Paul de la Piquerie and Rahul Varma look at some common rent review mechanisms and the issues they can create in practice

Rent review clauses are designed to deal with a commercial problem: the balance between the tenant’s desire for stability and the landlord’s desire to protect themselves against changes in the market.

This article looks at some common rent review mechanisms and the issues they can create.

Rent

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The starting point

In theory, rent review clauses ought to be construed in the same manner as any other contractual provision. For example, Lord Justice Leggatt stated in Co-operative Wholesale Society Ltd v National Westminster Bank [1995] 1 EGLR 97: ‘The principles to be applied in the construction of commercial rent review clauses are no different from those applying to the construction of any other commercial document.’

In reality, this statement is perhaps misleading. When construing rent review provisions, it has proven to be the case that:

  1. certain principles are applied more frequently by the court than others
  2. some principles appear to be accorded greater weight by the court than others, and
  3. there are some notions which appear only to apply to rent review clauses.

The most obvious of the latter is the so-called ‘presumption in favour of reality’, which is addressed below.

Wood v Capita Insurance Services Ltd [2017] UKSC 24

In Wood, the Supreme Court was keen to endorse both Arnold v Britton [2015] UKSC 36 and its previous guidance in Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900. However, whereas Lord Neuberger in Arnold emphasised the primacy of contractual language in the analysis, Lord Hodge in Wood stated (at paragraph 12) that:

‘To my mind once one has read the language in dispute and the relevant parts of the contract that provide its context, it does not matter whether the more detailed analysis commences with the factual background and the implications of rival constructions or a close examination of the relevant language in the contract, so long as the court balances the indications given by each.’

In rent review cases, the court is keen to try to give effect to the parties’ contracted intentions

Lord Hodge then highlighted (at paragraph 13) the relevance of drafting quality to the process of construction: ‘Some agreements may be successfully interpreted principally by textual analysis, for example because of their sophistication and complexity and because they have been negotiated and prepared with the assistance of skilled professionals. The correct interpretation of other contracts may be achieved by a greater emphasis on the factual matrix because of their informality, brevity or the absence of skilled professional assistance. But negotiators of complex formal contracts may often not achieve a logical and coherent text because of, for example… differing drafting practices, or deadlines which require the parties to compromise in order to reach agreement. There may often therefore be provisions in a detailed professionally drawn contract which lack clarity and the lawyer or judge in interpreting such provisions may be particularly helped by considering the factual matrix and the purpose of similar provisions in contracts of the same type.’

The ‘presumption in favour of reality’

This phrase is unique to rent review. In our view, the best explanation of the presumption is derived from the judgment of Sir Nicholas Browne-Wilkinson VC in British Gas Corp v Universities Superannuation Scheme Ltd [1986] 1 WLR 398: ‘…the general purpose of a provision for rent review is to enable the landlord to obtain from time to time the market rental which the premises would command if let on the same terms on the open market at the review dates. The purpose is to reflect the changes in the value of money and real increases in the value of the property…’.

The judge continued by stating that in the absence of clear words to the contrary, ‘the lease should be construed so as to give effect to the basic purpose of the rent review clause’.

However, the presumption will not override express words to the contrary which can only literally be interpreted as being at odds with it. For example, in Philpots (Woking) v Surrey Conveyancers [1986] 1 EGLR 97, the Court of Appeal held that the wording of the clause allowed the rent to fall below a market rent. There was no presumption, as was argued, that parties intended the rent never to fall below the rent initially agreed under the lease.

Previous decisions on specific wording

The general principle is, in theory, that words in a contract ought not to be construed by looking at how similar words were construed in other contracts. Again, however, the reality is that there have been many cases in which previous decisions have been regarded as more useful than others when construing other types of contract.

In Coventry City Council v Hepworth & Sons Ltd (1982) 261 EG 566, [1982] 1 EGLR 114, Mr Justice Warner stated that ‘…where the documents in question present substantially the same pattern, the earlier decision can be of the greatest persuasive force to the court of construction in the later case’.

The content of a good rent review clause

A rent review clause ought to include:

  • the date when the review will take place
  • the machinery for the review
  • the formula for determining the rent
  • what to do if there is a dispute.

Practice points

The machinery of the clause – what if there isn’t any?

A lack of machinery rarely makes the rent review clause void for uncertainty. This is because if one party asks the court for help, the court is not actually being asked to create a contract where none exists; instead, it is being asked to insert a term into a pre-existing contract. Contrast this, for example, to the position under a call option which does not specify the terms of the contract that is to be created when the grantee exercises the option. In the latter scenario, the court would, if it inserted its own clauses, actually be creating a contract between the parties where none would otherwise exist.

The bottom line is that in rent review cases, the court is keen to try to assist so as to give effect to the parties’ contracted intentions.

For example, in Stylo Shoes v Weatherall Bond Street (1974) 237 EG 343 (CA), a term was implied to allow the service of a trigger notice, and in Central & Metropolitan Estates v Compusave (1982) 266 EG 900, the court determined that in the absence of agreement (which was all that the rent review clause provided for), the court could determine the new rent.

Trigger notice requirements

The authorities have established that it is probably the case that if a lease simply says that notice is required, then there must be some form of writing.

If a rent review clause requires a particular form, then, when asking whether the notice complies with the requirement, one asks whether the notice is sufficiently clear to tell the recipient the server is exercising their rights under the lease. In practice, this should not be a hard test to satisfy.

It is a bad idea to serve a notice which is stated to be ‘subject to contract’ or ‘without prejudice’. This is because the recipient cannot be sure whether the server is willing to contract at the stated figure or is, instead, leaving open the possibility of coming back with a different figure in the future.

It is also worth noting that a landlord’s posited figure will generally not actually have to be a genuine pre-estimate of the rent. There is thus scope for being ‘ambitious’.

