Home > News > Locked-Down Lease Renewals (You can’t have your cake and eat it, even during a pandemic)

Introduction:

There is a story going around about a lease renewal case under the Landlord and Tenant Act 1954 (the “Act”), where the court was asked to insert a clause into the renewal lease which provided for the rent to be either suspended or abated in event of a continuation of the present Coronavirus pandemic or any future pandemic (a “Covid Clause”). According to the rumour, the court declined to include such a clause.

The case – if it exists – is almost certainly a County Court decision, so it will only be reported if one of the parties brings it to public attention. That may yet happen, but until it does, here are our thoughts on whether the court can impose such a provision, whether it should do so and whether any tenant asking it to do so is necessarily a good idea. Get yourself a slice of cake and a nice cup of coffee or tea and let us explain…

Section 34:

Under the Act, the determination of the rent payable for the renewal lease is determined by the court pursuant to the jurisdiction conferred upon it by section 34. For present purposes, subsection (1) is what matters:

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, there being disregarded –

(a) any effect on rent of the fact that the tenant has or his predecessors in title have been in occupation of the holding,
(b) any goodwill attached to the holding by reason of the carrying on thereat of the business of the tenant (whether by him or by a predecessor of his in that business)

The other disregards are not material here.

Section 34(1) dictates that, in the absence of agreement to the contrary, the rent payable under the renewal lease is the “open market rent” for the premises within the holding on the terms of the renewal lease.

The level of rent payable in the open market is whatever the court determines it to be, by a process of evaluation, based on the evidence which is put before it. The evaluation of the market rent pays no notice to the particular circumstances of the actual tenant seeking a renewal. Section 34 was described by Peter Gibson LJ in J Murphy & Sons Ltd. v. Railtrack plc this way:1

[13] Section 34(1), as it seems to me, contains within itself all the essential guidance needed for the determination of the rent on the hypothesis of a letting of the holding in the open market by a willing lessor with the specific statutory disregards referred to in the subsection, and only those disregards. I of course accept that the counterpart of willing lessor in the open market is a willing lessee.

So, if the market rent happens to be determined at a level the actual tenant cannot afford, say because its particular business has been harder hit by the pandemic than other businesses in the market for the subject premises, the court cannot take that into account. As HH Judge Iain Hughes QC said in Brooker v. Unique Pub Properties Ltd.:2

[21] The Act therefore requires an objective assessment of the market rent that would be offered by a hypothetical tenant for the agreed lease of the public house today. Although I am sympathetic to the position of [the tenant], who has operated the public house for many years, I cannot allow either that sympathy or the submission of [the tenant’s Counsel], in his first skeleton: “The circumstances are such that, in the absence of a reduction in rent, the claimants will go out of business”, to affect my judgment in this matter.

This is plainly right: not only does section 34(1) direct the court to determine the “market rent”, the disregards strip out any effect of the tenant having been in the premises previously. As the actual tenant is treated as just another hypothetical bidder in the imaginary market, it inevitably stands the risk of being outbid.

On the other hand, those disregards may help the actual tenant, at least in some circumstances. First, the disregard of the actual tenant’s previous occupation of the premises in section 34(1)(b) means that the rent under the renewal tenancy will reflect any rent-free period, whether by way of an inducement or to ease cash-flow during any fitting out, which may be available in the open market: even though the actual tenant will have the benefit of his actual fit-out.3 This can be a potent pro-tenant factor, as the established wisdom is that, in a free market, a sitting tenant who wishes to stay put will overbid the market in order to avoid having to relocate.4

So too the disregard of goodwill in section 34(1)(a). As and when the economy bumps back towards life, some retail, service and hospitality businesses may see their loyal customer base seek to actively support them in their recovery from the effects of lockdown. This might not be much in the way of a benefit, but it is one that the landlord cannot try and rentalise.

For now, keep these disregards in mind, as we will be coming back to them later.

