City of Subiaco v Homebase Management Pty Ltd
[2015] WASCA 54
•19 MARCH 2015
CITY OF SUBIACO -v- HOMEBASE MANAGEMENT PTY LTD [2015] WASCA 54
| SUPREME COURT OF WESTERN AUSTRALIA | Citation No: | [2015] WASCA 54 | |
| THE COURT OF APPEAL (WA) | |||
| Case No: | CACV:144/2013 | 5 SEPTEMBER 2014 | |
| Coram: | MARTIN CJ NEWNES JA MURPHY JA | 19/03/15 | |
| 26 | Judgment Part: | 1 of 1 | |
| Result: | Appeal allowed | ||
| B | |||
| PDF Version |
| Parties: | CITY OF SUBIACO HOMEBASE MANAGEMENT PTY LTD |
Catchwords: | Contract Lease Proper construction of rent review clause Turns on own facts Landlord and tenant Ground lease Rent review clause Proper construction Turns on own facts |
Legislation: | Transfer of Land Act 1893 (WA) |
Case References: | ADC Buildings Pty Ltd v Barana Properties (No 1) Pty Ltd [2005] NSWCA 224; (2005) 12 BPR 23,717 Bartlett v Salmon (1855) 6 De GM & G 33; 43 ER 1142 Basingstoke & Deane Borough Council v Host Group Ltd [1988] 1 All ER 824 BBC Hardware Pty Ltd v Payce Properties Pty Ltd [2000] NSWCA 262; (2000) 50 NSWLR 66 Burns Philp Hardware Ltd v Howard Chia Pty Ltd (1987) 8 NSWLR 642 Codelfa Construction Pty Ltd v State Rail Authority of NSW [1982] HCA 24; (1982) 149 CLR 337 Hinchcliffe v The Earl of Kinnoul (1838) 5 Bing N C 1; 132 ER 1004 Homebase Management Pty Ltd v City of Subiaco [2013] WASC 419 Pacific Carriers Ltd v BNP Paribas [2004] HCA 35; (2004) 218 CLR 451 Pacific West Systems Supply Ltd v BC Rail Partnership [2004] BCCA 247 Reardon Smith Line Ltd v Hansen-Tangen [1976] 3 All ER 570; [1976] 1 WLR 989 Ricciardello v Caltex Oil (Australia) Pty Ltd [1991] ANZ Conv R 445 |
JURISDICTION : SUPREME COURT OF WESTERN AUSTRALIA TITLE OF COURT : THE COURT OF APPEAL (WA) CITATION : CITY OF SUBIACO -v- HOMEBASE MANAGEMENT PTY LTD [2015] WASCA 54 CORAM : MARTIN CJ
- NEWNES JA
MURPHY JA
- Appellant
AND
HOMEBASE MANAGEMENT PTY LTD
Respondent
ON APPEAL FROM:
Jurisdiction : SUPREME COURT OF WESTERN AUSTRALIA
Coram : BEECH J
Citation : HOMEBASE MANAGEMENT PTY LTD -v- CITY OF SUBIACO [2013] WASC 419
File No : CIV 2393 of 2012
Catchwords:
Contract - Lease - Proper construction of rent review clause - Turns on own facts
Landlord and tenant - Ground lease - Rent review clause - Proper construction - Turns on own facts
Legislation:
Transfer of Land Act 1893 (WA)
Result:
Appeal allowed
Category: B
Representation:
Counsel:
Appellant : Mr J A Thomson SC
Respondent : Mr C G Colvin SC & Mr M J Keogh
Solicitors:
Appellant : Corrs Chambers Westgarth
Respondent : Herbert Smith Freehills
Case(s) referred to in judgment(s):
ADC Buildings Pty Ltd v Barana Properties (No 1) Pty Ltd [2005] NSWCA 224; (2005) 12 BPR 23,717
Bartlett v Salmon (1855) 6 De GM & G 33; 43 ER 1142
Basingstoke & Deane Borough Council v Host Group Ltd [1988] 1 All ER 824
BBC Hardware Pty Ltd v Payce Properties Pty Ltd [2000] NSWCA 262; (2000) 50 NSWLR 66
Burns Philp Hardware Ltd v Howard Chia Pty Ltd (1987) 8 NSWLR 642
Codelfa Construction Pty Ltd v State Rail Authority of NSW [1982] HCA 24; (1982) 149 CLR 337
Hinchcliffe v The Earl of Kinnoul (1838) 5 Bing N C 1; 132 ER 1004
Homebase Management Pty Ltd v City of Subiaco [2013] WASC 419
Pacific Carriers Ltd v BNP Paribas [2004] HCA 35; (2004) 218 CLR 451
Pacific West Systems Supply Ltd v BC Rail Partnership [2004] BCCA 247
Reardon Smith Line Ltd v Hansen-Tangen [1976] 3 All ER 570; [1976] 1 WLR 989
Ricciardello v Caltex Oil (Australia) Pty Ltd [1991] ANZ Conv R 445
- MARTIN CJ:
Summary
1 The appellant, the City of Subiaco (the City), is the owner of more than 3 ha of land situated at the corner of Salvado Road and Harborne Street in Subiaco. Since 1987 the City has granted a succession of ground leases over the land to the respondent, Homebase Management Pty Ltd (Homebase). Pursuant to those leases, at its own cost Homebase has carried out the work required to demolish the dilapidated buildings and other structures that were situated on the land and to construct new buildings which have been used for office, retail and showroom purposes, the ownership and right to use of which will revert to the City with the land at the expiry of the current ground lease.
