Martineau Galleries No1 Ltd & Anor v Birmingham City Council

JUDGE PURLE: The issue in this case relates to rent review provisions in a lease of premises in Birmingham made on 25^th November 1975 between the defendant Corporation ("BCC") as lessor and French Kier Developments Ltd ("French") as lessee. I shall call the claimants collectively "MG". The lease was granted pursuant to a development agreement containing an agreement for lease dated 7^th March 1972. French was the developer and BCC was the freeholder. There was to a be a mixed-use development. A substantial part was for use as a multi-storey car park and there was also to be a retail unit. The car park and retail unit were duly built. A petrol station and a public house were also originally provided for but were never in fact built. The rest of the development was offices. The development was to be in two phases with the lease being granted at the conclusion of phase 1.

No premium was paid for the lease. The term was 99 years from 24^th June 1975 with an option to renew for a further 26 years. There was a fixed rent for the first twelve years of £25,700. Thereafter the rent was the greater of the initial rent or the reviewed rent. The rent review provisions appear in clause 7, which forms an annexe to this judgment.

The first rent review took effect from the expiry of the twelfth year of the term. Subsequent review dates were and are at the expiry of “each subsequent twenty-first year of the term”.The parties agreed some time ago that the second review date was 24^th June 2008 and that is the current rent review with which this dispute is concerned.

Clause 7(a) requires an assessment of the “basic rental value” as at 24^th June 1980. This is agreed to be £2,425. BCC’srental entitlement is calculated by reference to the ratio that the initial rent of £25,700 bears to the basic rental value, i.e., 9.132 per cent. On any review the rent is only to be increased if the rental value at the review date exceeds the basic rental value, in which case the revised rent becomes 9.132 per cent of the higher rental value.

There is provision for the appointment of an expert valuer by the President of the RICS if the parties cannot agree the revised rent. These proceedings are designed to assist that process by providing the parties and therefore the valuer with answers to issues of construction.

Clause 7(h) requires determination at the review date of “the rents at which the sum total of the various parts of the demised premises could at that time be reasonably expected to be let.” The same clause continues by providing that the expected lettings are to be on the open market by a willing landlord to a willing tenant without taking a fine or premium for a term of twenty-one years having regard to the actual rents then receivable in respect of parts actually let with regard being had to the provisions of section 34 of the Landlord and Tenant Act 1954.

In this case the parts “actually let" at the review date were the car park and retail unit.

As we shall see, another clause - 7(j) - deals with vacant premises. However, clause 7(h) by its terms presupposes that there may be parts which are not actually let falling within it, but which are not to be treated as vacant falling withinclause (j). This presumably caters for the position where some part of the premises though not let is occupied and used by the landlord and so is not vacant either. The point was raised in argument though it is not at all clear to me that anything actually turns on the answer. For what it is worth I rule that as a matter of construction any part of the premises which might, for example, be occupied and used by the tenant rather than by sub-tenants would be within clause (h) and not within clause (j).

Clause 7(i) contains provisions relating to stepped rental increases concerning under lettings which produce an increase of the reviewed rent at the same time as any stepped increase. These are not directly relevant as there are no stepped rent provisions in any under-lease.

Clause 7(j) deals with the situation where the premises are partly vacant. It provides that if any part of the demised premises shall be vacant the rental value is the rent at which such part would at that time be reasonably expected to be let on the open market by a willing landlord to a willing tenant without taking a fine or premium for a term of, in this instance, 14 years. There are incidental provisions in (k) and (l)incorporating a limited disregard of improvements. Rents receivable are not referred to for obvious reasons: there can be none in the case of vacant premises.

Issues of construction arise in relation to both 7(h) and 7(j). The first issue is whether, as is contended by MG, a valuation for the purposes of 7(h) requires no assumption of vacant possession to be made in respect of sublet parts, so that the actual sub-tenancies are taken into account together with the costs or risks, if any, consequential upon owning sublet property. Thus, management costs over the period of a long lease may have a significant effect. There may also be periods affected by rental voids. The contention of BCC is (in effect) that an open market vacant possession valuation is required. Regard (but nothing more) is to be had to the actual rents receivable, as clause 7(h) expressly recognises. The actual rents receivable are, on BC’s argument, merely evidence of open market value, which is still to be assessed on a vacant possession basis.

