Key points

  • If the parties to a protected lease cannot agree the terms of the renewal lease, they will be decided by the court
  • The burden of persuading the court to change the terms of the existing tenancy rests on the party proposing the change, which must be fair and reasonable
  • The High Court has held that a lease with an all-inclusive rent should be renewed on terms which provided for a separate variable service charge

Background

A tenant whose lease is protected by the Landlord and Tenant Act 1954 has a right to a new tenancy when its existing lease expires, unless the landlord can make out one of seven grounds of opposition. Often the terms of the new lease are agreed between the landlord and the tenant without the need for court intervention, but the court has the power to set the terms of the new lease if the parties cannot agree.

The Act contains particular provisions dealing with the extent of the premises to be demised, the setting of the rent under the new lease, and the length of the term. In relation to all other terms of the tenancy, section 35 of the Act provides that the court "shall have regard to the terms of the current tenancy and to all relevant circumstances".

Edwards & Walkden (Norfolk) Ltd v The Mayor and Commonality and Citizens of the City of London concerned the renewal of a number of leases of Smithfield meat market in London. The landlord was the City of London; the tenants were the meat traders. There were two main issues in the case.

Issue 1 - Should the rent be reduced to take account of other income received by the landlord from the offices above the market?

A number of offices for commercial use had been built by the City above the market itself, which generated additional income for the City. The legal regime under which the market is operated by the City is governed by an old Victorian statute. The tenants argued, successfully, that the statute required the City to apply all the monies received from the commercial offices towards the maintenance and running costs of the market.

The tenants went on to argue that the income from the commercial offices should therefore be brought into account when setting the terms of the rent under their new leases. The court disagreed. This was because there was no provision in the tenants' leases which required the rent or service charge payable under those leases to be ringfenced by the City and spent on market purposes.

The City was obliged under the leases to provide services, and had to expend money in order to do so. However, it could use the sums received from the commercial offices to do this, and pay the rent and service charge received from the market tenants into its general funds to use in other ways.

Nor did the statute governing the operation of the market restrict the City to charging the market tenants only sums needed to maintain and operate the market, after deducting sums received from the letting of the commercial offices. There was therefore no reason why the rent from the office space should have any effect on the rent which a notional willing landlord and tenant would agree, for the purposes of the 1954 Act.

Issue 2 - Should the new leases contain an all-inclusive rent, or a separate rent and service charge?

The second area of dispute related to how the costs of maintaining the market should be dealt with under the new leases. The existing leases followed a rather unusual format. They contained a fairly standard service charge schedule under which the landlord covenanted to provide various services, and the tenants agreed to pay a service charge, separate from the rent payable under the lease, to cover the cost of those services.

However, the body of the lease itself provided that the tenants did not have to pay this service charge and only had to pay the main rent under the lease. The lease further provided that, in the event of a lease renewal under the Act, "the parties shall enter into negotiations to determine whether this Lease shall be renewed on an all inclusive rent or on a separate rent and service charge".

This unusual structure had come about because of a long-running dispute between the City and the market tenants. Previous leases had provided for a separate rent and service charge. However, this had been suspended in favour of an all-inclusive rent while some works had been carried out to the market which were disruptive to the tenants.

The works had gone on longer than intended and there were further negotiations between the City and the tenants which eventually resulted in the grant of the existing leases. The existing leases therefore recognised the ongoing dispute between the parties and effectively the issue was "parked" for the duration of those leases.

The tenants accepted that the money payable to the City under the new leases ought to be set at a rate which should cover the overall cost to the City of running the market and providing services. However, the tenants argued that the rent under the new leases should be all-inclusive.

They submitted that an estimate should be made at the start of the leases of the future maintenance and running costs for the period until the next rent review, and an overall rental figure set by reference to those costs (with provision for annual indexation by reference to inflation).

The landlord on the other hand wanted a separate and discrete service charge, which would vary from year to year, therefore producing a "clear" rent (which rent would be set at a lower level as a result).

The main difference between the parties was therefore how the risks of future changes from the original estimate should be borne between them. On the tenants' proposition, any excess of actual costs over the estimate would have to be borne by the City as landlord (although any reduction in actual costs would be for the retention of the City).

