Alan Hyam OAM, Australian Lawyer, practised at the NSW Bar for 37 years retiring on 30 June 2018. This article examines the principles extracted from recent court decisions relating to the determination of rent reviews pursuant to the relevant provisions contained in leases of commercial and retail premises. He will be delving further into this topic at the Retail and Commercial Leasing Review on Tuesday 16 March 2021.
Introduction
During the past twelve months or so a number of important decisions have been handed down by Australian courts which contain principles of law and valuation relevant to the determination of rent reviews of commercial and retail premises. These decisions are particularly relevant to lawyers and property professionals, who specialise in property law, in particular rent review determinations, and landlord and tenants of such premises.
Nature of Valuation
The general features and the essential nature of valuation was examined by Bell P in his dissenting judgment in Strike Australia Pty Ltd v Data Base Corporation Pty Ltd [2019] NSWCA 205. That case concerned an appeal arising from the determination of the market rent of premises in which the valuer was required by the relevant rent review clause of the lease to have regard to rents of comparable premises in the vicinity of the demised premises. His Honour also remarked on the difference between a person acting as an expert and as an arbitrator which is referred to herein. It must be noted that many of his Honour’s pronouncements in these regards are obiter dictum. However, I consider that the fact that the judgment was dissenting and some of his Honour’s remarks are obiter dictum, does not diminish from there relevance.
Bell P observed at [9] that the High Court has recognised on numerous occasions that the valuation of land (which his Honour took to include the determination of market rent) is an art and not a science. A number of High Court decisions were cited including Boland v Yates Property Corp Pty Ltd [1999] HCA 64; (1999) 167 ALR 575 in which Callinan J commented at [277]:
‘It should also be firmly kept in mind that valuation practice, like legal practice, cannot be an exact science. Both require the exercise of judgements and forming of opinions, often on matters in respect of which certitude is impossible and uncertainty highly likely.’
His Honour referred, at [10], to a number of other cases which contained similar statements. In Western Australian Planning Commission v Arcus Shopfitters Pty Ltd [2003] WASCA 295 McLure J likened, at [11], a valuation exercise to the exercise of judicial discretion, and observed at [71]:
‘…there is significant scope for legitimate variations in approach and method and it is inappropriate to formulate rigid rules as to what is required.’
Bell P remarked at [12] that valuation involves ‘subjective judgment and the steps in reasoning will not always be able to be articulated fully’, and cited a relevant passage from the Privy Council decision in Secretary of State of Foreign Affairs v Charlesworth Piling & Co [1901] AC 373 at 391. His Honour also cited authorities regarding the requirement that all relevant factors must be taken into account and expressed five key points at [22] which provide an overview of the both topics of ‘nature of valuation’ and meaning of ‘acting as an expert and not an arbitrator’.
Construction of Rent Review Clauses
The complex principles regarding the construction of the provisions of a contract requiring an expert to determine a dispute between the parties was examined by Hammerschlag J in Lainson Holdings Pty Ltd v Duffy Kennedy Pty Ltd [2019] NSWSC 576 at [44].
A brief summary of the principles of statutory construction is contained in the judgment of Nichols J in Redgum Developments Pty Ltd v GB Education Ltd [2020] VSC 142 at [34].
The general principles concerning the construction of contractual arrangements were considered in some detail by Archer J in Pilbara Iron Company (Services) Pty Ltd v Chevron (TAPL) Pty Ltd [2020] WASC 296 at [18]-[23] in the context of whether notice was effectively served outside of a stipulated time period under the provisions of a long term contract for the sale of natural gas. A summary of the general principles of contract construction by the Western Australian Court of Appeal in Black Box Control Pty Ltd v Terravision Pty Ltd [2016] WASCA 219 at [42] were cited by his Honour in Pilbara at [18]. The reasonable businessperson approach to construction were examined by Archer J at [19]. The question of whether a term of a contract is essential was examined by his Honour at [22]-[23].
Annual Market Rental Value
The term is defined in s 37(2) of the Retail Leases Act 2003 (Vic) [‘RLA’]. Similarly worded clauses are to be found in RLAs, or Acts with similar names, in most States and Territories. The following phrases are taken from s 37(2).
