In good or bad economic times determining the rent payable under a commercial lease is of the utmost importance to both landlords and tenants.
Most commercial leases include extensive provisions for reviewing the rent at regular intervals throughout the term of the lease. The majority of leases value the open market rent by reference to a hypothetical letting: a notional lease based on the actual lease terms but disregarding various items (e.g. tenant improvements).
The standard rent review clause also usually includes the option for the parties to refer the matter to independent arbitration/expert determination if no agreement is reached. In most cases rent review negotiations are dealt with by the surveyors for each party, who also prepare the submissions to the arbitrator/expert.
Whilst this commercial approach is often attractive and may potentially reduce costs, the recent decision in Cordoba Holdings Ltd v Ballymore Properties Ltd 1 provides a salient reminder of the pitfalls of the rent review process and the risks of failing to get it right.
Ballymore were the landlord of office premises in the Docklands area of London let to Cordoba under three separate 25 year leases. Cordoba used the premises as a data centre. The leases were subject to upward only rent reviews in the 3rd and 8th year of the term. At the time of the second rent review, the parties failed to reach agreement and agreed to refer the matter to an arbitrator in accordance with the terms of the leases. The arbitrator had to determine:
“the rent at which the Premises might reasonably be expected to be let on the open market at [the second review date] making the Assumptions but disregarding the Disregarded Matters...”
Under the definition of Disregarded Matters set out in the leases, the arbitrator was required to disregard any improvements to the premises carried out by the tenant (or its subtenants or predecessors in title). Both sides relied on the evidence of separate expert surveyors in relation to the rent payable.
The arbitrator determined the rent review on the basis that the premises could be used as a data centre, which attracted a higher open market rental level (£2.8 million per annum) than standard office premises.
The disgruntled tenant appeals...
The tenant, Cordoba, sought to appeal the decision on the basis that the arbitrator had failed to properly disregard improvement works carried out by Cordoba (outside of the demised premises) to increase the power supply to the premises in order to allow the premises to be used as a data centre. Its argument was that without these improvements the premises could not have been used as a data centre; and they should have been disregarded by the arbitrator, with the result that the rental value should have been determined on the basis of standard office premises, which would have been lower.
Cordoba’s appeal was based on two grounds:
- that the arbitrator had erred in law by failing properly to disregard tenant improvements undertaken by it to increase the power supply to the premises to its use as a data centre; or, alternatively,
- if the arbitrator had not as a matter of fact dealt with this issue at all, the award was subject to challenge on grounds of serious irregularity.
Ballymore argued that the onus was on Cordoba to provide evidence to properly demonstrate that tenant improvements had, in fact been carried out to the demised premises and that Cordoba had failed to do so.
The judge decides...
In short, the judge agreed with Ballymore and held that Cordoba’s appeal failed on both grounds. Cordoba was under an obligation to demonstrate that the power supply was to be disregarded for the purposes of rent review but had failed to do so in the course of the arbitration process. As a result, the judge held that the arbitrator had acted reasonably (and within his powers under the Arbitration Act 1996) in determining the rent payable by Cordoba under the leases of the premises on the basis that they were to be used as a data centre.
The moral of the story
Cordoba’s plight demonstrates the importance for parties involved in rent review in getting the process right. Cordoba’s error in failing to properly address the issue of tenant improvements during the course of the arbitration proved a costly mistake and effectively undermined its attempt to appeal the arbitrator’s decision.
This decision highlights the need for careful and thorough preparation in rent review proceedings. Landlords, tenants and their advisers should pay heed and carefully consider whether specialist legal advice is required at an early stage of the rent review process, and certainly prior to any third party referral.