2 The most recent lease relating to the land was executed in December 2003 and commenced on 1 January 2004. Following an extension and variation in 2007, the lease is for a term of 17 years, with two options of renewal, each for a period of five years. That lease provides for a review of the rental payable pursuant to its terms every three years commencing on 1 January 2006. The rental payable at each review is to be the highest of a number of alternatives. With effect from the review occurring on 1 January 2012, one of those alternatives is an amount equal to the 'Fair Market Rent', an expression defined by the lease.
3 The City and Homebase each engaged valuers to provide advice with respect to the amount equal to Fair Market Rent as at 1 January 2012. The advice provided by those valuers gave rise to a dispute as to the proper construction and effect of the relevant provisions of the lease relating to the determination of Fair Market Rent. Homebase commenced proceedings for the resolution of that dispute. The trial judge made a number of declarations with respect to the principles applicable to the determination of Fair Market Rent.
4 The City appeals against those declarations. For the reasons which follow, that appeal should be allowed and orders made to give effect to the reasons of this court after the parties have had the opportunity to consider those reasons.
The commercial purpose of the ground lease
5 Although the case turns upon the proper construction and effect to be given to the words used by the parties in their lease:
In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating.1
6 As I have noted, the City first entered into commercial arrangements with Homebase relating to the lease of the land in 1987. It is unnecessary to canvass in any detail the arrangements which were made prior to the commencement of the current lease, other than to observe that the arrangements have at all times had the characteristics of a ground lease - that is to say, a commercial arrangement pursuant to which the tenant is given the right to possession of the relevant land on the basis that it will carry out improvements on the land which will enhance its use and which will revert to the landlord at the expiry of the lease. Obviously the rental negotiated by the parties to such leases will take account of the extent of their respective rights and obligations including, in the case of the tenant, the obligation of carrying out improvements which will revert to the landlord upon the expiry of the lease, the costs of which must therefore be amortised over the period of the lease. That commercial characteristic of a ground lease usually has the consequence that, where the improvements to be carried out by the tenant are substantial, the tenant will require a long-term lease in order to amortise and recover the costs of those improvements over the life of the lease. The commercial arrangements between the City and Homebase have that characteristic, having now been on foot for 27 years, with Homebase having the capacity to extend its entitlement to possession for up to a further 16 years, if both options are exercised.
7 In 2002, Homebase commenced legal proceedings in relation to a rent review under the lease then in force. Those proceedings were settled, and pursuant to the terms of settlement, on 19 December 2003, a new lease was executed in place of the previous lease. The new lease took effect from 1 January 2004, and is the subject of these proceedings.
The lease
8 The lease is in a form capable of registration under the Transfer of Land Act 1893 (WA). As I have noted, the lease is for a term of 17 years, commencing on 1 January 2004. The lease gives Homebase two options to extend the term of the lease, each for a period of five years so that, at the option of Homebase, the lease might extend until early January 2031.
9 The land the subject of the lease is identified by a plan which is sch 1 to the lease. Schedule 3 to the lease sets out the various subleases current at the time of execution of the lease and includes particulars with respect to each subtenant, the area of the sublease and its date segregated as between subleases for retail purposes, display purposes, and office use. By cl 1.5 of the lease, City and Homebase acknowledged that the lease was granted subject to and with the benefit of those subleases and was to operate and take effect as a concurrent lease of the lessor's reversionary interest expectant on those subleases. No doubt the areas of the subleases specified in the schedule correspond to areas within the buildings and other improvements constructed by Homebase on the land. This is one of a number of provisions in the lease which expressly recognise and acknowledge the existence of those buildings and other improvements.