Willing landlord and willing tenant
A discussion on the willing landlord and willing tenant concept by Donaldson J in FR Evans (Leeds) Ltd v English Electric Co Ltd (1977) 38 P & CR 185 at 189 was cited and examined by Kyrou and Niall JJA, in the majority judgment, in Bevendale Pty Ltd v Lucky Eights Pty Ltd [2020] VSCA 312 at [127], [130].
An arm’s length transaction
The term ‘an arm’s length transaction’ was explained in the majority judgment in Bevendale at [131].
Free and open market
This term was discussed by the majority in Bevendale at [125]-[126].
Having Regard To
The term ‘having regard to’ in the context of s 37(2) of the Retail Leases Act 2003 (Vic) was considered by Nichols J in Redgum Developments Pty Ltd v G8 Education Ltd [2020] VSC 142 at [41]-[43]. His Honour remarked in relation to s 37(2), at [27]:
‘It delimits the valuer’s task by directing what it is the valuer is to determine when he or she determines “current market rent”.’
The phrase ‘having regard to these matters’ in s 37(2) was briefly explained by Kyrou and McLeish JJA at [132] that it:
‘indicates that the enumerated matters must be considered by the appointed valuer as part of the framework for assessing the market rent for the relevant premises’.
Have Regard To
The related term ‘have regard to’ was considered in detail in the context of ‘comparable premises in the vicinity of the demised premises’ by Bell P, in his dissenting judgement, in Strike Australia Pty Ltd v Data Base Company Pty Ltd [2019] NSWCA 205. The President recognised at [24] that:
‘the meaning of the phrase … may of course differ between contract and statute’.
His Honour relied on two decisions of the High Court and held that whilst the valuer was required to have regard to ‘comparable premises in the vicinity of the demised premises’, the valuer was permitted to have regard to comparable premises not in the vicinity of the demised premises, and does not exclude the valuer from having regard to matters not expressly referred to in the statute.
The Same or Substantially Similar
The sub-phrase in s 37(2) of the RLA, ‘the same, or … substantially similar’ was examined in the joint judgment of Kyrou and McLeish JJA in Bevendale Pty Ltd v Lucky Eights Pty Ltd [2020] VSCA 312 at [134].
Whether Determination Made in Accordance with the Lease
The complex question of whether a rent review determination was made in accordance with the lease was examined in detail by the NSW Court of Appeal in Strike Australia Pty Ltd v Data Base Corporate Pty Ltd [2019] NSWCA 205. The first ground of appeal was that the primary judge erred in failing to disregard the landlord’s property so that the demised premises were treated as cleared space inclusive of the landlord’s property, but otherwise serviced and usable. The legal principles in relation to the first ground of appeal were stated by Ward JA at [106]-[109], and her Honour gave her detailed reasons for dismissing the first ground of appeal at [135]-[145]. Basten JA rejected the first ground of appeal for slightly different reasons at [50], [53]. In his dissenting judgment at [22]-[29], Bell P held that the matters specified to be disregarded in the subject sub-lease were not exhaustive as to the matters to which the valuer was permitted to have regard to.
The second ground of appeal, that the primary judge erred in determining that the other comparable sale premises taken into account by the valuer were outside the vicinity of the demised premises, by Bell P at [2], Basten JA at [44]ff, and Ward JA at [159]ff.
A number of contentions that a rent review determination did not comply with the provisions of the lease were considered by Darke J in Haxglow Pty Ltd v Mirvac Retail Pty Ltd [2020] NSWSC 233. One of the contentions was that the determination did not comply with Australian Property Institute’s [API] Code of Professional Conduct in that the valuer did not comply with the requirements not to rely upon ‘information supplied by a client without appropriate qualifications or confirmation from other sources’, and did not take reasonable steps to gather relevant data; explain ‘the basis on which the opinion of value was formed’; and did not ‘ascertain and verify such relevant facts and information as a prudent valuer would have ascertained or verified in order to provide a professional valuation’. Other contentions were that the valuer did not comply with the provisions of the lease to disregard the goodwill of the business conducted on the premises; and did not have regard to lease incentives and concessions in relation to comparable sale properties.
