Plainlaw - did you know? - the law made plain - he end of upwards only rent review clauses? - The Code of Practice for Commercial Leases – the response from industry and government

The end of upwards only rent review clauses?
The Code of Practice for Commercial Leases – the response from industry and government

Background

The Code of Practice for Commercial Leases in England and Wales (2nd Edition) was launched in April 2002. Voluntary self regulation was the government’s response to its belief that inflexible lease terms and upwards only rent reviews (UORR) are unfair and bad for the economy.

The government is committed to promoting more choice and flexibility in the commercial property leasing market. It believes that UORR leaves tenants over exposed during downturns in the market.

Reading University provided an interim report on the Code in December 2002; a full report is due later this year. The interim report suggests that the Code has very little impact on commercial leases.

Consultation

On 1 June the government published a consultation paper “Commercial property leases: options for deterring or outlawing the use of upward only rent review clauses.” Its assessment of the interim report on the Code is summed up as follows in the consultation paper:

“Reading University’s interim evaluation of the 2002 Code of Practice for Commercial Leases has found that …the Code so far has had a very limited impact and that the use of UORR clauses is still deeply entrenched. Although the report finds that there is some scope for tenants to negotiate individual terms of leases, there are no signs of landlords offering alternative packages…The government is therefore now consulting on options to deter or prohibit inflexible leasing practices, focusing on the use of UORR clauses.”

Whilst the government points out that it is not yet committed to legislation the consultation paper says:

“The Government recognises that regulation of the terms of commercial leases could have unpredictable side-effects. Legislative action is always an action of last resort of Government. However, it would be justified if current voluntary measures were found not to be promoting greater fairness or efficiency in the property market or if the Government concluded that they had not satisfactorily addressed market imperfections.”

Options

The consultation document lists six options :

Option 1 – Do nothing

This option would avoid any unwanted side effects from legislation but since the voluntary Code of Practice is not seen as working, what the government sees as inflexibility in the market would remain.
Option 2 –Ban upward only rent review clauses

Legislation could be introduced requiring any periodic reviewed rent to be capped by reference to the open market rent. The legislation would also override any lease terms permitting only landlords to initiate reviews to ensure that landlords cannot prevent tenants from benefiting from the legislation but would not outlaw the use of indexation or fixed rental increases agreed at the outset of the lease.

The idea is that tenants would have the assurance that at rent review the rent would adjust to open market levels, so not placing them at a disadvantage compared with new market entrants.

This legislation would not be retrospective i.e. it would not be appropriate to legislate to change leases that are already in place. There would therefore be a two-tier market for some years.

This option could damage the investment market.
Option 3 – Ban upward only rent reviews subject to a floor of the initial rent

The government could legislate to impose upward/downward reviews, but landlords would be allowed to prohibit rents from falling below the initial rents reserved by their leases. This of course would have little impact on shorter leases where there is only one rent review during the term.

Again this could damage the investment market, although less so than Option 2.
Option 4 – Give tenants the right to break if the UORR produced a rent above open market levels

Legislation could provide for tenants to have a right to break their leases if an UORR results in a rent that exceeds the open market rent. It would also override any lease provisions permitting only landlords to initiate reviews to ensure that leases do not prevent tenants from exercising their rights to terminate because they are unable to initiate reviews.

Tenants would need to show that the current rent was above open market levels which inevitably would give rise to considerable argument between landlord and tenant.

Again, this could seriously damage the investment market.
Option 5 – Limit lease length

The government could impose a ceiling on lease lengths to limit the period of over-renting after an upwards only rent review. This would, however, sit uneasily with security of tenure. Unless the parties contract their leases out of Part 2 of the Landlord and Tenant Act 1954, landlords who grant business leases enter into virtually open-ended commitments to retain their tenants whilst tenants would only be committed to occupy premises for a minimum period.

For certain market sectors, notably in various leisure fields such as restaurants, however, longer leases are in the tenants’ interest where they have invested considerable sums in fitting out.
Option 6 – Require landlords to give prospective tenants priced options

Legislation could be introduced to require landlords to offer tenants alternatives to UORR, without prohibiting landlords and tenants from agreeing to use them. The government would not determine prices but landlords would be required to offer pricing using a standard format.

This would certainly achieve the government’s aim of greater choice but would be very difficult to police and enforce.

Landlords’ perspective

Legislation would affect property values.
The abolition of UORR would adversely affect sale and leaseback deals which are frequently used to finance business.
Falling rents would make lenders more cautious about lending against property.
Landlords may make a renewed call for the abolition of security of tenure if UORRs are banned. It seems unlikely that the government would abolish this protection for tenants.

Tenants’ perspective

UORRs need reform.
New entrants to the market have an advantage because they will be paying lower rents whilst the rents paid by existing tenants remain artificially high.
Landlords could seek substantial increases in rent in return for upwards/downwards rent reviews.

What happens now?

The consultation paper seeks responses by 30 September 2004 on why UORR clauses should remain prevalent and whether legislation should be introduced. Legislation would represent a major change in the property investment market in the UK which has taken pride in its lack of regulation and consequent attractiveness to investors.

Further information

The consultation document – “Commercial property leases: options for deterring or outlawing the use of upward only rent review clauses” can be obtained from:
http://www.odpm.gov.uk

This edition of “The law made plain” is written to provide you with general information. It is recommended that you seek specific professional advice before taking any action.