10 At the time of executing the lease in December 2003, the City and Homebase were, no doubt, each well aware of the buildings and other improvements on the land the subject of the lease. There can be no doubt that they intended the lease to apply to the land, building and other improvements. That intention is put beyond doubt by the definition given to the term 'Leased Premises' in cl 1.1 of the lease, which is defined to mean:
The land described on page 1 and all buildings and improvements thereon or hereafter erected thereon.
11 Further, there are various covenants within the lease which relate to the buildings and other improvements on the land. Under cl 4 of the lease, Homebase covenants to keep and maintain the Leased Premises (which includes buildings and improvements) well cleaned and in good sanitary condition and in good and tenantable repair and condition, and further covenants not to make any alteration to any building or structure on the land without the City's prior consent. The same clause obliges Homebase to permit the City to enter upon the Leased Premises for the purpose of viewing the condition thereof, and to insure and to keep insured 'all buildings and improvements of an insurable nature from time to time erected on the Leased Premises'. Further, by cl 6.2 of the lease, the City is given the power to enter upon the land to carry out or execute any repairs or works necessary to secure compliance with the terms of the lease.
12 Clauses 2.1 - 2.3 of the lease specify the rental payable during the term and any extension of that term. They provide:
2.1 Rent: 1.1.2004 - 31.12.2005
During the period from 1 January 2004 to 31 December 2005, the annual Rent shall be $520,000.00.
2.2 Rent: 1.1.2006 - 31.12.2011
During the period from 1 January 2006 to 31 December 2011, the annual Rent shall on each Review Date be reviewed and, on and from each Review Date, shall be the highest of the following amounts:
(a) an amount calculated by multiplying the annual Rent payable immediately preceding the Review Date by a fraction obtained by dividing the CPI as determined at 30 June immediately preceding the Review Date by the CPI as determined three years earlier;
(b) an amount equal to 25% of the Sublease Payments in the year ended 30 June immediately preceding the Review Date; or
(c) an amount equal to the annual Rent payable immediately preceding the Review Date.
2.3 Rent: 1.1.2012 - 31.12.2020 and during Further terms
During the period from 1 January 2012 to 31 December 2020 (and, if an Option is exercised, during a Further Term), the annual Rent shall on each Review Date be reviewed and, on and from each Review Date, shall be the highest of the following amounts:
(a) an amount calculated by multiplying the annual Rent payable immediately preceding the Review Date by a fraction obtained by dividing the CPI as determined at 30 June immediately preceding the Review Date by the CPI as determined three years earlier;
(b) an amount equal to 25% of the Sublease Payments in the year ended 30 June immediately preceding the Review Date;
(c) an amount equal to the Fair Market Rent; or
(d) an amount equal to the annual Rent payable immediately preceding the Review Date.
14 Clause 2.3 of the lease therefore has the effect that Fair Market Rent is to be one of the amounts considered for the purposes of ascertaining which of the amounts specified by that clause is the highest in relation to the rent review which was to take place on 1 January 2012, and each review thereafter. At the time the lease was executed, Fair Market Rent was defined to mean:
Fair Market Rent means the rent which the Leased Premises would reasonably command at the Review Date in a free and open market taking into account all relevant factors, matters or variables used in proper land valuation practice on the basis that the Leased Premises were vacant and available to be let on the same terms as are contained in this document (includes its Term) and as if this document included a term that the Leased Premises were to be put to the same use (and could only be put to the same use) as the use to which the Leased Premises are in fact put by the Lessee at the Review Date (whether or not that is the highest and best use of the Leased Premises) and:
(a) without taking into account the Lessee's and any sublessee's trade fixtures and fittings;
(b) taking into account permanent structural or other improvements to the Leased Premises made at the Lessee's expense and the actual use of those improvements by the Lessee; and
(c) ignoring any value attaching to:
(i) goodwill created by the Lessee's occupation of the Leased Premises; and
(ii) any licence or permit in respect of the business carried on by the Lessee or any sublessee on the Leased Premises.