His Honour cited the authorities upon which he relied in answering the question whether the determination was final and binding on the parties, which depended on whether the determination was carried out in accordance with the lease. Darke J also cited the decisions relied upon in considering the matter of an expert giving reasons, and explained, at [46]-[47], his conclusions regarding whether the reasons given by the valuer for his determination of the current market rent of the demised premises were adequate to disclose the essence of his method and his reasoning towards his conclusions. The matter of compliance with the code of the API was examined and explained at [50]-[54]. His Honour gave his observations regarding the disregard of ‘goodwill’, at [63]-[66], and the alleged failure of the valuer to have regard to incentives and concessions given to a lessee of comparable premises, at [67].
A rent review determination of child care premises which was challenged on four grounds contending that the determination was not made in accordance with the lease, in that the valuers did not fulfil the task required by them under the lease, in Redgum Developments Pty Ltd v G8 Education Ltd [2020] VSC 142. Nichols J summarised the governing principles at [13]-[15], in particular whether mere error or mistake amounted to a departure by the valuer from the terms and conditions of the contract. Her Honour also considered the meaning of the phrase ‘having regard to’, at [41]-[43], which has already been considered herein, and examined the four grounds of contention at [44]-[72].
Error of Law
In Lainson Holdings Pty Ltd v Duffy Kennedy Pty Ltd [2019] NSWSC 576, the resolution clause in a contract provided that disputes be referred to expert determination and that the expert was required to make a determination ‘according to law’. In the subject dispute, the expert held that Lainson had repudiated the contract which was accepted by Duffy terminating the contract, and not bound by the determination based on two arguments. The first argument was that the expert did not discharge the task entrusted to him by the contract, in that he did not make the determination the dispute ‘according to law’ which required him not to make any mistakes of law which effected the result. The second argument, cited at [31], was that ‘where parties contractually refer to an expert for determination a dispute in the decision of which a question of law becomes material … the Court can interfere where, on the face of the record, the expert has made a mistake of law’, thus, ‘the finding of the implied term it is a mistake of law which is obvious on the face of the record’. The legal principles which applied to the first argument were explained by Hammerschlag J at [38]-[43]. The meaning of the phrase ‘according to law’ was examined by his Honour at [49]-[53], who made observations concerning the second argument at [58]-[61].
Time of Essence
Pilbara Iron Company Pty Ltd v Chevron (TAPL) Pty Ltd [2020] WASC 296 concerned the question as to whether a notice issued outside of a stipulated period was effective in relation to a long term contract for the sale of natural gas. The presumption regarding time of the essence in rent review clauses was considered by Archer J at [32]-[40]. In particular, his Honour, examined the decision of the House of Lords in United Scientific Holdings Pty Ltd v Burnley Borough Council [1978] AC 904 which held that there is a rebuttable presumption that time stipulated in rent review provisions in a lease will not be essential unless that is expressly stated or necessarily implied. Reference was also made to decisions of the High Court and the NSW Court of Appeal in which the principles were accepted to be in Australia law. Archer J further considered, at [42] and [134], whether the circumstances of Pilbara were sufficiently analogous to apply the principles in United Scientific.
Application of Profits Method of Valuation to Rent Reviews of Hotels
The ‘profits method’ of valuation of hotel premises was described by the Victorian Court of Appeal in the joint judgment of Kyrou and McLeish JJA in Bevendale Pty Ltd v Lucky Eights Pty Ltd [2020] VSCA 312 at [192]:
‘Essentially, there are three steps in the process.
(a) An estimate is made of the gross income from the business. In the case of a hotel this will mean that an estimate is made of the likely income from such sources as the letting of rooms, the restaurant and bars and ancillary functions such as holding conferences or running a health club. In the case of a casino an estimate will be made of the amount which members of the club will gamble … and how much will be retained by the operators.
(b) An estimate is then made of the various expenses and outgoings involved in the operation of the premises. To take again a hotel as an example there will be staff expenses, purchasers of items such as food and drink, and outgoings such as fuel, rates , insurance and advertising.
(c) The difference between the income and the running costs is the net profit. This amount is available for the payment of rent. The final step is therefore to decide what proportion of the net profit should be taken as that which the willing lessee would be willing to pay as rent.
