Most commercial leases contain a fairly prescriptive rent review process, including terms for how to resolve any dispute between the parties as to the applicable rent and mechanisms for any adjustments to rent payable once the dispute has been resolved.

The recent High Court case of Rongotai Investments Ltd v Blaylock (As Trustees of Blaylock and Kerekes Family Trust) [2023] NZHC 2599 contains an interesting analysis of a rent review provision that was silent as to how any rent review dispute or adjustments should be handled.

The case involved Glasgow leases for 21 year perpetually renewable terms. The rent was reviewed at 7 yearly intervals to 5% of the Government Valuation (GV). Much of the case concerned the correct contractual interpretation of the rent review clause (Rent Review Clause) so we set this out here:

‘...for each succeeding period of seven years... during the currency of this lease and of any new lease granted in pursuant of these presents the yearly rental shall be a sum equal to five dollars per centum of the Government Valuation of the said land hereby leased in force on the first day of January of the year in which the particular period of seven years shall commence AND the Lessor shall prior to the commencement of each seven year period notify the Lessee in writing of the yearly rental that shall be payable by the Lessee during that seven year period.’

Given that the reviewed rent was therefore based on the GV, it is not surprising that the parties had variously lodged objections to the GVs for the ratings periods in 2007, 2012, and 2015 under the Ratings Valuations Act 1998. The objections were determined by the Land Valuation Tribunal in a series of decisions in 2019 and 2020. The lessor, Rongotai Investments Ltd (Lessor), appealed each of those decisions to the Land Valuation Court and the lessee defendants, Roger Max Blaylock and Yvonna Maria Kerekes as trustees of the Blaylock and Kerekes Family Trust; Bunnings Ltd and NZ Cash Flow Control Ltd (Lessees) variously cross-appealed the Land Valuation Tribunal decisions.

The Land Valuation Court found that the Land Valuation Tribunal had erred in its determinations. Consequently, the decisions of the Land Valuation Tribunal were set aside and the GVs were substituted with new, higher valuations for the properties. This in turn meant that the GVs for the relevant properties for the relevant rating periods were higher than the GVs that were used to set the rent for the relevant rent review periods.

The Lessor then duly issued notices of backdated rent adjustments to each of the Lessees, based on recalculations of the rent owing as a result of the outcome of the objection process, and the proceeding concerned the Lessor’s claim against the Lessees for backdated rent (which, in total, amounted to approximately $1.3 million).

The case was to hear the Lessees’ applications for summary judgment and/or strike out in respect of the Lessor’s claim.

Key issue

The Lessor’s claim turned on whether the Rent Review Clause provided for the recovery of backdated rent where the GV was subsequently increased through the GV objection process.

The Lessor and Lessees agreed that the Rent Review Clause was fundamental to the Lessor’s underlying claim and to the Lessees’ applications for summary judgment and/or strike out. Therefore, in considering the above question, the Court considered the principles of contractual interpretation to determine how the clause should be construed. Referring to Firm PI 1 Ltd v Zurich Australian Insurance Ltd, the High Court affirmed in paragraph 60 that an objective interpretation is the proper approach.

“The aim [is] to ascertain the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract”.

The Court recognised, in paragraph 31, that an objective approach accords with the desirability of certainty which is needed for the ‘conduct of commerce [and] of holding people to the bargains they make...’ However, the Court stated that a clause should be read in context so that the promotion of commercial certainty doesn’t erode the parties’ intentions.

Does an objective interpretation of the Rent Review Clause provide for the recovery of retrospective rent where the GV is subsequently varied?

The Lessees contended that an objective interpretation of the Rent Review Clause required the rent to be fixed at a sum to be determined prior to the commencement of the relevant 7 year period. In their view, a subsequent alteration of the GV might become applicable to a future rent review occurring after the date of alteration, but can have no retrospective impact on the existing yearly rental that has already been set for the relevant 7 year period. In other words, the rent for each 7 year period is ‘fixed and immutable’ once notified by the Lessor based on the GV in force at the commencement of the seven-year rental period, reflected in paragraph 33. The Lessees posited, in paragraph 56, that such an interpretation allowed for finality and certainty. 