I was referred to a number of authorities which are all cases on particular rent review provisions. The first to which I should refer is Oscroft v Benabo [1967] 1 WLR 1087, a decision of the Court of Appeal. That case determined, probably obiter, that under section 34 of the Landlord and Tenant Act 1954 the court will take into account the effect of any subtenancy affecting the premises. It is not difficult to see why that is so in the case of a renewal, which is what section 34 is all about, especially when the particular subtenant may have rights deriving from the lease granted by the original landlord. The same does not necessarily follow in the case here of a rent review. Nevertheless, the express provision in Clause 7(h) that regard is to be had to section 34 is some indication that in the case of sublet parts the valuer is not undertaking a hypothetical vacant possession valuation. The point is far from conclusive, however. The main point of the reference to section 34 may be to incorporate the disregards in (a) to (d) of that section.

Against that clause, clause 7(h) refers expressly to the aggregate of the rents at which the sum total of the various parts of the demised premises could be let. That suggests looking at each part of the premises separately and not at an overriding lease of the whole. The fact that (h) and (j) deal with vacant and occupied premises separately again rebuts any suggestion that there might be a requirement to look at an overriding lease of the whole. None of this, however, answers the question of whether or not the valuations of the sublet parts are to be vacant possession valuations. On the contrary, the requirement for regard to be had to the actual rents then receivable by the lessee is in my judgment a strong indication that one is valuing the individual leases subject to the existing tenancies, and not merely treating the existing rents as comparables, for which it would not be necessary to make special provision.

The strongest argument against the construction advanced by MG is that this might enable MG as tenant artificially to reduce the rent by, for example, granting a tenancy at a premium or to an associated company at a reduced rent. Considerations like that caused the Court of Appeal in Ashworth Frazer Ltd v Gloucester City Council [1997] 1 EGLR 104 by a majority to construe the word “receivable” as meaning rent that was capable of being received if sublet, and not the more natural construction, which appealed to Millett LJ, of rent in fact receivable in the particular circumstances of the case. The majority’s decision was in line with the modern approach to construction that the alternative more commercial construction is to be preferred. Mr Morgan, counsel for the tenant in that case, had argued that the clause in question was not a rent review clause but a rent sharing agreement, but the court did not accept that argument.

In my judgment, the problem in the Ashworth Frazer case was more acute than it is here. The court was confronted with the words “rack rents receivable” as the standard by reference to which the rent was to be reviewed. Here, the rents receivable are referred to in clause 7(h) but it is only one of the factors to which regard has to be had. It is not determinative so that, for example, the council simply gets 9.132 per cent of whatever the passing rents add up to. It is a factor which the valuer takes into account. Regard can be had to a matter even when upon reflection it is of no real relevance. Thus, in the hypothetical example of an artificially low rent, it would be open to the valuer, having had regard to it, to place little or no weight (because of its artificiality) upon the actual rent when calculating the rental value of the demised premises. It seems to me, therefore, that the mischief that the court was concerned to avoid in Ashworth Frazer is not present here.

Closer to the present case, in my judgment, are certain observations of Millett J in Leigh and Others v CertibiltInvestments Ltd [1988] 1 EGLR 116. That was not a case of a development lease but concerned an industrial estate described as “already elderly” at the date of the original demise. The estate was already then adapted for subletting in parts, though probably not fully let at the date when the lease was originally granted but considered as capable of being fully let at the time of the review date 21 years later. That is different from the present case, in which the provision for a split rent, with the developer getting the bulk of it, was attributable to the fact that the developer developed the premises at its own expense and the rental values were to be ascertained by reference to the premises as developed without disregarding the initial construction works of the developer.

In Leigh v Certibilt, Millett J observed that there was no evidence that the original lessee was the developer or that it had spent substantial capital sums in improving the property prior to obtaining the lease. That of course contrasts very much with the present case. Then he went on to say this:

“Finally (and most importantly), when the estimated

aggregate rack-rental value of the demised premises ...”

[and there he was taking the expression from the

lease itself to which he added the observation]

“(whatever that may mean) has been agreed or

assessed by the valuer in accordance with the

provisions in that behalf contained in the lease,

the landlord does not obtain the benefit of the

whole (or anything like it) of the difference

between that and the original rent but only half.”

