The implications were that the market value was significantly discounted. Peter Lewis, Patner at Rosling King, discusses the dangers to landlords of early break clauses in commercial leases.
Britel Fund Trustees Limited (“Britel”) was the landlord of a retail DIY warehouse of approximately 37,000 square foot in Tottenham Hale Retail Park, and had applied for the grant of a new tenancy under Part II of the Landlord and Tenant Act 1954 (the “1954 Act”). All the terms had been agreed with the tenant, B&Q plc (“B&Q”), save for the annual rent and interim rent. On the advice of an expert surveyor, Britel suggested an annual rent of £698,500 (or £18.90 per square foot) whereas B&Q, on the advice of its own valuer, argued for an annual rent of £281,000 (or £7.60 per square foot).
Of fundamental importance to the decision was the existence of an early mutual rolling break clause.
The parties agreed that there were two main issues:
- should allowance be made for a three month so called ‘rental holiday’?
- what is the open market rent for the lease with its break clause?
Applicable law
Section 34 of the 1954 Act stipulates that in default of an agreement between a tenant and landlord, a court may determine the rent payable under a tenancy granted by a lease, having regard to the terms of the tenancy, but disregarding matters including:
- any effect on rent of the fact that the tenant has or his predecessors in title have been in occupation of the premises;
- any goodwill attached to the premises by reason of the carrying on thereat of the business of the tenant; and
- any effect on rent of an improvement carried out by a person who was the tenant at the time the improvement was carried out, and who was not obliged to do so under an obligation owed to their immediate landlord.
Rent free period
In addressing whether allowance should be made for a three month ‘rental holiday’, HHJ Mitchell considered the conflicting decided cases. One school of thought appears to take a narrower approach, reluctant to import any factors not stipulated in the 1954 Act. On the other side, there is a greater willingness to give due regard to the comparables. The Court opted with the latter approach and one favoured in recent decisions by finding that a rent free period of three months would be granted and applied over the entire ten years of the lease. Further to this, the Court added that when considering comparables, like must be compared with like.
Open market rent
Complications arose due to the presence in the new lease of the early break clause. The Court agreed with B&Q’s argument that the market rent should be determined on the basis that the hypothetical tenant would be a discounter (i.e. a tenant who only requires a quick fit out of the premises and trades at a discount rate) rather than as a DIY retailer.
This is because the mutual rolling break clause, which drew considerable attention in the valuation, meant that Britel could exercise the break when B&Q would have been trading for less than 2.5 years, when the time required to fit out the premises is considered. Indeed, both experts contended that no DIY retailer would have taken a lease with this early break clause. The Court found that the market rent payable by a discounter was £466,940 per annum whereas it would have been £603,100 for a DIY retailer. HHJ Mitchell made this valuation without the benefit of comparable evidence owing to the lateness of this concession at the hearing.
Having established that the hypothetical tenant would be a discounter, it was necessary to determine the discount to reflect the early break clause. The Court held that the discount for a DIY retailer would be 25 per cent whereas it would be 20 per cent for a discounter. After applying the discount, the valuation was found by the Court to be £373,700 per annum. This represents a striking difference to the £603,100 per annum valuation (assuming the lease did not have any break clause) HHJ Mitchell would have found for the landlord, had the early break clause not rendered the lease unsuitable for any retailers other than discounters.
Post-Britel Fund Trustees Limited lessons
There are no indications that the decision will be appealed. Landlords should consequently think carefully about inserting an early break clause into commercial leases and be mindful of who the hypothetical tenant is. It was illustrated in this case that both factors can have a pronounced impact on market value that is difficult to ignore. The Court firstly discounted the market value owing to the early break clause. The value was further reduced when the Court conceded to the opinion of the experts, who stated that no DIY retailers would accept the early break clause, meaning that the hypothetical tenant was not a “willing lessoree.”
The case also illustrates that a court may adjust the market rent to take into account a rent free period and that comparable evidence should be carefully reviewed to ensure the comparisons are on a like-for-like basis and appropriate adjustments made.