(b) ignoring any value attaching to permanent structural or other improvements to the Leased Premises made at the Lessee's expense;
The decision of the trial judge
16 In his reasons, the trial judge identified the relevant provisions of the lease and the background to the dispute, which he summarised in these terms:
The essence of the dispute between the parties is that Homebase says, and the City denies, that in assessing Fair Market Rent, it must be taken into account that the notional lessee must construct the premises, at its cost, on the land to enable it to be put to the use to which Homebase puts the Leased Premises. There is also a dispute about the length of the term of the notional lease to be entered at a Review Date.2
17 After referring to principles of contractual construction which are not contentious, the trial judge focused attention upon the definition of Fair Market Rent. He first noted that the ascertainment of the rent which the Leased Premises would reasonably command at the Review Date in a free and open market required an objective assessment of the amount which a hypothetical willing but not anxious lessor and a hypothetical willing but not anxious lessee would agree as the rent for the premises under a lease the terms of which were determined by reference to the criteria set out in the definition.3
18 After paraphrasing the definition of Fair Market Rent, the trial judge observed:
Homebase submits, and I accept, that in this context, the reference to the Leased Premises being 'vacant' is a reference to the premises not being tenanted, rather than a reference to the land being unimproved.
Nevertheless, it is common ground that the rent is to be determined on the basis that the land is unimproved vacant land. Homebase submits, and I accept, that that is part of the effect of subpar (b) of the definition (set out in [15] above).
The City submits that in the definition of Fair Market Rent, the Leased Premises does not bear the defined meaning in cl 1.1 of the Lease - as the land and all buildings and improvements - but refers only to the land. I agree that the notional lease is of unimproved land. In my view, that arises from the proper construction of the definition as a whole (inserted into cl 2.3) and, in particular, from subpar (b) of the definition. One way of expressing that construction may be to say that in cl 2.3, Leased Premises refers only to the land and not to the improvements. (footnotes omitted)4
19 As will be seen, the conclusion that the Fair Market Rent to be assessed was not the market rent payable for a ground lease of the Leased Premises (that is to say, the land the subject of the lease including the buildings and other improvements erected thereon, but ignoring the value of those buildings and other improvements because their cost had been borne by the lessee), but rather was the market rent payable in respect of a hypothetical piece of land without any buildings or other improvements upon it was critical to the conclusions reached by the trial judge. Before us there was contention as to whether this was, in truth, 'common ground', or whether the trial judge misapprehended the subtleties in the respective positions of the parties. It is unnecessary to resolve those contentions.
20 The trial judge then observed that the definition required Fair Market Rent to be assessed on the assumption that the lease included a term to the effect that the Leased Premises could only be put to the same use as the use to which they were in fact put by Homebase at the Review Date, irrespective of whether or not that was the highest and best use of the Leased Premises. After noting that the City was under no obligation to make any structural or other improvements to the premises, and that Homebase had in fact constructed buildings and improvements to enable the land to be used for retail, office and showroom purposes, and that those buildings and other improvements would revert to the City upon the expiry of the lease, the trial judge reasoned:
Thus, in the notional lease to be used to assess Fair Market Rent as at 1 January 2012:
(a) the land is taken to be unimproved vacant land, and the value of the actual improvements on the land is to be ignored;
(b) the lessee is obliged to use the premises in the way being used by Homebase at the review date, namely for bulky goods display rooms, offices and showrooms;
(c) the lessor is not obliged to construct any buildings or improvements;
(d) it would be necessary for structures to be constructed on the notionally vacant land in order for it to be used for the sole permitted and required purpose; and
(e) any permanent structural or other improvements made by the lessee would revert to the City at the end of the lease.
To my mind, it follows from these features that it is necessarily a further element of the context in which the notional rent is to be determined that the hypothetical willing but not anxious prospective lessee would have to incur the cost of constructing the permanent structures and other improvements to the land that are necessary to put it to the same use as it was being put by Homebase at the relevant review date, and, at the end of the lease, those improvements would belong to the City. That further element is a matter to which a valuer must have regard, in the same way as the valuer must have regard to the elements summarised in (a) - (e) of the previous paragraph.5
21 The trial judge then turned to the dispute between the parties with respect to the assumption properly made as to the term of the lease for the purposes of assessing Fair Market Rent at the Review Date. He noted that the City submitted that Fair Market Rent should be assessed on the basis of the rental payable in respect of a further term of 27 years from the Review Date, whereas Homebase submitted that the rental should be assessed on the basis that the term expired in early 2031, if both options were exercised. The trial judge gave reasons for preferring Homebase's position.