O'May v City of London Real Property Co Ltd

A similar issue was before the court in the leading case on section 35; O'May v City of London Real Property Co Ltd (1983). In O'May, under the terms of the existing tenancy, the landlord was responsible for repairs and maintenance of the exterior and common parts. In return for a reduction in rent, the landlord proposed that, under the new tenancy, the tenants should bear (by way of service charges) a proportion of the cost of such repairs.

The House of Lords in that case rejected the landlord's proposal. It ruled that the burden of persuading the court to change the terms of the existing tenancy against the will of either party rested on the party proposing the change.

The change proposed must be fair and reasonable, taking into account the comparatively weak position of a sitting tenant requiring renewal. There was no obligation to make the new terms conform with market practice if to do so would be unfair to the tenant.

Application of O'May to this case

The High Court in Edwards & Walkden noted that there were significant differences between the present case and O'May. First, the parties had agreed that the City should be entitled to recover its costs of maintaining and operating the market - they just disagreed about how that should be done.

The court thought that the weight to be attached to the payment structure under the existing leases was "considerably diminished" because of the history of the negotiations of those leases.

As far as the renewal was concerned, the parties had agreed that the City should be able to recover the costs of running the market from the tenants. The tenants' proposal created a risk that this principle would not be carried into full effect.

The court therefore ruled that the landlord had shown good and sufficient reasons to justify a change in the payment structure under the new tenancies to a separate rent and service charge.

Things to consider

Although to an extent this case turns on its own facts, cases on section 35 of the Act are not all that common, and so it is of interest for that reason.

The City had agreed that any existing repairs required at the start of the new leases would be paid for by the City and not charged for under the service charge. So the issue between the parties was confined to the costs of ongoing services and any repairs which may be required in the future.

This seems to have had some influence on the court's decision. It certainly meant that the City could not simply defer necessary repairs until after the grant of the new leases in the hope that it could then re-charge the costs to the tenants.

Another unusual feature of the case was the scope of the services being provided by the landlord. The majority of the service costs were directly attributable to the running of the tenants' businesses; for example, energy and chilled water required for meat refrigeration; the provision of a system to transport meat hygienically around the market; meat inspection.

If the tenants' business were not located in the market, these were costs which they would have had to meet themselves. The court therefore thought that it was "just and fair" that the tenants should directly bear the risk of fluctuations in these costs.

Costs relating to repair and maintenance of the market buildings themselves only formed a small part of the expenditure by the City. This is different from an average office building or shopping centre where the majority of the costs relate to the building itself rather than the nature of the businesses being run from it.

Because the existing leases did contemplate a separate service charge, albeit that it was not in operation, Edwards & Walkden can be distinguished from O'May itself, which made no such provision.

There must surely be few commercial leases left which are protected by the Act and which contain an all-inclusive rent. However, landlords under such leases should not assume that Edwards & Walkden means that they will always be able to amend the terms of such leases on renewal to accord with current market practice.

There are some statements in the judgment which both landlords and tenants may find worrying. For example, the court thought that "the cost of repairing and maintaining the Market buildings can ... fairly be described as being for the joint benefit of the City as freeholder and the tenants as long term occupiers of the Market ... This is not a case where there is a high turnover of tenants, where the interest of the landlord in the fabric of the building which is let can more readily be regarded as entirely distinct from that of its tenants".

Later in the decision, the judge said: "I consider that there is a stronger argument for the tenants that the City should bear the risks of unforeseen upward fluctuation in the costs of maintaining the fabric of the Market buildings [as opposed to the service costs attributable to the tenants' businesses]. However, ... the tenants are long-term occupants of the premises ... There is therefore less reason than in some landlord and tenant contexts (where there may be a greater turnover in tenants) to distinguish strongly the respective interests of the landlord and tenants in maintaining the fabric of the building."

In reality, so-called "clear", or "FRI" (full repairing and insuring) leases are very much the market norm, although tenants may (particularly in the current climate) try to negotiate a service charge cap. Shorter leases may be all-inclusive, but they are unlikely to be protected by the Act.

And despite the statement in O'May that there was no obligation to make the new terms conform with market practice if to do so would be unfair to the tenant, the judge in Edwards & Walkden suggested that: "Current market practice supports the inference that adoption of a variable service charge to cover the provision of services by a landlord to a tenant in multi-occupied commercial premises is generally regarded as fair by both landlords and tenants." This could be used as ammunition by landlords seeking to change the terms of outdated leases on renewal.