There has not been a shortage of reported cases in the area of commercial landlord and tenant in 2006. Some are merely concerned with the construction of lease wording, some provide a reminder of basic principles and a few even indicate a degree of development of the law. We also have much to look forward to in 2007, independently of what the courts decide. Let us start with case law.

General issues

The only decision that merits mention under this heading is that in Kilmartin SCI (Hulton House) Ltd v Safeway Stores plc [2006]. There, Patten J had to interpret provisions found in the RICS Code of Measuring Practice (fifth edition). The Code defines net internal area (NIA) as ‘the usable area within a building measured to the internal face of the perimeter wall at each floor level’, subject to certain express exclusions. He held that ‘usable’ in this context meant use for any sensible purpose in connection with the purposes for which the premises were to be used. It did not mean that each and every part of the NIA had to be capable of being used for the purposes for which the premises as a whole were to be used, in this case Class A1 Retail. Furthermore, areas could fall within the NIA whether or not they could be strictly classified as ‘floor’ area.

This is possibly the first reported occasion when the court has had to interpret a provision of the Code. The decision emphasises the need for practitioners to consider the appropriateness of the definitions in the Code before simply incorporating it by reference into documentation.

Rent and rent review

There are four cases to consider:

Geared rents

The main issue in Watergate Properties (Ellesmere) Ltd v Securicor Cash Services Ltd [2006] was the treatment on rent review of a fixed additional rent reserved by the lease. The arbitrator had deducted from his determination of the then market rental value of the premises the amount of the additional rent. The landlord appealed under s69 of the Arbitration Act 1996 on the basis that the award was obviously wrong, and asked the court to reinstate the additional rent as part of the rent payable. Lewison J allowed the appeal, holding that the arbitrator’s decision was wrong. To achieve the commercial purpose of the lease, the hypothetical lease had to be deemed not to contain an obligation to pay any additional rent.

The courts have long recognised that the hypothetical tenant in such a case must be assumed to adjust their bid downwards, so that the ultimate result on review is a rent that reflects the then open-market rent for the premises. In other words, the benefit of the additional rent is lost. It is the job of the draftsman to counter this expressly.

How to view the premises

In Earl Cadogan & anr v Escada AG & ors [2006] the court had to decide whether the rent review clause assumed a single unit or two adjacent units. (The tenants had taken a lease from the landlord of two adjacent retail units with the intention that they should be combined into one by the tenants.) HHJ Mackie QC held that the premises should be valued as two separate units, as they stood at the commencement of the lease. While the clause in question might not be commercially realistic, it was clear. Read literally, it led to this conclusion. It was neither ambiguous nor incapable of implementation. There were no rival constructions between which the court could make a commercially sensible choice.

This is a reminder that where the wording in question is clear and unambiguous on its face, the court has limited ability to apply the presumption-of-reality approach. It is also a reminder of the need, on occasion, to have a separate (and probably extended) definition of ‘demised premises’ for the purpose of rent review.

Section 17 notices

The decision by Hart J in Scottish and Newcastle plc v Raguz [2006] has set the proverbial cat amongst the pigeons, at least as far as property managers are concerned. Two registered leases held together had been transferred twice. Rent reviews due respectively in 1995 and 1996 were not completed until 2000. At that point, the landlord served notices pursuant to s17 of the Landlord and Tenant (Covenants) Act (LT(C)A) 1995 in Form 1 on the original tenant. These covered, in each case, the current quarter’s rent and the arrears of increase due from the rent review date. (Section 17 requires notice to be served ‘within the period of six months beginning with the date when the charge becomes due’.)

The specific question for the court was whether this was the correct procedure. Alternatively, should the landlord have served notices in each case in Form 1 (containing the appropriate warning) within six months of each rent day on which the reviewed rent first accrued – even though at that point it could not be demanded from the tenant because its amount had not been fixed, and then served notice in Form 2 within three months of the date on which, having been determined, the reviewed rent became capable of demand.

The judge held that the latter was the correct procedure, despite the fact that it could, in some cases, have an odd result. (For instance, the Form 1 notices might well have to show a nil liability.) Any other conclusion would cause unfair hardship to the original tenant.

It follows that a landlord wishing to preserve its position in relation to a former tenant or former guarantor, while a rent review is pending, must serve Form 1 notices (containing the appropriate warning) throughout and a Form 2 notice when the rent review has been concluded.

Equitable set-off

Finally, under this heading, we come to Edlington Properties Ltd v JH Fenner & Co Ltd [2006]. Here the Court of Appeal confirmed the first-instance decision of Bean J. The appeal judges held that where the reversion to a lease is transferred, the tenant cannot set off against rent falling due after the date of the transfer a damages claim arising out of a breach by its former landlord, unless the lease specifically provides for this. They emphasised the personal nature of a right of equitable set-off. This suggests that a tenant under an agreement for lease containing development obligations should consider insistence upon provisions that preserve its rights of equitable set-off both against the original landlord and any successor landlord.