22 After referring to a submission by the City to the effect that the construction advanced by Homebase, and which had been accepted by the trial judge, led to a result that offended commercial common sense or was otherwise unlikely to have been intended by the parties, the trial judge observed:
Homebase's construction may appear to be capable of producing outcomes that would seem, on the face of it, to be surprising. However, as I have said, the nature and purpose of a rent review clause means that any consideration of whether a particular construction leads to a result that is unjust or unreasonable will often be of little assistance. The competing interests of the lessor and the lessee are irreconcilable. … The parties' opposing contentions should not be resolved by what seems fair or just or reasonable, but by reference to the language of the clause in its context.6
23 The trial judge made a declaration in the following terms:
This Honourable Court declares that upon the proper construction of the lease between the plaintiff as lessee and the defendant as lessor dated 19 December 2003, as amended (Lease), when determining 'an amount equal to the Fair Market Rent' for the purpose of cl 2.3 of the Lease:
(a) the 'Term' means the period from the Review Date to 31 December 2020 and any extension thereof consequent upon the exercise of the first, alternatively the first and second options pursuant to cl 8;
(b) the effect of paragraphs (a), (b) and (c) of the definition of 'Fair Market Rent' in cl 1.1 of the Lease is to require the Fair Market Rent to be determined on the basis that the Leased Premises referred to in the definition of 'Fair Market Rent' is vacant land, being the land described on page 1 of the Lease (Land);
(c) regard must be had to the fact that:
(i) a hypothetical willing but not anxious prospective lessee would have to incur the costs of constructing permanent structural and other improvements to the Land that are necessary to put the Land to the same use as it was put by the plaintiff at the relevant Review Date under the Lease; and
(ii) such permanent structural and other improvements would revert to the lessor upon the Lease ending.
25 The commercial consequences of the declaration made by the trial judge are, with respect, exceptional. They include:
(a) at each Review Date the market rent is to be assessed on the assumption that any prospective hypothetical tenant would only agree to pay a rental which took account of the cost which would be incurred by that tenant constructing buildings or other improvements on land which was entirely unimproved, but leaving out of account any value to be attributed to those buildings or other improvements;
(b) as at each Review Date, the rental assessed will diminish because any prospective hypothetical tenant would have to amortise the cost of the buildings and other improvements notionally to be constructed on the unimproved land over a shorter period;
(c) there will inevitably come a point in the life of the lease at which the amortised cost of the construction of the buildings and other improvements over the remaining life of the lease will exceed the commercial value of possession of the premises, with the result that there would be no market for a lease on the terms posited by the declaration and therefore no Fair Market Rent;
(d) the 'permanent structural and other improvements to the Land that are necessary to put the Land to the same use as it was put by the [lessee] at the relevant Review Date' are not specified in any way - for example, as to area, standard and nature of finish, manner of construction, etcetera, and would inevitably give rise to uncertainty and disputation.8
26 While there are limits to the extent to which a court can or should bring its view of commerciality to bear upon the task of construing a contract by reference to the words used by the parties, commercial consequences as exceptional as these strongly suggest error in the process of construction.
The proper construction of Fair Market Rent
27 As I have already indicated, it is appropriate to construe the words used by the parties to define Fair Market Rent in the context of the general character of their commercial arrangement, and the commercial objectives and purposes of their arrangement evident in the words they have used. As I have already observed, the commercial arrangement between the City and Homebase is a ground lease - a species of lease which has been known to commerce and to the common law for centuries.9 There is nothing unusual or exceptional about this ground lease - Homebase has been required to construct buildings and other improvements, the benefit of which will revert to the City upon the expiry of the lease. However, Homebase derives commercial advantage from the buildings and other improvements during the life of the lease in the form of the rental received from the subtenants specified in sch 3 to the lease against which the capital cost of those buildings or other improvements can and no doubt will be amortised over the life of the lease.
28 Viewed in this context, the words used by the parties in their definition of Fair Market Rent require the assessment of nothing more or less than the amount of rental that would be agreed between a willing but not anxious lessor and a willing but not anxious lessee as at the Review Date as the rental payable pursuant to a ground lease containing the same terms and conditions as the lease between the parties for premises to be put to the same use as that to which they were put by the lessee at the Review Date, irrespective of whether or not that was the highest or best use of the land. Because the rental is to be paid for a ground lease, it necessarily follows that the rental is to be assessed on the basis that the willing but not anxious tenant will not be prepared to pay the landlord a rental which reflects the value of buildings or other improvements constructed at the tenant's costs, but will recover that cost through a process of amortisation over the life of the lease. The intention of the City and Homebase to achieve this objective is evident from the terms of the amendment which they made to the definition of Fair Market Rent in 2007 which made clear that the rental was to be assessed ignoring any value attaching to permanent structural or other improvements to the Leased Premises made at the expense of Homebase. As I have noted, that is one of the commercial characteristics inherent in a ground lease. It is the corollary of the expectation of the tenant under such a lease that the cost of buildings or other improvements effected at its expense will be recovered by the commercial benefits derived from their use during the life of the lease, which was no doubt the expectation of Homebase at the time it carried out the development between 1987 and 1988.