…
A willing lessee of premises such as a hotel would be likely to be faced with substantial initial expenditure. The rule …. that the tenant’s fixtures and all chattels are taken to be removed means that the incoming lessee would have to provide items such as bedroom furniture and equipment for the restaurant and common parts. When a comparable method of valuation is used it is not usually necessary to do a calculation of initial fitting out costs since the need to fit out the premises will be a factor already taken into account in the rent agreed or determined for the comparables. The use of the profits method entails the cost of fitting out and similar work being brought into the calculation since it is a cost which will be borne by the lessee in order to make a profit. The usual means of paying regard to this aspect of the operation is to estimate the capital cost involved and then to rentalise it over the period of the expected life of the equipment. The annual or rentalised sum will then be an item of expenditure to be put into the notional accounts. A similar process would be necessary if a willing lessee would expect to carry out improvements to the premises.’
In examining the ‘profits method’ of valuation of hotel premises in the determination of rent reviews, the majority of the Court of Appeal in Bevendale cited the following passage from the judgment of Croft J in Epping Hotels Pty Ltd v Serene Hotels Pty Ltd [2015] VSC 104 at [45]. [61]:
‘As Hill and Redman indicate this does not mean that the value of fixtures and fittings that may be required for the generation of profit through the conduct of the hotel business are necessarily excluded from the calculations required to estimate the current market rent. What it does mean is that the value is treated in the calculations in such a way that, as between the notional prior and future tenant, the value is in effect “cancelled out” so that the future tenant is not advantaged or disadvantaged in the rental calculation as a result of the prior tenant’s expenditure and owner ship of the fixtures and fittings. Clearly, in my view, this is the objective and meaning of the provisions of s 37(2) of the [RLA] which are relevant to this proceeding.
…
Thus, as explained in the preceding reasons, [the] provisions [of s 37(2))], properly construed, for the reasons indicated, do allow the Valuer to assume the existence of the tenant’s fixtures and fittings for the purpose of employing the so-called “profits method”, provided that the value of those fixtures and fittings is treated in the calculations in such a way that the value is in effect “cancelled out”.’
The decision of the Court of Appeal in Serene Hotels Pty v Epping Hotels Pty Ltd [2015] VSCA 228 was adopted by the majority in Bevendale at [196]-[199], who decided at [199]:
‘… that the profits method did not infringe the prohibition in s 37(2) of the RLA in relation to tenant’s fixtures and fittings.’
In this regard Tate JA said in Serene Hotels at [74]:
‘A valuation of current market rent is a sophisticated and multi-dimensional exercise. As mentioned at the outset, s 37(2) does not mandate any particular methodology. To be consistent with s 37(2) it is sufficient that the methodology employed ensures that any regard paid to fixtures and fittings is only regard paid to the market norms providing that the assumption of average good management and reasonable trading levels is well founded and there is no celebrity factor or enhanced or high-end fixtures and fittings.’
Robson AJA gave more detailed reasons at [97], [99]-[106].
Whether Valuations Comply with Appropriate Method of Valuation
The term ‘current market rent’ is defined for the purposes of the Retail Leases Act 2003 (Vic) in s 37(2). Similar definitions are contained in Retail Lease Acts in the other States and Territories. The provisions of s 37(2) were explained in the majority judgment in Bevendale Pty Ltd v Lucky Eights Pty Ltd [2020] VSCA 312 at [124]-[128], [130]-[137], [139]-[142], [187]-[191]. The majority explained at [124] that the phrases in s 37(2):
‘… contain key concepts which are critical to identifying the framework within which the Valuer was required to undertake his task.’
The key phrases relevantly are: ‘free and open market’; ‘willing landlord and willing tenant in an arm’s length transaction’; ‘rent … for premises (assuming) they were unoccupied’; ‘same or substantially similar use’; ‘goodwill created by the tenant’s occupation’. The majority summarised the relevant principles at [187]-[191]. In particular, their Honours referred to the ‘presumption of reality’ often applied by English courts. Under that presumption the demised premises are valued at the review date as they actually were at the review date, on the terms of the actual lease, and in the circumstances as they actually existed at that date, subject to the language of the rent review clause. Their Honours observed at [191] that:
‘The presumption has received little consideration in Australia.’