Landlord and tenant covenants

Here we concentrate on just two cases.

Exclusion of liability

In Avonridge Property Co Ltd v Mashru & ors [2006] the appellant had granted lengthy subleases to the respondents in return for substantial premiums. In each sublease the appellant had covenanted to pay the rent reserved by the headlease but had sought to qualify that covenant by the addition of the words:

… but not, in the case of [the appellant] only, so as to be liable after the landlord has disposed of its interest in the property.

The appellant did subsequently assign the headlease to a third party. The issue for the House of Lords was whether the appellant still remained liable to the respondents, following that assignment.

The House of Lords, by a majority of four to one, held that the appellant did not remain liable. The covenant bound the appellant’s successors in title. Accordingly, it was a landlord covenant of the tenancy. However, the qualifying wording did not fall foul of the antiavoidance provisions contained in s25(1) of the LT(C)A.

Lord Nicholls stated that there was nothing in the 1995 Act to suggest that the statute was intended to exclude the parties’ ability to limit their liability from the outset in whatever way they agreed. The statutory release provisions were intended to provide an additional route whereby a landlord could achieve a release from obligations that would otherwise survive the transfer of the reversion. The legislation was not intended to close any other exit route available.

This decision has attracted some adverse comment, not simply because five judges, namely the judge at first instance, three members of the Court of Appeal and one law lord, took the opposing view. Landlords’ solicitors now have to consider, as a practical risk-management issue, whether they should automatically include an exclusion provision of this kind in leases that they draft.

Extent of the obligation to repair

Janet Reger International Ltd v Tiree Ltd [2006] involved an unsuccessful claim by a tenant for specific performance of a landlord’s repairing obligation in relation to the structure of premises within a building that had been redeveloped. Under the lease, the landlord covenanted to use reasonable endeavours to maintain, repair and renew the structure. The basement began to show signs of damp. The cause was identified as a defectively installed damp-proof course. As a result the tenant was forced to relocate.

The deputy judge dismissed the claim, holding that there was no disrepair. (On the evidence, there was no deterioration to the bricks or blocks in the structural walls.) The fact that there was a loss of amenity owing to bad workmanship did not automatically mean that there was disrepair. The obligation to repair did not require the landlord to remedy defective workmanship that had not been the cause of damage to the structure, even though the defect might make the demised premises unsuitable or unfit for occupation.

A tenant of newly developed or redeveloped premises should always seek adequate warranty protection in relation to the possibility of defects in design, construction or materials resulting in either damage to the premises or a loss of amenity.

Forfeiture and termination

There are five cases here to review:

Curing a mistake by construction

The lease in Littman v Aspen Oil (Broking) Ltd [2006] contained a mutual break right exercisable on not less than six months’ notice in writing. It was expressly provided that, in the case of a landlord’s notice, the tenant must have paid the rent and observed the tenant’s covenants in the lease for the lease to determine at the break date. The tenant served notice to determine the lease, contending that its right to do so was unconditional. The landlord argued that as the tenant had not complied with the tenant’s covenants in the lease, the break notice was ineffective.

At first instance, Hart J held that the break clause was an absurdity. He accordingly construed the words ‘in the case of notice given by the landlord’ as meaning ‘in the case of a notice given by the tenant’. The tenant appealed. The Court of Appeal decided that the judge was correct to hold as he did. This is a useful example of the court correcting an obvious error in the lease by means of construction rather than rectification. Two conditions must be satisfied for such an error to be corrected as a matter of construction. There must be a clear mistake on the face of the document and it must also be clear what correction ought to be made to remedy the mistake.

Rectification: the only possibility

Against that, in KPMG LLP v Network Rail Infrastructure Ltd [2006] Blackburne J was not prepared to construe a lease as if eight lines of apparently omitted text had been reinstated. (The earlier agreement for lease indicated the error.) While recognising that the agreement for lease was a relevant background circumstance, he said that it was essential in such a case for it to be clear to the court not only that words had been omitted, but also what those words were. Here this was difficult because it was clear on the evidence that after the agreement for lease had been entered into, the parties had gone on further to amend the terms of the draft lease.

However, he held that there should be rectification of the lease on the basis of mutual mistake, notwithstanding that the negotiations had been carried on over 20 years earlier and that the landlord had discovered the mistake six years previously.

What constitutes material compliance?

The Court of Appeal gave firm guidance in Fitzroy House Epworth Street (No 1) Ltd v The Financial Times Ltd [2006] on the test for material compliance with lease obligations in the context of a conditional break right. (The landlord had contended here that the tenant was in breach of its obligations on the basis that the premises remained in disrepair. Accordingly, the lease had not been terminated.)

