We recently acted for B&Q in the case of Britel Fund Trustees Limited v B&Q Plc which illustrates the significant impact that an early break clause may have on the rent payable under a renewal lease.
Proceedings were issued between Britel Fund Trustees Limited (Britel) and B&Q plc (B&Q) under Part II of the Landlord and Tenant Act 1954 (the 1954 Act) to determine the terms of a new lease of a retail warehouse circa 37,000 sq ft with an open non-food retail planning consent on Tottenham Hale Retail Park..
During the course of the proceedings all terms of the renewal lease were agreed save for the rent (the passing rent being £776,139) to be payable on commencement of the renewal lease. Importantly, the parties had agreed that there would be a mutual rolling break which could be exercised on or after 30 June 2018.
Britel, supported by expert evidence, contended that rent payable should be £698,500 pa and B&Q also supported by expert evidence, contended that the rent payable should be £281,000 pa. The Court was required to determine the rent in accordance with Section 34 of the 1954 Act.
The applicable law
The relevant part Section 34 of the 1954 Act states:
"(1) 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)…"
There were two main issues considered by the Court:
- When considering comparable evidence, how should the Court treat any initial three month rent-free period ?; and
- What was the open market rent for the lease with the break clause?
Three month rent-free period
B&Q contended that in real world transactions an incoming tenant would be granted a three month rent-free period to allow for a period of fitting out. On this point there was conflicting authority but the Court found that given the disregard in Section 34 (1) (a) which has the effect that the tenant is assumed to have vacated the premises, and thus a tenant taking a lease of the subject premises would require a period for fitting out, a three month rent holiday should be taken into account. The Court commented that this raised a number of issues:
- The rent free period should be applied over the entire term of the lease. In this case the lease was to be granted for a period of 10 years (120 months) and as such a discount of 2.5% should be applied to the final rent determined by the Court;
- It is important that comparables are considered on a like for like basis e.g. if a comparable relates to a lease granted for a 10 year term with a three month rent free period, then a further discount should not be applied.
The open market rent
Section 34 (1) of the 1954 Act is based on the assumption that there is an open market rent for the premises and accordingly, that there is a prospective tenant who is not in occupation and who would be willing to take the lease at that rent. Throughout the proceedings negotiations took place on the basis that the likely tenant would be one of the main DIY retailers. As such it was agreed that the open market rent for a 10 year term to a DIY retailer should be ascertained and this should then be discounted to take account of the break clause. B&Q proposed a discount of 50% and Britel proposed a discount of 10%.
During the second day of the trial both experts accepted that this was an artificial approach as no DIY retailer would accept a lease with such an early break clause. As a result B&Q submitted that the only potential tenant for the subject premises would be a discounter – someone who trades goods at a discount who would carry out a very basic fit out. The difficulty for the Court was that no comparable evidence was available to establish what the market rent would be to such a discounter. However, the Court took evidence from both experts as to what their view on such a "discounter" rent would be.
The Court determined that the market rent which would be payable by a DIY retailer would be £603,100 pa and that the market rent which would be payable by a discounter would be £466,940 pa. In order to conclude the valuation exercise the Court considered what discount should be applied for the early break clause in each scenario. It was agreed that the discount attributable to the break clause would be less if a discounter took the lease and as such the Court determined that the correct discount for a lease to be granted to a DIY retailer would be 25% and that the correct discount for a lease to be granted to a discount retailer would be 20%.
Once the Court had carried out these two separate valuation exercises, it concluded that the correct approach was to value the market rent on the basis that a discounter would take the lease of the premises. This decision was reached principally on the basis that it had been agreed that no DIY retailer would take the lease with such an early break clause. Therefore the market rent for the premises was determined to be £466,940, but with the 20% deduction for the break clause, this fell to £373,700.
On 8 October 2015 B&Q made a Calderbank offer to settle the rent payable under the renewal lease at £480,467 pa which was stated to expire on 12 October 2015. (The claim was originally listed for trial on 14 October 2015.) The Court found that as a result of the Calderbank, Britel should pay all of B&Q's costs post 12 October 2015. In addition, since B&Q had in effect won the litigation, as the eventual rent was much closer to the figure they had originally sought, Britel were ordered to pay two thirds of B&Q's costs pre 12 October 2015.
It is important when considering how the Court will determine the rent payable by reference to Section 34 of the 1954 Act to consider who is likely to be the hypothetical tenant of the subject premises, taking into account all the terms of the renewal lease: in this case the early mutual break clause was very significant. Particular points to note are that:
- The likely pool of potential tenants will decrease when the subject premises is large;
- The Court may adjust the market rent determined to take account of a notional three month rent –free period, though careful analysis of comparable evidence is required to ensure "like for like" comparisons;
- An early landlord break clause is likely to have a depreciating effect on the market value and again the depreciating effect is likely to be higher when the premises are large and will require an extensive fit out; and
- Parties should always consider making a Calderbank Offer even if, due to circumstances, it can only remain open for acceptance for a short period.