8 October 2020
Red alert - Autumn 2020 – 1 of 6 Insights
The High Court has rejected the literal interpretation of an index-based rent review clause that produced arbitrary and irrational results. In coming to its decision, the Judge helpfully restated the laws governing the interpretation of commercial contracts and confirmed that this will be based on the perspective of a reasonable third party.
In this claim, Monsolar IQ Ltd was Woden Park Ltd's tenant of bare agricultural land in the Vale of Glamorgan for a term of 25 years and six months, with a tenant's rolling break option. The rent payable under the lease was subject to review annually on each anniversary of the date of grant of the Lease, with the revised rent calculated pursuant to an index linked formula.
Read literally, the effect of the formula in the first year of the lease was to increase the rent by the RPI increase over that year. However, in the second year the rent would be increased by the RPI increase over that year and the previous year. This would continue to happen throughout the term, so that by the end of year 25, the revised rent currently payable would be further increased by the aggregate RPI increase over the first 25 years of the term, rather than the past year alone.
The tenant argued that there had been a clear mistake in the drafting of the formula. Its evidence was that the use of formula would eventually result in the rent being increased from £15,000 in Year 1 to just over £76 million by Year 25. It contended that this was never intended and that the purpose of the RPI increase was to maintain the rent in line with inflation. Had non-cumulative RPI increases applied, the tenant argued that rent in Year 25 was be expected to be £30,000, a far more reasonable figure.
The landlord's contended that the assumptions made by the tenant were incorrect and that risk was shared, as RPI can also decrease. Its modelling produced a rent of £380,660 in year 25. It argued there had been no mistake and that the resulting rent did not necessarily produce such an absurd result that an objective observer would conclude that it must be mistaken in its terms.
The true construction of a commercial contract must be assessed from the perspective of a reasonable person who has all of the background knowledge that would reasonably have been available to the parties when the contract was entered into. The context of the contract may therefore be important. If there are two possible interpretations, the Court will likely accept the interpretation that is most consistent with business common sense.
Based on the relevant case law, the questions for the Court in this case were:
If both those conditions were satisfied, the lease would be interpreted contrary to the literal meaning of the words. If one condition is unsatisfied, then the tenant could only obtain relief through a rectification order. Interestingly, the tenant had not claimed rectification as an alternative remedy.
The Court accepted the tenant's submission that the increases in rent produced were "irrational and arbitrary", since the increases bore no relation to the increase (if any) in the index during the one year periods following each review date. The formula, taken literally, was deemed to be "wholly illogical". Although the tenant had a break option that would enable it to escape the worst of the increases, there was no sensible way to explain why a landlord would have required a rent review clause to be drafted in these terms.
Having concluded that there was a clear mistake in the drafting, the Court then reviewed what the true meaning of the clause should be. In doing so, the Judge reviewed the language used and concluded that the RPI increases were intended to apply to the reviewed rent each year, rather than to the initial rent, thereby enabling the rent to be compounded each year. The Court held that, unlike in other similar cases, there were no other credible conclusions to reach.
Given how prevalent issues with this type of clause have been, many tenants will no doubt seek to rely on this case as a means to escape unaffordable provisions. However, the circumstances and context of each case will always differ, so this may not be the last we see of these disputes coming to Court.
by Multiple authors