In holding that the first-instance judge had applied the wrong test, the appeal judges said that the issue of material compliance had to be determined on an objective basis. The motivation of the parties and their conduct was irrelevant. Materiality had to be assessed by reference to the landlord’s ability to relet or sell the premises without either delay or undue expenditure.

It is interesting to note that the Court of Appeal also confirmed that there is no practical difference between ‘material’ and ‘substantial’ in such a case.

A compromise agreement

A tenant’s break right also featured in Legal & General Assurance Society Ltd v Expeditors International (UK) Ltd [2006]. There, the tenant served a break notice in June 2003, purporting to determine its lease on 30 December 2004. The break right was conditional, inter alia, on compliance with the tenant’s covenants and delivery of vacant possession. Following discussions about the tenant’s accrued liability for repairs, the landlord and tenant entered into an agreement in October 2004 whereby in consideration of a payment by the tenant of £172,000 the landlord released the tenant from all liability past and present under the lease.

After the break date, the landlord claimed arrears of rent and service charge, contending that the tenant had failed to give vacant possession. At the break date, it had left quantities of unwanted property on the demised premises, its personnel were still clearing up and it had failed to surrender the keys. The tenant argued that the October 2004 agreement settled all claims between the parties, including the exercise of the break rights. The lease had therefore been validly terminated.

Lewison J found for the tenant, holding that it was an implied term of the agreement that the break notice was to take effect and that the landlord had waived its right to compliance with the remaining conditions set out in the break clauses.

The judge went on to say that, had it been necessary to decide the point, he would have held that the tenant had breached its obligation to give vacant possession since the landlord could not have gone into occupation on the break date without difficulty.

Possession can also be shared

Last under this heading we come to Akici v LR Butlin Ltd [2006]. There the Court of Appeal overruled the decision in Tulapam Properties Ltd v De Almeida [1981], which had held that it was impossible for a tenant to share possession (as opposed to occupation) of demised premises. The appeal judges said that the concept of sharing possession can arise where the tenant shares possession in the form of joint ownership. (Here the tenant had allowed an unconnected company to trade from the premises for two years.) The lease in question contained a covenant by the tenant not to assign, underlet or part with possession of the demised premises, nor to share possession of them. The landlord’s section 146 notice, however, referred to a parting with possession only and was therefore bad. The landlord’s attempt at forfeiture accordingly failed.

Business lease renewals

There are only two cases to look at in this context:

An intention to demolish

In Wessex Reserve Forces & Cadets Association v White & anr [2006] the landlords opposed renewal on the ground that they intended to demolish or reconstruct. All the structures on the premises, save for one small stone shed, had been placed there by the tenant and the terms of the lease obliged the tenant to remove these at the expiry of the term. The question whether the landlords satisfied the ground of opposition was ordered to be tried as a preliminary issue.

The deputy judge held that the structures were tenant’s fixtures, and ruled in favour of the tenant. A landlord would generally be unable to establish a reasonable prospect of demolishing a tenant’s fixtures since the tenant would usually remove its fixtures at the termination of the tenancy. The evidence in the present case was that the tenant intended to do so. The landlords appealed. The Court of Appeal dismissed the appeal, holding that the ground in s30(1)(f) of the Landlord and Tenant Act 1954 had not been made out. If the tenant complied with its obligations at the end of the term, there would be no buildings in respect of which the landlords could have an intention to demolish.

The authorities make it clear that in such circumstances the landlord must not only have a firm and settled intention to carry out the works in question, it must also establish that it has a reasonable prospect of being able to bring that state of affairs about by its own act of volition.

Sublet and renew

The decision in Pointon Group York plc v Poulton [2006] takes more space to cover. There the landlord had let a suite of offices to the tenant for a term expiring on 23 June 2005. The lease included the right for the tenant to use certain identified parking spaces, during normal business hours, in connection with its business. In June 1998, the tenant sublet the offices to a firm of solicitors for a term expiring on 20 June 2005. It continued, however, to use the parking spaces in connection with other premises it occupied within the same building. In early 2005 the tenant decided that it wished to re-occupy the offices for the purpose of its business after the subtenants had vacated on the expiry of the sublease. In May that year, the tenant informed the landlord of this.

The subtenants, to comply with their obligations under the sublease, employed contractors to decorate and re-carpet the offices, and to install telephone and computer equipment. While this work was being undertaken, the tenant’s representatives attended on no less than two separate occasions in order to plan how the offices might be used in the future, and to check on progress of the works. The decorating and re-carpeting works were completed on 21 June 2005, the day after the sublease expired. During this time, the parking spaces also continued to be used by the tenant’s employees.