Failure to Give Reasons
The Victorian Civil and Administrative Tribunal considered in Leonelle Service Centre Pty Ltd v Rany Pty Ltd [2019] VCAT 1752 the question of whether a determination can be set aside on the ground of mistake in failing to give detailed reasons for the determination at [60]-[62]; the requirement that the valuer specify the matters which was had regard to in making the determination at [66]-[72]; and the failure of the valuer to identify the path of his reasoning at [78]-[80].
Confidentiality of Information
The vexed question of the validity of information provided to the valuer on a confidential basis was examined by the VCAT in Leonello at [73]-[74], citing s 38 of the RLA.
Difference between a Valuer acting as an Expert and an Arbitrator
This topic was discussed by Bell P in his dissenting judgment in Strike Australia Pty Ltd v Data Base Corporation Pty Ltd [2019] NSWCA [2019] NSWCA 205, which was mostly obiter dictum, at [18]-[22]. The characteristics of an expert determination as distinct from an arbitration award were summarised at [21]:
- Whilst there may be a dispute in existence rather than just a determination to avoid a dispute, there will ordinarily be a dispute of kind which can be determined in an informal way by reference to the specific technical knowledge or learning of the expert: Capricorn Inks Pty Ltd v Lawter International (Australasia) Pty Ltd [1989] 1 Qd R 8 at 15, 28; Zeke Services Pty Ltd v Traffic Technologies Ltd [2005] QSC 135; [2005] 2 Qd R 563 at [24].
- The appointee is directed to make an appraisal in money terms of property value or loss or damage or the like by the use of some special knowledge or skill possessed by him or her: In Re an Arbitration Between Dawdy and Hartcup (1885) 15 QBD 426 at 430; Capricorn Inks at 28.
…
- It has the advantage of being expeditious and economical. This is so because an expert determination is informal and experts apply their own store of knowledge and expertise to their observations of the fact s, which are of a kind with which they are familiar: Zeke Services at [27]; Straits Exploration (Australia) Pty Ltd v Murchison United NI [2005] WASCA 241; (2005) 31 WAR 187 at 192.
- Experts, unlike arbitrators, can undertake their own investigations, without disclosing them to the parties and generally can determine the question before them according to their own experience without being constrained by the contentions of competing parties: AGE Ltd v Kwik Save Stores Ltd [2001] SC 144 at 148,151.
- Experts are entitled to act solely on their own expert opinion: Palacath Ltd v Flanagan at 166.
The five following key general points were derived from an overview of the cases concerning valuation and what is meant to act as an expert and not as an arbitrator, at [22]:
- valuation is a field of specialised expertise which involves subjective judgments and evaluative choice;
- prima facie, all relevant information, that is to say matters or considerations affecting value, should be taken into account in a valuation exercise;
- ‘experts’ draw upon their own knowledge, skills and observations;
- given the broad and quasi-discretionary nature of valuation, valuers may be given some guidance by contractual parties or the legislature as the case may be as to what to have regard to and what to disregard in what may be a wide ranging exercise; but
- the ultimate exercise is a valuation (or rent determination) in respect of which the valuer is an expert and is to apply his or her expertise.
The above key points were adopted by Niall JA, in his Honour’s dissenting judgment in Bevendale Pty Ltd v Lucky Eights Pty Ltd [2020] VSCA 312, who remarked at [323]:
‘The aphorism that valuation is an art and not a science (River Bank Pty Ltd v Commonwealth (1974) 4 ALR 651, 653 (Stephen J): Boland v Yates Property Corporation Pty Ltd [1999] HCA 64; (1999) 167 CLR 575, 579-80 [12] (Gleeson CJ), 651 [277] (Callinan J) captures the idea that what is involved is a judgment, based on all relevant material, that may be made in a variety of different ways and is not singularly correct.’
Alan Hyam OAM was admitted to the NSW Bar in 1973 and retired from practice on 30 June 2018. He was the holder of an Australian Practice Certificate and practised in property law specialising in valuation and rent review matters. Alan is now designated as an Australian lawyer. During his practice at the Bar he undertook matters in several parts of Australia, and matters involving both legal and valuation principles. He was appointed as an arbitrator in major property disputes. Alan was often required to undertake valuations of a complex or unusual nature. Alan was awarded the Medal of the Order of Australia (OAM) in 1993 for services to local government and the community, having served as an Alderman of Parramatta City Council for 27 years, Mayor for six terms and Lord Mayor for three terms.
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