VCAT's recent decision in Q St Kilda Tenancy Pty Ltd v Kane (Building and Property) [2023] 75 provides helpful guidance for retail landlords and tenants concerning rent reviews and the operation of section 35(2) of the Retail Leases Act 2003 (Vic) (RLA).

This case concerned the lease of a serviced apartment, originally run as part of a Quest franchise. The lease provided for an initial term of 5 years, with options for 3 further five year terms.

Importantly, the lease provided that upon the exercise by the tenant of an option for a further term, the rent would increase by CPI, but any such increase was "capped" at 4% (Rent Review Clause).

Shortly after the tenant exercised its option for a second further term, the tenant applied to VCAT alleging the Rent Review Clause was void and seeking market rent review to fix the rent for the second further term.

The tenant originally argued the Rent Review Clause was a 'ratchet' clause prohibited by s 35(3) of the RLA. However this argument was subsequently abandoned, and at the hearing the tenant argued that the Rent Review Clause was a "mixed" rent review clause prohibited by section 35(2) of the RLA.

Section 35(2) of the RLA provides:

The basis or formula on which a rent review is to be made must be one of the following:

(a) a fixed percentage;

(b) an independently published index of prices or wages [for example CPI];

(c) a fixed annual amount;

(d) the current market rent of the retail premises; [or]

(e) a basis or formula prescribed by the regulations.

The tenant argued that the Rent Review Clause had two separate '"limbs" and was a mixture of a fixed percentage and CPI.

Member Nash agreed and adopted a strict construction of section 35(2) holding at [31]:

I consider that the wording of [the Rent Review Clause] refers to more than one method or formula for calculating the rent as it requires an assessment of rent after the application of the CPI and then an assessment of that rent to ensure it is not greater than an increase of 4%, and if it is, it is then limited to a 4% increase, which is an alternative calculation; it is not the application of the CPI formula but the application of fixed percentage. Any rent review which involves having regard to more than one method of rent review calculation must fall foul of the terms of s 35(2).

The consequence of Member Nash's findings was that a market rent review was ordered under s 35(7) of the RLA. This was so despite the "cap" on CPI in the Rent Review Clause was drafted by the tenant, was solely for its benefit and was consistent with the consumer protection public policy underlying the RLA.

The decision emphasises the importance of ensuring retail leases include only one prescribed method under s 35(2) of the RLA when establishing rent for a further term.

For retail tenants with leases incorporating similar rent review clauses, it presents a potential opportunity to seek a market rent review, or to negotiate a rent reduction.

Post script: Following the decision, the landlord successfully applied for an order for possession of the premises relying on unrelated breaches of the lease by the tenant. The tenant's application for relief against forfeiture was dismissed and the landlord has retaken possession.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.