Following a sustained period of yield compression, we believe that 2007 will herald rental growth until the current shortage of supply is ended as new developments come onto the market. Rent review clauses in existing leases will be dusted down and come under great scrutiny as landlords seek to maximise rent increases. Clauses in new longer leases currently being negotiated as part of the booming pre-let market will also need to be checked very carefully.

For some time now, the ‘Presumption of Reality’ principle has taken centre stage, with valuers encouraged to value the actual arrangement between the parties at the time of the rent review as opposed to some artificial position that could be suggested by a legalistic analysis of the precise words used in the lease.

Two cases in 2006 have served reminders that the principle is still important, but that the lease wording must be ambiguous before the principle can be applied and that it is not the starting point or an overriding principle.

In Faucet Inn Pub Company Plc -v- Ottley Corporation SA, the case turned on the permitted use under the lease and how that use should be valued on review.

The permitted use was as a restaurant/bar/delicatessen or such other use within Class A1 as the landlord might approve, such approval not to be unreasonably withheld. The actual use at the time of the rent review was as a bar.

The rent review clause required the valuation to be on the assumption that the premises were ‘available to be let fit for immediate occupation and use for the permitted use’ and the landlord argued that this meant any use to which the landlord could not unreasonably withhold consent. For its part, the tenant argued that the actual current use should be the basis of valuation.

Crucially from the tenant’s point of view, the rent review clause required the valuer to disregard any rent free period which might be offered to Tenants for fitting out purposes.

Finding the lease wording ambiguous, the Judge decided that the fact that any fitting out costs had to be disregarded meant that no fitting out works would take place, leading to the conclusion that the actual current use should be valued.

Right at the other end of the spectrum was the case of Cadogan & Another -v- Escada AG and Others, confirming that where the wording is clear, no matter how unfair or divorced from reality the result, then the wording must be allowed to prevail.

In this case, the premises comprised two adjoining retail units at 194/195 Sloane Street in London at basement, ground and first floor levels, with an office on the first floor of 194 with its own staircase from the ground floor and entrance from the street. In the Lease, the tenant was under an obligation to remove the office entrance to the first floor at 194, the office partitioning, and the existing staircases in both units, and to install new staircases from the ground floor to both the basement and the first floor. These were the ‘Works’.

The rent review clause required the valuer to assume ‘the existence of the new staircases between the floors, and to disregard the Works save insofar as they include the staircases referred to above’.

At review, the tenant argued that the premises should be valued not only with the new staircases in place, but also with the old staircases still there, the office on the first floor with its own staircase still there and likewise the separate entrance to that office. The landlord understandably argued that the presumption of reality should apply to require the valuer to assess the premises as actually laid out at the time of review.

The Court sided with the tenant saying that ‘the clause is neither ambiguous nor incapable of implementation. The wording arrived at may not be very sensible from a business point of view but that is a feature of innumerable agreements reached as a result of a compromise expressed in wording that neither side would originally have chosen’.

These two cases, especially the second one, remind both parties and all their professional advisers to read carefully the final version of a document to be sure that it reflects what has been agreed and that there is no ambiguity.