The Lessor, on the other hand, primarily submitted that an objective interpretation of the clause would necessarily lead the reasonable person to understand that the rent payable for any given rental period is based on the ‘correct’ GV, as opposed to any GV notified at the commencement of the 7 year period. The Lessor also asserted that, where the correct GV is determined later, the corrected valuation can take effect retrospectively. It cited CH Bailey Ltd v Memorial Enterprises Ltd in support of this proposition and as precedent for retrospective increase in rent. It said that the use of the words ‘Government Valuation’ means that the parties must be taken to have understood that the rent review process was subject to the well-known statutorily-prescribed objection procedures under the Rating Valuations Act. Given that the Ratings Valuations Act expressly provides that the corrected valuation applies retrospectively, the parties must be taken to have understood that the GV could change and that the ultimate settled GV would be taken, as a matter of law, as applying retrospectively.

The Lessor further submitted that this retrospective approach fits comfortably with the case law in commercial lease disputes. In CH Bailey Ltd v Memorial Enterprises Ltd the English Court of Appeal interpreted a rent review clause which provided that increased rent, when ascertained, ‘shall be substituted from such date’ (i.e. the rent review date) and that, although the reviewed rent may be ascertained later, the increased rent was to be paid from the earlier date meaning that it ‘operates retrospectively’. Further, it contended that the implication of ‘correct’ into the Rent Review Clause is necessary to give business efficacy to the leases.

Additionally, the Lessor argued that the requirement that it give tenants notice of the yearly rent payable in advance of each 7 year period does not render ‘time of the essence’ for the purposes of identifying the quantum of the rent to be paid. It relied on United Scientific Holdings Ltd v Burnley Borough Council in submitting that time is not generally ‘of the essence of the contract’, including rent review clauses, except where it is inequitable not to treat the failure of one party to comply exactly with the stipulation as relieving the other party from the duty to perform their obligations under the contract. It pointed out that it had given the notices required under the Rent Review Clause and therefore no inequity arises. In its view, the fact that the quantum was to be subsequently corrected does not invalidate the notice given or mean that the quantum of rent in the notice must continue to apply. 

The Lessees considered that both CH Bailey Ltd v Memorial Enterprises Ltd and United Scientific Holdings Ltd v Burnley Borough Council could be distinguished because they involved materially different rent review mechanisms to the Rent Review Clause. In particular, those mechanisms provided for the rent to be determined by arbitration which triggered a retrospective payment of the new rent as an expected consequence. In their view, the Rent Review Clause here by contrast required the rent to be determined with ‘certainty and finality’ prior to the commencement of each 7 year period.

The Lessor also contended that a correct interpretation of the Rent Review Clause requires consideration of the parties’ conduct in undertaking their contractual obligations after the leases were entered into.

High Court Decision

The High Court concluded that the Lessor had a ‘tenable argument’ that the parties were to be taken to have intended that the GV used to set the rent for each 7 year period would be the correct GV, not simply the valuation notified prior the commencement of the relevant 7 year period. This would entitle the Lessor to retrospective recovery of underpaid rent. The Court accepted that an alternative interpretation would result in commercial absurdity in the event that a mere mistake, such as valuing the rent at $1, would cause a Lessor to suffer considerable loss for the entirety of the rental period. 

The judge stated that ‘an interpretation of the rent review clause such that it has retrospective effect poses [no] problems.’ 

He noted that such a construction of the clause does not result in unfairness as the Lessees would be merely paying rent that would have been payable had the correct GV been imposed at the outset: the Lessees had use of the money for the period of time that the incorrect GV was in force and had therefore ‘benefitted from the error’.

Commentary

Contractual certainty has long been endorsed as a foundational principle of contract law. The issue before the High Court in Rongotai Investments Ltd was whether the Lessor was entitled to retrospective adjustment of rent pursuant to a successful challenge of the GV in the Land Valuation Court. In determining the matter, the Court ultimately had to determine whether the reviewed rent is ‘fixed’ once implemented at the commencement of a rent term, or may be subject to retrospective change.

This case did not involve a substantive determination of the issues but it does prompt interesting considerations for analysing and drafting rent review clauses. In particular, what do the parties consider should happen in the event of either an error in the setting of a new rent and/or a dispute? Should it be open to either party to require a retrospective re-calculation, necessitating a refund or top-up for any over or under payments or should the calculation be expressed as final and binding on the parties (perhaps excepting only any manifest error)? Greater certainty, through express provisions drafted into the rent review clause, may be preferable over the need to rely on the Court for contractual interpretation.

It will be interesting to follow this case to learn the outcome of the Court’s substantive determination. However, based on the judge’s reasoning and comments, we suggest that outcome would favour the Lessor.