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There are lessons for landlords, tenants and others negotiating lease transactions in a recent Supreme Court case which looked at a landlord’s ability to increase the rent upon review to market in circumstances where the starting rent was on a concessionary basis.

Landlords, tenants and others negotiating lease transactions should consider if there are any particular elements of the lease transaction, or the context in which it is negotiated, which have a material bearing on the rent that should be paid under the lease and should therefore be taken into account (or disregarded) in any further assessment of the rent. If there are, then these may need to be expressly mentioned in the lease.

In Hubbard v KiwiRail Ltd [1], which was recently before the Supreme Court, there were some novel arguments by the tenant as to why the landlord was not entitled to significantly increase the rent. These included propositions that a significant rent increase amounted to a derogation of grant (i.e. was inconsistent with the grant of lease to the tenant) or amounted to frustration. The case is a reminder of the importance of critically considering the method of reviewing rent under a lease during initial negotiations.

Background facts

The tenant leased a large block of land in Onehunga, Auckland from Kiwirail. The lease had an initial term of 5 years and contained a right of renewal for a further term of 5 years. The lease gave the landlord, Kiwirail, the right to terminate the lease on 24 months’ notice during the renewed term if it required the land for rail purposes. In other words, the lease had a second term of a maximum of 5 years but this could be reduced to 2 years at any time.

The rent was subject to review upon renewal, by notice to the tenant, on the following terms:

Specifying the annual rent, such rent to be determined by [the landlord] to reflect the current market rent of the leased land, based on the highest and best use of the leased land, as at the rent review date.

The commencing rent was $34,300 plus GST. In 2009, before the lease was signed, Kiwirail advised the tenant that the rate proposed was not the market rent but was at a concessionary rate.

Kiwirail assessed the rent, upon renewal, at $123,200 per annum plus GST (almost quadrupling the initial rent). The tenant provided Kiwirail with its rental valuation at $75,000 per annum plus GST. The parties’ respective valuers met and, on an express without prejudice basis, made a joint recommendation of $100,000 plus GST ‘based on their assessment of the market value for the land and excluding improvements’.

The tenant did not approve the rent settled upon by the two valuers and refused to pay the increased rent, causing it to be in default of the lease. Kiwirail therefore issued a notice under the Property Law Act 2007 of its intention to cancel the lease and the tenant sought relief from the Court against cancellation. It submitted 16 grounds for relief, many of which were novel. They included:

  • It was an implied term of the lease that any increase in rent would not be so great so as to make it impossible for the tenant to continue in business.
  • Kiwirail, as a state-owned enterprise, had a social responsibility not to impose rent increases which have the effect of ‘destroying a business’ and a lease by a Government body should be ‘above board and ethical’.
  • When a tenant signs up a lease, ‘they have a right to expect the renewal to be achievable and a credible extension of the original lease’.
  • The Bill of Rights Act 1990 (section 27(1)) provides that ‘every person has the right to the observance of the principles of natural justice by any tribunal or other public authority which has the power to make a determination in respect of that person’s rights, obligations or interests protected or recognised by law’.
  • A tenant has a right to quiet enjoyment and to stay on the property for the duration of the lease and so a prohibitive rent amounted to a derogation of grant.
  • The new rent amounted to a frustration of the lease.

The court rejected all of those grounds except whether the quadrupling of rent could be regarded as a derogation of right. The derogation of grant has been explained as:

If a man agrees to confer a particular benefit on another, he must not do anything which deprives the other of the enjoyment of that benefit: because that would be to take away with one hand what is given with the other. [2]

In the High Court, the judge considered there was room to argue that a deliberate ‘ramping of the lease’ could amount to a derogation from the obligations of having granted a lease with a right of renewal.

Ultimately, the Court considered that the fate of the tenant’s application depended entirely on whether the rent agreed by the valuers was justified. It therefore looked at the methods used by the valuers in assessing the rent and found that neither had squared up the rent review test set by the lease: they had both used the traditional and classic valuation methods without examining the standard imposed in the lease and analysing what is required. The lease required the rent to be reviewed to the ‘current market rent of the leased land’; which meant the current market rent of the land on the terms it was leased. Those terms include the right for the landlord to terminate on 24 months’ notice. The fact that the valuers had ignored the disadvantages of the particular lease terms, meant that the rent might be challenged successfully through arbitration.

However, this case concerned an application to seek relief against cancellation and the method of assessing the rent was not a proper basis for the Court to grant relief against cancellation. The Judge concluded that this did not excuse the tenant from paying the increased rent in the meantime in accordance with the lease requirements.

What does this mean for you?

There are lessons from this case for landlords, tenants, and others negotiating commercial leases. If there are any particular elements of the lease transaction which should be taken into account, or disregarded, in any further assessment of the rent then these may need to be expressly stated. A typical example, as in this case, is a rent concession or lease inducement. However, there may also be other elements of the lease that the parties do or do not want taken into account for the purposes of a market rent review. In this case, one such element included the fact that the landlord had the ability to cancel the lease on 24 months’ notice (which reduced certainty of tenure for the tenant).

Each lease transaction will have its own set of terms and, like many other provisions in the lease, the rent review mechanism may require amendment to meet the parties’ intentions and should not be blindly adopted.

[1] 2016] NZHC 1061, [2016] NZHC 1937, [2016] NZHC 2719, [2017] NZCA 282, [2017] NZCA 375, [2017] NZSC 153

[2] Johnson & Sons Limited v Holland [1988] 1 EGLR 264 (EWCA) 

This article was authored by Michelle Hill.



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