29 The amendment made to the definition of Fair Market Rent in 2007 made it clear that the rental was to be assessed by reference to a hypothetical negotiation between landlord and tenant as at the Review Date on the assumption that each was to derive the benefits, and bear the burdens customarily associated with a ground lease. The amendment was directed to the allocation of the economic benefits and burdens anticipated by the parties to the hypothetical negotiation and makes clear that the landlord could not expect a higher rental because of value attributed to improvements carried out at the tenant's expense. It was neither necessary nor appropriate to deal specifically with the economic allocation of the cost of the buildings and other improvements in the course of the hypothetical negotiation because:
(a) as the parties well knew, and as the 2007 amendment expressly recognises, the buildings and other improvements had been effected at the tenant's expense; and
(b) the buildings and other improvements on the land are expressly included in the definition of 'Leased Premises', and are therefore included within the lease on the same terms to be hypothetically negotiated between a willing but not anxious lessor and lessee.
30 The trial judge appears, with respect, to have fallen into error by concluding that the paragraph introduced by amendment in 2007 had a quite different effect - namely, the effect of requiring the rental to be assessed by reference to a hypothetical negotiation with respect to the rental payable for land which was entirely unimproved as at the Review Date. There are a number of reasons why this conclusion was erroneous.
31 First, par (b) of the definition of Fair Market Rent requires the rent to be assessed 'ignoring the value' attached to the improvements effected by the tenant. That requirement is fundamentally different in character to assessing the rent as if the improvements did not exist.
32 Second, in the definition of Fair Market Rent, the parties have referred to 'the Leased Premises' no less than eight times. That is a term which they have defined to mean the land and all buildings and improvements thereon. The trial judge's conclusion that a Fair Market Rent is to be assessed as if the Leased Premises do not include the buildings or other improvements on the land is contrary to the clear and unequivocal express terms of the lease.
33 Third, the definition of 'Fair Market Rent' requires the rent to be assessed by reference to a hypothetical negotiation for a lease on the same terms as the lease between City and Homebase. As I have pointed out, that lease contains numerous provisions relating to the maintenance of the buildings and other improvements on the land at the time of its execution.
34 Fourth, the conclusion at which the trial judge arrived assumes the hypothetical prospective tenant is under an obligation to carry out considerable building works and other improvements. However, there is no obligation to that effect in the lease and any such assumption is contrary to the requirement that the hypothetical parties are assumed to be negotiating for a lease on the same terms as the lease between City and Homebase.
35 Fifth, if it had been the intention of the City and Homebase that Fair Market Rent was to be assessed on the basis of an assumption that any prospective tenant was to bear the cost of carrying out extensive building and other improvements on the land, it would be expected that they would have included a provision to that effect in their definition of Fair Market Rent, having regard to the specificity of other matters included within the definition.
36 Sixth, the attribution of an intention to the parties to the effect that Fair Market Rent was to be assessed by reference to an obligation on the part of any prospective hypothetical tenant to carry out extensive building and other improvements to the land is contrary to facts of which they were well aware at the time the lease was executed - namely, that there were extensive buildings and other improvements on the land which had been carried out at the tenant's expense, and which were to revert to the City upon the expiry of the lease, after the tenant had derived economic benefit from their use during the life of the lease.
37 Seventh, as I have already noted, the assessment of Fair Market Rent by reference to an assumed obligation on the part of any prospective hypothetical tenant to carry out the building works and other improvements necessary to put the land to the use to which it was put at the Review Date necessarily begs a number of very significant questions as to the extent, nature, quality and finish of the buildings and improvements to be carried out. In the absence of any specification of such matters, uncertainty and disputation would appear inevitable, and such an intention should not be attributed to the parties in the absence of clear words having that effect.10
38 For these reasons, the assessment of Fair Market Rent is not to be undertaken on the basis that any prospective hypothetical tenant would have to carry out the extensive permanent structural and other improvements necessary to enable the land to be put to the same use as it was put by Homebase at the relevant Review Date. The appeal must be allowed and the decision of the trial judge to that effect set aside.