Leaving aside the disregards and the terms of the renewal lease for the moment, section 34(1) is highly likely to have a profound effect on the merits of any tenant’s attempt to get a Covid Clause included in the renewal lease. This is because the market rent under the Act is determined by reference to the conditions appertaining in the market at the
date upon which the court determines what the new rent should be.5

So, if the valuation date for a lease renewal occurs during the present pandemic,6 it is highly likely that the market rent for the premises will already reflect the impact of the pandemic on the market. We are, of course, not valuers – but we might have crossexamined one or two of them. It seems to us self-evident that a section 34 valuation of, say, a café on a high street, is going to be a lot lower if one assumes a valuation date of, say, 1st May 2020 than if you assume a valuation date of, say, 3rd February 2020. If, however, the evidence is that the market for the particular class of premises in question has not been adversely affected by the pandemic, the tenant is going to struggle to justify
the inclusion of a Covid Clause under section 34: if the market is not affected by the pandemic, the market rent does not reflect the travails of one tenant amongst many.7

Accordingly, any tenant seeking a Covid Clause may be faced with a counterargument that it is already going to be “benefiting” from the market being at particular low at the valuation date.

One of us has been around for long enough to remember a version of this argument in respect of valuation dates which fell during the economic crash of 2008.8 In 2008, a few landlords were arguing, with some success, that it was unfair to fix a rent for a lease which may run for years by reference to adverse market conditions which might not last
for as long.9 Although, as we have seen, the tenant cannot argue that it is unfair to set a “market rent” he cannot afford, the landlord may be able to convince the court to do something about a rent which is set during a depressed market.

The Act specifically permits the court to insert provision for a rent review. This is in section 34(3):

Where the rent is determined by the court the court may, if it thinks fit, further determine that the terms of the tenancy shall include such provision for varying the rent as may be specified in the determination.

Because the court can introduce rent review provisions if it “thinks fit”, the court has a discretion which it does not have when determining the rent under section 34(1). Thus, in Dukeminster Ltd. v. West End Investments (Cowell Group) Ltd., it was held that the terms of a review mechanism to be included was not to be determined by reference to market practice, but by reference to what was “appropriate and inherently fair and reasonable” in the circumstances of that case.10

Accordingly, a landlord facing a valuation date during a pandemic which has driven values down may be able to persuade the court to include machinery which will review the rent sooner than might otherwise have been the case.11 If the market has recovered, then the very purpose of rent reviews is to reflect changes in the values of property and/or inflation:12 it would be consistent with this purpose to insert a review.

Equally, if the market is still in the doldrums because the effects of the pandemic have been worse than anticipated, it might be hard for the landlord to avoid the court thinking it “appropriate and inherently fair and reasonable” for any review machinery to operate upwards or downwards. After all, landlords can’t have their cake and eat it.13

What about the tenant? Could a tenant use section 34(3) as a form of Covid Clause, which reduces the rent payble during a pandemic?

At first glance, this seems doubtful, albeit for practical reasons, not legal reasons. The tenant’s need for a rent reduction during a pandemic is a consequence of the immediate and traumatic loss of business – and cashflow – caused by the imposition of a lockdown and/or social distancing. Practically, the tenant may not have the time and resources to implement a review and go through even a simple expert determination process before the money runs out. A classic rent review will probably take far too long to be of any use. However, subsection 34(3) does not just give the court jurisdiction to impose a periodic review of rent: it allows the court to fix a variable rent which can automatically change with circumstances.

There is only one example under the Act:14 in Fawke v. Viscount Chelsea, the Court of Appeal imposed a “differential rent” in a renewal lease, with a lower rent to be paid until the premises were put into repair, with a fixed increase thereafter.15 Goff LJ said:

I see no reason why the court should not determine a rent increasing by fixed amounts at specified times. By the same token the court has, in my judgment, power to provide that the rent shall not commence, or shall be at a less rate, until repairs are effected, or shall cease to be payable or be reduced as from the time, albeit later than the commencement of the new lease, when they are in fact started and until completed.

Agreeing, Brandon LJ said:

To take an extreme example, let it be supposed, first, that, under the terms of the tenancy, it is the obligation of the lessor to put the premises into repair; secondly, that the premises are, at the commencement of the tenancy, so seriously out of repair, by reason of previous fire or flood, that they are of only partial use to the lessee; thirdly, that an appreciable period must necessarily elapse before the lessor can begin to perform his obligation of putting the premises into repair; and, fourthly, that, while the lessor is performing that obligation, the disturbance will be such that the premises will be virtually of no use to the lessee at all. In those circumstances it may well be that the market rent of the premises, which would be appropriate after they had been put into repair, would be appreciably reduced during the period which would necessarily elapse before the work of putting them into repair was begun, and even more reduced during the further period while such work was being carried out.

