UK: Hotel Valuers and Investors Reminded of Risks with Complex Hotel Rent Calculations

Last Updated: 9 June 2010
Article by Tom Page and Nick Moore

A recent case in the UK courts has provided a timely reminder to valuers that they have to fully understand the complex rent calculations in hotel leases in order to properly carry out their valuations.

The claimant investors in this case were the Danish equivalent of limited partnerships and were controlled by a Danish company, Scanplan. Scanplan identified four hotels in England, of which it bought one in each investor's name. Each hotel was leased to a hotel operator and each lease contained a provision by which, in certain circumstances, a turnover rent would become payable instead of the base rent. The defendant was the valuer appointed by the investors to prepare valuation reports to aid the acquisition. The case involved the investors' claim that the valuer had negligently valued the hotels by not taking into proper consideration the true effect of the complex rent calculation provisions.

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Turnover rent provisions

The turnover rent payable was assessed by reference to the amount by which a percentage of the hotel's gross turnover for any relevant turnover period exceeded the base rent payable in respect of that period. In other words, if the turnover of the hotel increased to a certain point, the tenant would have to pay rent at a commensurately higher level. In any turnover period, where the specified percentage was less than the base rent, the shortfall would be rolled over into the next (and each successive) turnover period and would be deducted from the next payment of turnover rent. Therefore, where the tenant failed to reach the specified percentage from its turnover, so that there was a shortfall when compared to the base rent, the tenant carried forward the benefit from that shortfall to the next and successive turnover periods.

The net effect was that turnover rent would only actually become payable when the total shortfall, which might have built up over successive periods, had been fully accounted for. The inclusion of such a lease provision, as was the case here, can adversely affect the prospect of rental income growth.

Investors' claim

The valuer prepared valuations of the hotels and referred to the shortfall provision. However, its forecasts for when the rents would increase under the arrangement did not take that provision into account. The investors therefore claimed:

  • that the valuer owed and breached a duty to take reasonable care not to misstate in its valuation reports any important matter it might have considered important when undertaking the valuation exercise, including the operation of the shortfall provision; and
  • that failures in the valuer's method of valuation rendered it liable in negligence, regardless of whether its valuations were within a permissible bracket around the correct valuation.

Lack of reliance

The Court held that the valuer did indeed owe a duty of care as alleged by the investors and that, in ignoring the shortfall provision, it had breached that duty in its forecasts as to when the hotels might generate surplus rent. However, on the facts, the breach of duty was of no consequence because Scanplan had not relied on that part of the reports.

Scanplan had clearly been given correct advice as to the effect of the provision and on the evidence had understood that advice. In its attempt to obtain investment in the investor vehicles, Scanplan had created its own prospectuses in which it omitted to include certain elements of the valuer's valuation reports. The prospectuses set out Scanplan's own forecasts and calculations. It could not be argued that the valuer's error was causative of the claimed loss.

Valuation within a "reasonable bracket"

The Court also found that although a valuer could be in breach of duty by falling below the standard of a reasonable valuer in his methodology, that valuer would not be liable in negligence if it could be shown that, notwithstanding the error, the valuation figure produced was within a reasonable bracket. In determining what the permissible bracket might be, there were a limited number of comparables. The investment market in hotels was immature and there was an improving market at the material time, which created particular difficulties for valuers.

Taking those factors into account, the Court held that the appropriate margin of error might well have been in excess of 10 per cent. In this case, the valuer's valuations had been within 10 per cent of the correct figure and were to be considered by reference to the overall valuation rather than to the yield percentage. Accordingly, although justified criticisms could be made of the way in which the valuer went about its valuations, liability could not be established. The judge commented that in the ordinary valuation case, a valuer's performance should be judged by the final figure, not the minutiae of how he got there. In short the law focuses on the result, not how it is achieved.

Comment

Variable rent provisions are particularly common in hotel leases for accounting reasons. They also help to mitigate operating risk/sector downturn. As well as being a reminder to valuers to always read carefully the relevant lease provision and if necessary seek advice, investors should also take note of the circumstances in which valuers may be absolved of any liability for their mistakes. In this case:

  • Scanplan knew and understood the shortfall clause and therefore the negligent omission by the valuer was not causative of the investors' loss; and
  • the valuations provided were within the reasonable range of values that a non-negligent valuer might have calculated.

In light of the above the court found no liability on the part of the defendant valuer and the claim in relation to negligent valuation also failed.

Further reading: (1) K/S Lincoln (2) K/S Chesterfield (3) K/S Wellingborough v CB Richard Ellis Hotels Ltd (No.2) (2010)

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 04/06/2010.

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