39 Fair Market Rent is to be assessed as at each Review Date in accordance with the natural and ordinary meaning of the words used in the definition of that term - namely, by reference to the rental which a willing but not anxious lessor would agree to accept and a willing but not anxious tenant would agree to pay under a ground lease on the same terms and conditions as those contained in the lease between the City and Homebase on the assumption that the land is to be used for the uses to which it was being put as at the Review Date, irrespective of whether or not that is the highest and best use of the land, without taking into account the trade fixtures and fittings attached to the land by Homebase or any sublessee of Homebase and ignoring any value attaching to permanent structural or other improvements made at the expense of Homebase or to any good will created by Homebase's occupation of the land, or any value attaching to any licence or permit in respect of the business carried on by Homebase or any sublessee on the land. Because the rental to be assessed is the rental which would be paid by hypothetical parties to a ground lease, the outcome of the hypothetical negotiation is to be assessed on the assumption that the landlord would not expect to receive, and the tenant would not expect to pay, rent reflecting the value to be derived from buildings or other improvements erected at the tenant's expense, and on the basis that the tenant would expect to recover the cost of such buildings or other improvements from the economic benefits to be derived from their use over the life of the lease.
The term of the lease
40 As I have noted, there was a dispute between the parties with respect to the term of the lease to be assumed for the purposes of assessing Fair Market Rent. That dispute arose in the context of their dispute as to whether Fair Market Rent was to be assessed on the basis of attributing notional construction costs to any prospective tenant. In that context, the assumed term of the lease was of profound significance, because it affected the period over which the assumed construction costs were able to be recovered through a process of amortisation. In that context, the trial judge's conclusion that the term of the lease to be assumed was its actual term had the exceptional commercial consequences to which I have referred. It was in that context that Homebase conceded, for the purposes of this appeal, that the trial judge was in error, and should have found that the term of the lease for which the hypothetical parties were assumed to be negotiating as at each Review Date was a term of 17 years with two five-year options as and from that Review Date.
41 For the reasons I have given, Fair Market Rent is to be assessed on the assumption that any capital costs borne by the tenant with respect to buildings or other improvements on the land are to be recovered by amortisation over the life of the lease. Accordingly, the remaining term of the lease makes no difference to the process of amortisation or its outcome. There is therefore no reason to depart from the natural and ordinary meaning of the language used in the definition of Fair Market Rent, which requires the rental to be assessed by reference to a lease on the same terms as the lease between City and Homebase - that is, a lease for a term of 17 years commencing in January 2004 and expiring in January 2021, with two options to extend the lease for a term up to January 2026 and January 2031 respectively.
Conclusion
42 This appeal should be allowed and the decision of the trial judge set aside. Following the publication of the court's reasons for decision, the parties should be directed to confer with a view to agreeing upon a minute of orders which will give effect to these reasons. In the event that the parties are unable to agree upon such a minute after conferral, directions should be made for the exchange of competing minutes and submissions on the basis that the court will determine the appropriate relief to be granted on the basis of those minutes and written submissions without further oral argument.
43 NEWNES JA: I agree that the appeal should be allowed, for the reasons given by Martin CJ. I also agree with the course his Honour proposes to determine final orders in the appeal.
44 MURPHY JA: The appeal concerns two specific aspects of the proper construction of the term 'Fair Market Rent' as it appears in, and is applied to, the relevant instrument of lease between the appellant as lessor, and the respondent as lessee.
45 The learned primary judge observed11 that the two specific matters in dispute were:
(a) whether, in assessing 'Fair Market Rent', it must be taken into account that the notional lessee must construct the premises, at its cost, on the land to enable it to be put to the use to which the lessee puts the Leased Premises; and
(b) the length of the term of the notional lease to be entered into at the Review Date.
46 The broad background to the dispute is that the lessor originally leased the site to the lessee by a ground lease dated 20 May 1987.12 Pursuant to the terms of that ground lease, in 1987 - 1988 the lessee undertook an extensive development of the site, including the construction of various buildings at a cost of $7 million.13 The lessee used the premises for showrooms, offices, and, by subletting, retail.14
47 The parties fell out and the original lease was terminated by agreement.15 Following this a new lease was entered into on 19 December 2003. It is that lease which is the subject of the current dispute.
