that a landlord,
in 1989, might not have been satisfied by a rent review to Ross on Wye rents
‘toned’ up by reference to north Bristol comparables. He was equally
unconvinced by the suggestion that no tenant would have accepted a lease which
would necessarily produce an over-rent. The major purpose of this transaction
was, of course, to produce a large capital sum for the tenant, whose intention
was to retain occupation of the property for the duration of the lease;
over-renting might not have been a concern.
Given that
the commercial outcome did not demand a particular construction, the judge
returned to the words used. He felt that these very much more readily carried
the meaning contended for by the landlords. The presumption of reality did not
demand that the notional premises be assumed to be located in Ross on Wye for the
very good reason that that presumption could hardly carry much weight where the
parties had manifestly decided to gear the rent to notional rather than the
actual premises.
point
In case he
was wrong on the meaning of the words used, the judge did go on to consider
whether the landlords had made out a case for rectification. In order to do so
they had to show that there was a clear common intention that the rent should
be reviewed to best rents in the specified area and that this had been made
outwardly clear. As the judge commented, he had heard much oral evidence as to
the subjective intention of those involved in the negotiations and, as he put
it, ‘the natural tendency to allow interest to shape recollection was apparent
on both sides’.
In the event
he concluded that, while the plaintiffs believed that the rent was to be
reviewed by reference to the best rents in the area and that this had been an
important factor in their decision to invest, and while the defendants had at
the very least anticipated that this might have to be conceded, the evidence
did not demonstrably show that this had actually been agreed, and hence
rectification was not available.
It is hard
to disagree with the judge’s view on the meaning of the clause as drafted. Nevertheless,
the plaintiffs must consider themselves fortunate. They had made a large
investment in circumstances where the terms of the rent review were crucial.
They had not issued clear instructions to their solicitors on this matter and
they had certainly not checked the terms of the rent review clause for
themselves. They were lucky that the words turned out to be right!