Brandon LJ then said that same approach might be used if the premises were rendered unusable by a fire or a flood. However, he continued:

A further question could in theory arise as to whether, in a case where the situation with regard to the state of repair was such that the premises would, in effect, be worthless to a lessee for a certain period, the court would have power to determine a nil rent for that period. That question does not, however, arise for decision in the present case [and] … I should prefer to reserve this further question until there is a case in which the facts found make a decision on it necessary.

So, it seems to us that this is a lonely, but reasonably sturdy, basis for a tenant to seek  Covid Clause in effect by asking for a downward “differential rent” pursuant to section 34(3) to kick in and reduce the rent to a fixed minimum at any time that a pandemic was in being.16 In light of Stephenson LJ’s doubts, as quoted immediately above, we suggest that seeking a nil rent might be unduly courageous, but seeking a Covid Clause which caused a significant reduction in the rent payable could work.

Accordingly, we consider that the court could impose, in effect, a Covid Clause by applying the jurisdiction conferred by section 34(3). Whether or not it would exercise that jurisdiction is difficult to assess in the abstract: we think it would very much depend on the state of the evidence of the market for the subject premises at the valuation date. The less affected by the pandemic that the market value appears to be, the more likely the court is to let the market values prevail without making specific provisions to deal with the present or any future pandemic and vice versa.

We do, however, consider that any tenant seeking to use section 34(3) as surrogate Covid Clause may find an early rent review imposed as a quid pro quo. The overall assessment of what is “fair and reasonable” for the purposes of section 34(3) will take into account that the tenant might be getting a benefit of sorts by having the commencing
rent determined whilst the market is in a very weak state and getting some benefit from those disregards.

What about section 35?

So far, we have been looking at a Covid Clause being inserted, in effect, by section 34(3). The court would (probably)17 also have an alternative jurisdiction to impose a Covid Clause which took the effect of a rent cesser provision under section 35 of the Act.

By section 35(1), the court is given an apparently wide discretion to incorporate new terms in a renewal tenancy:

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.

Our underlining. As we all know, in O’May v. City of London Real Property Co Ltd., Lord Hailsham LC interpreted the words we haev underlined to mean that the court must first consider the terms of the current tenancy and that the burden of persuading the court to impose a change in those terms against the will of the other party must rest upon the party proposing the change.18 That party must also show that the change proposed must be “fair and reasonable”. Lord Hailsham said:

… the court must begin by considering the terms of the current tenancy, that the burden of persuading the court to impose a change in those terms against the will of either party must rest on the party proposing the change, and that the change proposed must, in the circumstances of the case, be fair and reasonable, and should take into account, amongst other things, the comparatively weak negotiating position of a sitting tenant requiring renewal, particularly in conditions of scarcity, and the general purpose of the Act which is to protect the business interests of the tenant so far as they are affected by the approaching termination of the current lease, in particular as regards his security of tenure. I derive this view from the structure, purpose, and words of the Act itself.

In that case, the landlords wished to vary the terms so as to impose upon the tenants a service charge, thereby transferring the financial risk and burden of keeping the building, of which the demised premises formed part, in good repair. A modest reduction in rent was proposed to take account of this variation. It was held that the variation would not be ordered, since the tenants were being asked to accept new risks which were unpredictable and inconsistent with the limited nature of their interest in the land. Lord Wilberforce said:

The character of the two parties’ interests in the land – the landlord’s an indefinite one by freehold, the tenants’ a limited one over a comparatively short period, even though capable of renewal if the tenant so wishes, is such as to call for the assumption of long term risks by the former: his benefit too is long term and will not, according to the evidence, emerge till the 1990’s. Transference of these rights to the leaseholders, accompanied, as is inevitable, by separation of control, creates a risk disproportionate to their interest. If it is reasonable for the landlord to wish to get rid of these risks in exchange for a fixed payment (reduction in rent) it must be equally, or indeed more, reasonable for the tenants to wish, against receipt of that reduction, to avoid assuming it. The tenants are being asked to bear all the risks of property management, a business which they have not chosen, being management by others in the interest of those others. The present distribution of burdens is that freely and contractually agreed upon so recently as in 1972. To recast it involves a serious departure from the terms of the current lease. In my opinion, a court which has to have regard to the terms of the current lease ought not to sanction such a departure, and such other circumstances as should fairly be taken into account – the landlord’s wishes and the increasing acceptance by others, in different situations, of clear leases – are insufficient to give grounds for so doing.

We consider that the tenant seeking a Covid Clause under section 35 is going to have a harder time than if he sought an abatement provision under section 34(3). We have two reasons.

