In late June, the Court of Appeal (Whelan, McLeish, Emerton JJA) overturned a decision of Croft J concerning the construction of a commercial lease rent review clause.
The lease was between a company called PCCEF (an acronym appearing to stand for ‘Point Cook Community Entertainment Facility’) and the Geelong Football Club of a premises out of which the Geelong Football Club operated a gambling facility.
The lease commenced in 2009 for a term of 20 years, together with three further options, each of 10 years.
The lease contained a rent review clause, as is common in long-term commercial leases, and provided for the parties in the event of disagreement to appoint an expert every five years to determine the revised amount of rent according to the movement of the market. Every year in between the review years (not being a market rent review year), the rent was to increase by 3%.
Schedule two of the lease contained the relevant clauses.
It provided that the annual rent would increase by 3% of the annual rent payable in the prior year on each anniversary of the commencement of the lease, except for each Market Rent Review, which was every fifth year.
It then provided that either party may notify the other of its opinion of the current market rent at each market rent review year.
If the parties failed to agree the new rent for each market rent review year, a licensed valuer was to be appointed an expert to determine the market rent for the premises.
The critical clause of the rent review provisions in schedule 2 of the lease was as follows:
Notwithstanding any such agreement or determination, the annual rental payable in the first year following any Market Rent Review Date shall in no circumstances be more than 5%, nor less than the annual rental paid in the year immediately prior to the Market Rent Review Date in question.
This clause was described in the judgement as providing a "cap" and "collar".
With the rent commencing at $996,000 plus GST in 2009, in 2016 the Geelong Football Club contended that the market rent for the premises should be reduced to $680,000.
The Geelong Football Club contended that the critical clause quoted above should be read as providing a "cap and collar" as a "cushion": [33] of the Court of Appeal decision.
The Geelong Football Club asserted that the words “payable in the first year [after a market rent review] shall in no circumstances be … less than the annual rental paid in the year immediately prior“ meant that in the second year following the market rent review (the seventh year of the lease), the increase of 3% would apply to the market rent review amount, rather than applying to the amount paid in the sixth year, (which would have been a 0% increase on top of the fifth year’s rent, as the market rent was less than the fifth years rent). In this way, it provided a year of ‘grace’ to the party disadvantaged by the changes in the market, so that it would be able to adjust its expectations in the following year.
PCCEF on the other hand contended that the “cap and collar” operated to ensure that the rent payable by the tenant to the landlord would never decrease. After the 0% increase was applied under the collar because of market rent being less than the current years rent under the lease, 3% increase in the seventh year would apply to the rent payable in the sixth year which had not increased from the fifth year’s rent.
Croft J accepted the Geelong Football Club's contention, but the Court of Appeal unanimously agreed with PCCEF's contention about the meaning of the clause quoted above.
Justice Croft observed:
Moreover, it is clear enough that the objective purpose of market rent review provisions is, broadly speaking and subject to the terms of the particular lease, to seek to maintain rents at something close to the current market rental for premises as that might vary — upwards or downwards — during the term of the particular lease. Clearly, this is likely to be a more important consideration for parties the longer the lease term, as fixed rents in fluctuating market conditions might seriously disadvantage one or other party. In the present circumstances, the lease term — which might extend for 50 years if options to renew our exercised — indicates that, objectively, the parties were seeking to achieve this objective in including rent review provisions as they appear in the Lease.
However, the Court of Appeal reasoned that because the 3% increase in each year other than a market rent review year applies to "the annual rental payable immediately prior”, the 3% must operate in the seventh year on actual rental paid in the sixth year, rather than the nominal market rent as had been valued.
The Court of Appeal opined:
In our view, the judge departed from the natural meaning of the words in the Lease because he was influenced by assumptions concerning the commercial purpose of rent review clauses in general. In fact, those assumptions were not borne out by the terms of the Lease.
Although there was a long tradition of treating and interpreting demises of land differently to commercial contracts, there has developed a trend for leases to interpreted just like any other commercial contract. The understanding of a reasonable business person interpreting the plain words of the commercial document may well be very different to the understanding of a leasing specialist practitioner with knowledge of some of that history.
The case serves as a warning to practitioners in drafting rent review clauses not to rely on any preconceived notions of the purpose or commercial intent generally of rent reviews, but to spell out very plainly exactly what the parties desire to occur when the rent payable is adjusted under the lease.