A lease that contains open market value rent review provisions will usually provide for the rent to be determined by a third party if the landlord and tenant cannot agree it. The lease should specify whether the third party, usually a surveyor, is to act as expert or arbitrator in making that determination.
In Metropolitan Property Realizations Ltd v Atmore Investments Ltd, the tenant held an underlease of a small parade of shop units with residential flats above. The lease was for a term of about 99 years, with around 57 remaining at the time of the review. The rent review provisions stipulated that the rent review surveyor was to act as an arbitrator.
The new rent payable on review was the greater of:
i. the passing rent; or
ii. a rent equal to six elevenths of "the yearly rent value of the demised premises".
The yearly rent value of the demised premises was defined as "the amount which shall in [the arbitrator's] opinion represent a fair yearly rent for the demised premises at the relevant date having regard to rent values then current for the property let without a premium with vacant possession and to the provisions of this Lease (other than the rent hereby reserved)".
In order to apply the rent review formula, the fair yearly rent had to be calculated first. The six elevenths proportion would then be applied to this figure to determine the amount payable by the tenant. It was common ground between the parties that, in assessing the fair yearly rent of the premises, the six elevenths calculation should be ignored.
The arbitrator started by analysing what a notional tenant of the demised premises would receive by way of rental income from the shops and the flats. Several adjustments were made to this, including a deduction to represent a management charge and a deduction to reflect possible void periods during the rent review period. This produced a final figure of £118,000 per annum.
Having established the value of the rental stream in the hands of the notional tenant, the arbitrator then equated that figure with the fair yearly rent of the premises for the purposes of the lease. However, this meant that there was no element of profit for a notional tenant taking a lease of the premises. The yearly rent of £118,000 payable by the tenant to the landlord simply equated to the monetary value of the sub-lettings made by the tenant.
The tenant appealed against the arbitrator's award under section 68 of the Arbitration Act 1996. This provides that a party may appeal on the ground of a serious irregularity affecting the award which has caused (or will cause) substantial injustice to the applicant.
The High Court ruled that there is a high threshold which must be crossed before a court will be justified in intervening in an arbitration award under section 68. However, the court found that this threshold had been crossed. The arbitrator was required to determine the notional rent which a notional tenant would pay. If there is a glaring illogicality contained in the central reasoning in an award, the court may intervene.
The arbitrator's approach assumed that a notional tenant would take a notional lease at a rate which included a profit element for itself. Unfortunately, the arbitrator's calculation did not in fact include any element of profit for the notional tenant and the arbitrator failed to identify the amount of profit which would be appropriate. On that basis, the arbitrator's award was obviously flawed as a matter of the commercial logic which he himself decided should be applied. It could not be regarded as a rationally sustainable resolution of the issue which he had to determine. This amounted to a "serious irregularity" within the meaning of section 68 which had caused substantial injustice to the tenant, who would otherwise have to pay an excessive amount of rent under the lease for an extended period of time. The court remitted the matter to the arbitrator for re-determination (limited to determination of the appropriate element of profit to be taken into account).
Things to consider
While this interpretation of the lease seems correct on the drafting, one can't help wondering whether the tenant is gaining the benefit of double-discounting, since the six elevenths proportion is then applied to the figure arrived at as the fair yearly rent. Was this appreciated by the original draftsmen of the lease?
The court commented that the arbitrator had failed to identify the amount of profit which would be appropriate. However, arguably, even if the arbitrator had looked at the profit issue, he should have invited the parties to make submissions on it, rather than determining it in the absence of any submissions addressing the issue.
The fact that an arbitrator's award may be subject to challenge is sometimes cited as a reason why it may be preferable to appoint an expert instead, although the appointment of an expert may well have worked against the tenant in this case. If an expert is to be appointed, the scope of the expert's remit must be carefully defined. The expert cannot conclusively rule on matters beyond his remit.