Impact of the prohibition on commercial lease provisions
This note summarises the changes we have seen in commercial leases as a result of the introduction of legislation in Ireland prohibiting upward only rent review provisions in commercial leases entered into after 28 February 2010. In particular, we set out below some of the mechanisms used to avoid the legislative provisions in certain circumstances. Also, we have made reference to a recent High Court case in Ireland in which the Tenant, Bewleys Café, challenged the wording of the upwards only rent review clause in its commercial lease and the courts ruled in favour of Bewleys i.e. that the rent could in fact be reviewed downwards.
The Current Legislation and its Effects
The legislative reform in this area was driven by public policy and the economic downturn. Commercial tenants found themselves struggling to pay high rents, particularly in prime city centre locations, notwithstanding that open market rents and property valuations generally had fallen substantially.
Section 132 of the Land and Conveyancing Law Reform Act 2009 (the "2009 Act") came into force on 28 February 2010. This Section provides that any rent review clause in a lease created after 28 February 2010 will be construed as meaning that the reviewed rent will be an amount which is less than, greater than or the same as the existing rent. In other words, the rent payable under the lease will be revised upwards or downwards in accordance with open market.
The introduction of the 2009 Act has created a two-tier market comprising: (i) legacy leases entered into prior to 28 February 2010 which will continue to have an upwards only rent review clause for the remainder of the lease term; and (ii) leases entered into since 28 February 2010 which are reviewed upwards or downwards on an open market basis. Landlords and Tenants have adopted alternative methods of calculating rental uplifts to dilute the impact of the legislation, as set out below.
Alternative approaches taken by Landlords to circumvent the legislation
The introduction of the 2009 Act has given rise to uncertainty for Landlords in terms of monitoring the future rental income stream from its commercial lettings. As a result and without contravening the legislation, Landlords have attempted to negotiate alternative rental provisions to minimise the effect of the 2009 Act, or at the very least, to retain certainty as to future rental levels, detailed as follows:
Stepped Rent – During the term the parties agree a predetermined upward stepped rent at agreed intervals. This approach is advantageous for Landlords as it provides certainty and simplicity in calculating future rental income. However, it is also rigid and takes no account of increases or decreases in property valuations and market rents.
Indexation Based Review – The parties agree that the rent will be reviewed in accordance with the increase/decrease of a pre-agreed index (e.g. the Consumer Price Index). This index tracks changes in retail prices and alters the rent on review to reflect these changes.
"Cap and Collar" Provisions – The parties may agree what is commonly known as a "cap and collar" provision. A 'cap' limits the amount by which rent can be increased on a rent review and a 'collar' stops the rent falling below a certain level. These provisions are becoming more widely used in recent times.
Turnover Rent – The parties may link changes in rent payable to turnover. This is often used in retail leases where the rent is calculated by reference to the turnover generated by the Tenant with the rent payable often expressed as a percentage of this turnover. This approach provides the Tenant with greater flexibility and enables the Landlord to monitor the Tenant's performance and take immediate action if performance drops. Similarly, where a Tenant trades above expectations, the Landlord is in a position to take advantage of this rather than waiting for a rent review. The disadvantages for the Landlord are the lack of certainty of the amount of rent payable and the reliance which the Landlord must place on the turnover information from the Tenant.
Shorter Term Lease – A shorter term commercial lease of less than 5 years may be agreed thus negating the necessity for a rent review.
Landlord Triggers Rent Review – It may be agreed that it is the Landlord's option only to trigger the rent review i.e. even if the market rent has fallen, the Tenant is at the mercy of the Landlord as to whether a rent review takes place.
The Bewley's Decision
It is worth nothing that the question of upwards only rent reviews recently came into focus in a 2013 High Court decision of Justice Peter Charleton in Ickendel Limited v Bewley's Café Limited (the "Bewley's Case"). The Bewley's Case concerned the interpretation of the rent review provisions in a 35 year lease that commenced in 1987. Under the terms of the lease, the rent payable by Bewley's Café was to be reviewed upwards every five years.
At the 2012 rent review date, Bewley's Café argued that it was entitled to set a revised rent in line with the current open market level provided that the new rent was greater than the original rent payable at the commencement of the lease in 1987. Justice Charleton agreed with this approach and held that, while the lease did contain upwards only rent review provisions, the baseline rent for the purposes of each rent review was to be interpreted as the initial rent payable at the commencement of the lease, rather than at the commencement of the rent review period.
The new methods of rent review employed by Landlords and Tenants would appear to circumvent the 2009 Act, particularly where a "review" does not occur during the term of the lease. While such rent review provisions have not been before the courts, the 2009 Act does not require commercial leases to contain upwards/downwards rent review provisions, rather it prohibits the use of traditional upwards only provisions. Perhaps the more worrying precedent for Landlords is the recent Bewley's Case. As set out above, this case is under appeal to the Supreme Court and a decision is expected shortly.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.