He then observed that the only purpose of the clause could have been that the tenant needed some compensation for potential voids, for the expense of management, including the cost of re-letting units from time to time, and a profit rental. His conclusion was that the valuer was to assume vacant possession; otherwise the tenant might get a double benefit – a discounted rent to take into account factors such as management costs and voids, of which he would only have to pay half for the same reasons.

That is the conclusion that Ms Jackson for BCC urges upon me in this case. She says that final point, which Millett J regarded as the most important, is present here even though the other two points are not. However, in my judgment, the final point cannot be taken on its own. The reason why Millett J could find no other explanation for the rent reduction was precisely because that was not a case of the developer spending capital on the property in order to obtain the lease. In the present there was a development agreement and the logic is the other way round. In my judgment, the reasoning of Millett J supports MG’s, not BCC’s, case.

I was also referred to the decision of His Honour Judge Paul Baker QC sitting in the High Court in Scottish & Newcastle Breweries PLC vSir Richard Sutton’s Settled Estates [1985] 2 EGLR at 130. In that case he was referred to Oscroft v Benabo, which he also regarded as obiter, and explained the decision on the basis that it would be strange if the landlord could insist on the tenant taking a sublet part under section 32 of the 1954 Act and at the same time make him pay for the vacant possession value of it. He considered the case was not conclusive of the matter. On the particular construction of the rent review clause before him, the learned judge, having stated that the starting point was that vacant possession would ordinarily be presumed because otherwise the tenant could by artificial means manipulate the rent review to his own advantage, went on to construe the particular clause in the tenant’s favour. The notional lease was not assumed to be with vacant possession but would be assumed to be subject to the existing under-lettings. That case merely demonstrates that different clauses are construed in different ways and I do not find anything of particular assistance in the actual decision when I come to consider the issues before me.

Returning to the present clause, I have already said that, in my judgment, a valuer would be entitled to place little or no weight on artificial rents. That seems to me, as I have said, the main mischief that needs to be avoided. Once that is avoided, then this can be seen as a fairly common developer’s lease under which the developer has through its own efforts acquired, as regards the occupied parts, a number of sub-tenancies. It would be wrong in my judgment to deprive the developer of the benefit of the work which it has done and to attribute a higher rent than should be attributed to those sublet parts. Quite what weight the valuer puts upon the existing sub-tenancies, and their particular terms, when looking at a rent review which is to last for 21 years, is a matter for him but he is not required, in my judgment, to assume vacant possession; on the contrary, he is required to have regard to the actual rents then receivable and, as there is no assumption of vacant possession he would be entitled also to consider the terms of the sub-leases in ascertaining the appropriate rent for the sublet parts, to the extent that he considers that exercise relevant. This is not expressly mentioned in clause 7, but does not need to be, as the process of ascertaining a proper rent for sublet premises may require consideration of all the terms of the sublettings.

Turning now to clause 7(j) one incidental question that has arisen is whether or not the relevant part or parts of the demised premises can now be defined. Mr Fetherstonhaugh QC for MG points out that as a matter of fact the offices are now vacant in their entirety and therefore the offices are, according to him, the part that must be valued. It is not open to the valuer to value the offices in parts because, as a matter of fact, the offices as a whole are now vacant, and therefore constitute the relevant part to be valued. That strikes me as an argument which is excessively semantic. In my judgment, it is for the valuer to decide which part of the demised premises should be valued separately from others in the light of his experience of the market and market conditions at the review date in 2008.

Miss Jackson QC for BCC contended (and formulated a declaration to this effect) that the valuer is free to consider that the vacant parts are being offered for letting together or in such parts, for example, floor by floor, for a term or terms of 14 years for occupational use as would secure the highest bid or bids on the open market. In my judgment, that must be the correct approach and I will make an appropriate declaration. I will not, however, accede to the declaration that she seeks precluding the valuer from having regard to voids and costs of management. It seems to me that the valuer is entitled to have regard to such matters but quite what weight he places on that is a matter for him. It may be that in given circumstances the impact will be greater or less depending upon the circumstances.

I shall, therefore, invite the parties through their counsel when they have had chance to consider this judgment to formulate an appropriate declaration or declarations to give effect to my rulings.

THE rent hereby reserved shall be reviewed on the last day of the