First, it is a pretty safe bet that the current lease will not have a Covid Clause. It is noticeable that, notwithstanding the 1918 pandemic and the more recent SARS outbreak in 2002-4, such provisions are still not regular features of leases. Accordingly, a tenant seeking to have one inserted into a renewal lease will have to overcome the inertia imposed by the O’May principle and set up a case that the current lease terms need to be amended to take into account the risk of a continuing or future pandemic By contrast, the test for including a “differential rent” under section 34(3) is the more relaxed, “if the court thinks fit”.

Secondly, we consider that the logic applied against the landlord in O’May might be applied against the tenant seeking to include a Covid Clause. In O’May, the landlord wanted to place some of the commercial risk of repairing the premises onto the tenants, through a service charge. The House of Lords thought it wrong to impose that risk on the tenants, even if they might obtain the countervailing benefit of a reduced rent. A landlord asked to accept a Covid Clause is being asked to accept a very significant new risk – no rent – which is most unpredictable. It is also inconsistent with the nature of the landlord’s interest in the land: where the premises are not let on a turnover rent, the landlord does not participate in the relative success or failure of the tenant’s business, whether conducted from the premises or more generally.19 In the absence of a turnover rent, the landlord bargains for a fixed income, subject perhaps to periodical reviews to an open market value; it does not bargain to share the risk of an economic downturn making it difficult for the tenant to pay the rent.

The same is true of the position where the court is being asked to insert some form of differential rent under section 34(3), which is to apply during a pandemic. However, it seems to us that the test required to satisfy the implication of such a clause under section 34(3) – “if the court thinks fit” – imposes a lower threshold than that imposed by section 35, as applied in O’May.20

Accordingly, our view is that section 34(3) is a significantly better way to achieve the effect of a Covid Clause than section 35(1).21

This is all very well but…

Having decided that the court has the jurisdiction to impose a Covid Clause and having identified what criteria it might apply when doing so, we come to our last point: is it actually wise for a tenant to try?

We are no more valuers than we were a few paragraphs ago when we last denied it. However, any lawyer who has cross-examined a few valuers will have come to appreciate that there are certain circumstances in which sections 34 and 35 of the Act are subject to Newton’s Third Law of Motion: for every action, there is an equal and opposite reaction.

Section 34(1) directs the court to determine the open market rent for the premises on the terms of the renewal lease, as determined by the court. This is why the rent is always the last thing to be determined.22

This is where the tenant might come to regret arguing for a Covid Clause. Such a clause is, at least in the current market, still highly unusual. It seeks to change the burden of an unquantifiable risk of an extreme economic downturn from the tenant to the landlord and, for that very reason, it might be considered an onerous landlord’s covenant, the imposition of which will increase the rent payable throughout the term.23 The imposition of an onerous clause is the action; an increased rent throughout the term is the likely equal and opposite reaction. A reversion subject to an onerous clause in the lease is always less valuable than an identical reversion which is not subject to it, which give the landlord a decent justification for asking a higher rent than otherwise be the going rate.

Now, it may well be that, when the court has heard all the evidence, it will decide that the state of the open market is such that a landlord will not be able to extract a premium for bearing the new risk: the market may be so dead that any letting on any terms is still better than nothing. It may also be the case that these clauses will become so common that rents will naturally adjust to accommodate them and such clauses will no longer be treated as onerous. However, in the absence of either eventuality, the tenant might find that its cunning wheeze to insulate itself from the economic risk of a future pandemic becomes an immediate and possibly significant additional cost to the tenant which lasts for the length of the lease.

Any tenant considering asking for a Covid Clause needs to get some very, very good valuation advice first. Only if there is clear evidence that such a clause will not cause an unwelcome increase in the rents should the tenant move on to seeking the very, very good legal representation needed to convince a court to include such a clause and to further convince the court that the tenant is not trying to have a benefit under the renewal lease that it does not have to pay for.

In conclusion:

  • The Act gives the court jurisdiction to impose what we have called a “Covid Clause” in a renewal lease;
  • all other things being equal, the court is more likely to impose such a provision as a differential rent under section 34(3) rather than as an other term under section 35;
  • either way, the imposition of a Covid Clause may have unwelcome consequences for the tenant, such as
    • increased frequency of rent reviews and/or
    • an increased rent because the Covid Clause is considered onerous; and
  • even in lockdown, you can’t have your cake and eat it.