On 24 June 2005, the day after the lease expired, the landlord changed the locks to the offices, so denying the tenant further access to them. The landlord also clamped a number of cars parked by the tenant’s employees in the parking spaces. On 8 July 2005 the tenant served a request for a new tenancy on the landlord pursuant to s26 of the Landlord and Tenant Act 1954. The validity of the section 26 request hinged upon whether the lease had been continued beyond its contractual expiry date by virtue of the 1954 Act.

The issues for the Court of Appeal were principally whether:

• the right to use the parking spaces constituted ‘premises’ that could be ‘occupied’ by the tenant for the purposes of s23(1) of the 1954 Act; and

• the events occurring during the period of three days between the expiry of the sublease and the expiry of the lease were capable in law of amounting to occupation by the tenant for that purpose.

On the first issue, the Court of Appeal held that the right conferred on the tenant by the lease to use the parking spaces did constitute ‘premises’ that could be ‘occupied’ by the tenant for the purposes of s23(1) and, on the facts, were occupied by the tenant. An incorporeal hereditament could constitute premises for the purposes of s23(1). Furthermore, incorporeal hereditaments were capable of occupation. The earlier decision of the Court of Appeal in Land Reclamation Co Ltd v Basildon District Council [1979], while holding that a right of way could not be occupied, was not authority for the proposition that no incorporeal hereditament can be occupied.

On the second issue, the Court of Appeal held that the tenant had been in occupation of the offices for the period of three days between the expiry of the sublease and the expiry of the lease. Applying Bacchiocchi v The Academic Agency Ltd [1998] it was held sufficient for the tenant to use the premises ‘in some other way as an incident in the ordinary course or conduct of business life, provided that the premises are occupied by no other business occupier and are not used for any non-business purpose’.

The activities of the tenant’s representative were clearly incidental to the tenant’s business. The carpet layer was performing an activity for the purpose of the tenant’s business even though he was employed by the subtenants in order to fulfil their obligations under the sublease.

(In Bacchiocchi the Court of Appeal had held, in the context of the compensation provisions in ss37 and 38 of the 1954 Act, that a tenant could occupy for the purposes of its business without being physically present provided that it was using the premises in the ordinary course or conduct of business life and that no one else was in occupation.)

Apart from deciding a number of technical issues, this case also provides a neat illustration of the ease with which a tenant who has sublet the whole of its business premises may get back into occupation immediately before the expiry of the contractual term of its lease and then claim a new tenancy.

What lies ahead?

The present position with regard to the Code of Practice for Commercial Leases is that the joint working party was reconvened earlier to look at the possibility of producing a stronger and more concise code, an easily disseminated guide for tenants, and model heads of terms reflecting the guidance contained in the Code of Practice. The new edition of the Code of Practice should appear shortly, ahead of the other two items. At the same time, the British Property Federation is considering an accreditation scheme to demonstrate the industry’s commitment to a new version of the Code of Practice

(Slightly less newsworthy is the fact that at the same time, the RICS Property Measurement Group is apparently considering a redraft of the Code of Measuring Practice.)

Staying with guidance, ‘Service Charges in Commercial Property: RICS Code of Practice’ will have effect from 1 April 2007. Whilst also voluntary, it is suggested that the new Code of Practice will have more prominence by virtue of its status as an official RICS guidance note. It is specifically endorsed by the British Property Federation, the British Retail Consortium, the British Council for Offices, the British Council of Shopping Centres and the Property Managers Association, and is applicable to England and Wales only. (What promises to be a worrying report following the 2006 Loughborough University Enterprises study into service charges may also be a motivating factor.)

We may also see further amendments to the Landlord and Tenant Act 1954. Before the Regulatory Reform (Business Tenancies) (England and Wales) Order 2003 came into force on 1 June 2004, the government gave an undertaking to review the impact of the reforms at the end of one year and to report back to Parliament. Largely with the assistance of a panel made up of representatives of the main industry and professional bodies and of a number of prominent commercial property lawyers, the Department for Communities and Local Government has recently submitted a report to Parliament. It makes recommendations for a number of amendments to the existing legislation. (Unsurprisingly, the majority relate to the process of contracting out.)

The remedy of distress may soon cease to be available to commercial landlords, at least in the form we presently recognise. In July of this year, the Tribunals, Courts and Enforcement Bill was published in draft, with detailed explanatory notes, to invite comment before a version is introduced into Parliament. Part 3 abolishes the common law right to distrain for rent arrears and replaces it – in the case of commercial premises – with a modified ‘out of court’ regime to be known as commercial rent arrears recovery. Such changes are regarded as long overdue.

To conclude, the Law Commission has just published its final report on termination of tenancies for tenant default, together with a draft Bill. Perhaps 2007 will at last see this area of the law effectively codified.