Appointment of third parties

Almost all review clauses allow the appointment of a third party if there is no agreement. The third party is usually a surveyor to be appointed by the president of the Royal Institution of Chartered Surveyors (RICS). Most clauses also provide a date or a point in time, to be calculated by reference to other events, by which the appointment must have been requested by one or the other of the parties. In considering whether such time limits have been complied with or not, it should be noted that RICS’ policy is that the date upon which an application is made to it is the date upon which it receives a request to appoint. It is not, for example, the date when the requesting party actually pays the application fee that RICS requires. The latter is regarded by RICS as part of the ‘processing’ of an application that has already been made, not as a condition precedent to the application itself.

In the event of a dispute between the parties to the lease on whether an appointment has been made or requested on time, RICS will normally simply appoint in any event and progress the contracted process, leaving it to the aggrieved party to seek a declaration from the court that the date has actually been missed. This is regarded as the most practical way of dealing with the dispute.

If a party wishes to challenge the identity of the individual appointed, then the test that that party must satisfy is to establish that the appointment was one which no reasonable president could make. This is not considered an easy test to satisfy.

Expert determination or arbitration?

Expert determination is usually seen as cheaper than arbitration, but this is an over-simplistic view. A simple provision for expert determination might provide that the parties put together an agreed bundle for the expert and allow them to make their decision in writing. This might be cheap. However, a more complicated (and perhaps more useful) clause might provide that in addition to the above, one party files submissions and these are then responded to, after which the expert can ask questions of the parties in writing and require evidence if need be, followed by a detailed written decision with an expressly agreed ability to appeal. This is not likely to be any cheaper than arbitration.

Expert determination is also generally perceived to be quicker than arbitration, but this is subject to the same caveat above: it depends on the detail of the procedure set out in the clause. It is also noteworthy that the costs of an arbitration are assessable under section 64 of the Arbitration Act 1996, whereas in many instances, the costs of an expert are simply agreed by the landlord and tenant to be payable in full.

If the landlord and tenant have agreed to be bound by the decision of an expert, then even if that expert gets the answer wrong, this doesn’t mean that the decision is appealable

One point which is quite important to consider is whether any points of law are likely to arise in the third party’s role. If they are, then it might be more appropriate for the matter to be determined by an arbitrator than by a surveyor acting as an expert. One might expect / hope that a surveyor acting as an expert would refuse their instructions if they were to be required to decide a point of law that was beyond their competence. However, they will not always do so, and even if they did, one might still find that by that point, considerable cost and time had been incurred.

The difficulty is that if such a point is decided by an expert and if the landlord and tenant have agreed that they are bound by the decision of that expert, then even if the expert gets the answer wrong (even to the point of having done so negligently), this does not mean that the decision fails to bind or is appealable. For such a decision to be appealable, it must be proven that the expert materially departed from their instructions.

Another notable point is that, unless the parties have set out in the rent review clause the procedure that is to be followed on an expert determination, there will be no set (or predictable) procedure to be followed. This is not the case with arbitration. Moreover, an expert who has not been expressly permitted to do so under the terms of the lease, or by subsequent agreement between the parties, may not be able to compel disclosure or the giving of evidence by a party.

One must not lose sight of the fact that parties can agree to vary the machinery of the rent review clause so as to use expert determination instead of arbitration or vice versa. However, if a party is not an original party to the lease, then such a variation may not bind an original tenant or guarantor unless they also agree to the change of procedure.

Is time of the essence?

This is one general principle of contract law which does seem to entirely survive specific application to rent review clauses. Time is not of the essence unless one of the following is true:

  • the clause says so
  • there are sufficient indications to the contrary in the express words of the lease
  • there are sufficient indications to the contrary in the inter-relationship between the clause and other clauses
  • there are sufficient indications to the contrary in the surrounding circumstances.

Both tenant and landlord have the ability to make time of the essence. However, if the step in question is one which both landlord and tenant have the ability to take under the lease, then the aggrieved party cannot make time of the essence for the taking of that step by the other – the remedy, instead, is for the aggrieved party to take the step itself.

The basis of valuation

It is assumed (whether the lease says this or not) that the market rent is the rent to be paid by a willing tenant to a willing landlord.

The hypothetical tenant is not to be given the qualities of the actual tenant, and so usually cannot be treated as a bidder in the hypothetical market.

There are some cases in which the hypothetical landlord has been given the property-owning characteristics of the actual landlord, but this is obviously not correct.

A surveyor is not allowed to assume that the tenant and landlord might agree to vary the terms of the lease

The property is usually assumed to be in the physical state which it is actually in. However, there are two particular exceptions to this rule. The first is that any disrepair arising from a tenant’s breach of covenant is not allowed to be taken into consideration. The reason for this is that it would reduce the market rent, and so would allow the tenant to gain an advantage from its own wrongdoing. The second is that if the terms of the lease permit the tenant to remove the tenant’s fixtures at the end of the lease, then it will be assumed by the valuer that the tenant has done this.

The term of the lease is usually considered to be a term which is the same as the remaining period of years under the current lease, not simply another grant for the same term as the current lease. There is a presumption to this effect. The possibility of renewal under the Landlord and Tenant Act 1954 ought to be taken into consideration, unless the clause states that this should be disregarded.

Other terms are assumed to be the same unless the rent review clause states otherwise. A surveyor is not allowed to assume that the tenant and landlord might agree to vary the terms of the lease (for example, to allow a different user). However, this should be distinguished from the situation in which the terms of the lease already allow a landlord to give or withhold consent to particular activities by the tenant (for example, assigning the term or altering the premises), in which case the valuer is entitled to consider the likelihood of the tenant making such a request, and the response of the landlord to it.