Nic Taggart and Nick Grant

_________________

1 [2002] EWCA Civ 679; [2002] 2 EGLR 48, 49 (CA); [2003] 1 P&CR 7 (CA).
2 [2009] EWHC 2599 (Ch); [2009] 3 EGLR 59 (HH Judge Iain Hughes QC, sitting as a deputy High Court judge).
3 See the unreported county court cases referred to in Reynolds and Clark, Renewal of Business Tenancies (5th edition, 2017) paragraph 8-154.
4 Assuming, of course, the sitting tenant can afford to overbid. On the received wisdom in the context of the Act, see Humber Oil Terminals Trustee v. Associated British Ports [2012] EWHC 1336 (Ch); [2012] L&TR 28 at [179] (Sales J).
5 Lovely & Orchard Services Ltd. v. Daejan Investments (Grove Hall) Ltd. [1978] 1 EGLR 44, 46-7 (HH Judge John Finlay QC, sitting as a deputy judge of the Division). The Judge also held that the court may also have regard to any events which can reasonably be expected to happen between that date and the date when the renewal lease ought to commence. By reason of section 64 of the Act, this will be three months and 21 days after the application for a new tenancy is disposed of.
6 Other pandemics may become available.
7 The tenant may face the same sorry situation that Mr. Brooker faced in Brooker v. Unique Pubs: outbid by those in the hypothetical market who could afford a higher rent.
8 Other crashes are available.
9 Little did we then know…
10 [2019] L&TR 4 at [37]-[41] (HH Judge Saggerson, sitting in the County Court at Central London). Given the language used in section 34(3), we respectfully and wholeheartedly agree with HH Judge Saggerson’s approach to both the inclusion of rent review machinery and its terms.
11 For instance, a ten-year term with a review at year five might become a ten-year term with reviews at years two and six.
12 See the famous statement of principle in British Gas Corporation v. Universities’ Superannuation Scheme Ltd. [1986] 1 WLR 398, 401 (Sir Nicolas Browne-Wilkinson V-C).
13 There are a number of cases on whether it is right to impose upwards only reviews, discussed by Reynolds & Clark in paragraphs 8-160 to 8-172. This is not the place for an in-depth analysis, but our view is that, in current market conditions and having regard to the decision in Dukeminster, any landlord angling for an early review date is going to have to accept an upwards-downwards review as a quid pro quo.
14 There are two cases dealing with the question of a differential rent outside of the context of the Act. They were both concerned with the construction of rent review clauses and both courts held that a differential rent was not available: see National Westminster Bank Ltd. v BSC Footwear Ltd. (1980) 42 P&CR 90; [1981] 1 EGLR 89 (CA) and Clarke v. Findon Developments Ltd. [1984] 1 EGLR 129 (Walton J).
15 [1980] QB 441 (CA). The following quotations are on pages 453 and 457-8. Stephenson LJ agreed with the judgments being quoted. There are bits of the decision in this case which are probably not right, but that is another story.
16 There is a whole world of pain available to anyone who has to draft the definition of the circumstances in which a Covid Clause might operate. We’re not going there: we are just looking at whether it is possible for such a clause to be inserted into a renewal lease as a matter of principle.
17 There is some room for debate as to whether all provisions in a lease which relate to the level and payment of rent properly so-called (as opposed to sums reserved as rent, such as service charges) are covered by section 34 or section 35. Another one for another day: let us assume for now that section 35 is available for sake of argument (although we harbour dark doubts).
18 [1983] 2 AC 726 (HL). The following quotations are from pages 740-1 and 749.
19 The landlord accepts the risk of the tenant becoming insolvent – largely because it is a risk that cannot be excluded, only hedged against by taking some comfort from a guarantee.
20 We do note that the court can use section 35 to impose quite major shifts in the economic balance between the parties, as it did in the Smithfield Market case, Edwards & Walkden (Norfolk) Ltd. v. The Mayor and Commonality and Citizens of the City of London [2012] EWHC 2527 (Ch); [2013] 1 P&CR 10 (Sales J). Such cases are, however, very rare.
21 We would, however, be tempted to put both options before the court: if there are two cakes available to eat, you double your chances of the Judge fancying one of them.
22 Cardshops Ltd. v. Davies [1971] 1 WLR 591 (CA).
23 Put another way, as the effect of a Covid Clause is to pass the economic risk of a pandemic to the landlord, as if it were insuring the tenant’s business against this form of business interruption, the landlord ought to receive a premium by way of increased rent for taking the risk.

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