48 It appears that the original lease was a ground lease with the lessee agreeing to undertake the development of the site on the basis that all the improvements undertaken by the lessee would revert to the lessor at the conclusion of the lease. Ordinarily in such cases, the lessee seeks a long-term lease which allows it sufficient time to recapture the costs of its investment. The period required to amortise an investment undertaken under a ground lease would presumably ordinarily depend upon factual matters, including the nature of the land involved, and the nature and scale of the development.
49 In the present case, the original lease was terminated and the new lease was entered into on 19 December 2003, with the new term commencing on 1 January 2004. There was no requirement that the lessee undertake any development on the site. That had already been done.
50 Martin CJ has set out the relevant rent review provisions contained in cls 2.1 - 2.3 of the lease instrument. In addition, by cl 2.7, the rent determined on a rent review can never be less than the rent payable immediately prior to the rent review date.
51 As at the relevant date, the lease instrument defined 'Fair Market Rent' as follows:
Fair Market Rent means the rent which the Leased Premises would reasonably command at the Review Date in a free and open market taking into account all relevant factors, matters or variables used in proper land valuation practice on the basis that the Leased Premises were vacant and available to be let on the same terms as are contained in this document (including its Term) and as if this document included a term that the Leased Premises were to be put to the same use (and could only be put to the same use) as the use to which the Leased Premises are in fact put by the Lessee at the Review Date (whether or not that is the highest and best use of the Leased Premises) and:
(a) without taking into account the Lessee's and any sublessee's trade fixtures and fittings;
(b) ignoring any value attaching to permanent structural or other improvements to the Leased Premises made at the Lessee's expense;
(c) ignoring any value attaching to:
(i) goodwill created by the Lessee's occupation of the Leased Premises; and
(ii) any licence or permit in respect of the business carried on by the Lessee or any sublessee on the Leased Premises.
53 Accordingly, if the term 'Fair Market Rent' were to be broken up into its component parts as it applied at the relevant review date, it may be seen to be in the following terms:
(a) the rent which the Leased Premises would reasonably command, in a free and open market (taking into account all relevant factors, matters or variables used in proper land valuation practice):
(i) at the relevant Review Date;
(ii) on the basis that the Leased Premises were vacant and available to be let on the terms in (iii) and (iv) below;
(iii) on the basis that the same terms as contained in this instrument, including its Term, would apply to the letting (subject to (iv) below); and
(iv) on the basis that under this instrument there were (it is to be assumed) a term to the effect that the Leased Premises could only be put to use for showrooms, offices and retail - even if that were not the highest and best use of the Leased Premises as at the rent review date;
(b) without taking into account the Lessee's, and any sublessee's, trade fixtures and fittings;
(c) ignoring any value attaching to permanent structural or other improvements to the Leased Premises made at the Lessee's expense; and
(d) ignoring any value attaching to:
(i) goodwill created by the Lessee's occupation of the Leased Premises; and
(ii) any licence or permit in respect of the business carried on by the Lessee or any sublessee of the Leased Premises.
the land described on page 1 and all buildings and improvements thereon or hereafter erected thereon.
55 The term 'Review Date' is defined to mean:
each of 1 January 2006, 1 January in each and every succeeding third year during the Term (commencing 1 January 2009), 1 January 2021 and 1 January 2026.
56 Clause 4(j) of the lease instrument provides for the use to which the Leased Premises may be put under the lease instrument. It is in the following terms:
The lessee to the intent that the obligations may continue throughout the Term agrees with the Lessor as follows:
(j) not to use or permit to be used the Leased Premises for any purpose or purposes other than such purpose or purposes as are from time to time permitted by law. (emphasis added)
57 Clause 4(q) provided, in effect, that the lessee would, upon the expiration or sooner determination of the Term, deliver up the Leased Premises and all additions thereto and fixtures and fittings therein to the Lessor in good and tenantable repair and condition, fair wear and tear excepting.
58 The 'Term' was defined to mean 'the term of this document and includes any renewal pursuant to cl 8' (cl 1.1). Page 1 of the lease instrument described the 'term of lease' as 17 years commencing on 1 January 2004. Clause 8 provided for two options of renewal, each for five years, in favour of the lessee, as more particularly set out later in these reasons.
59 The general purpose of a rent review clause was referred to in Basingstoke & Deane Borough Council v Host Group Ltd.17 The court's observations in that case, referred to below, provide an apposite statement, in broad terms, of the general purpose which may be inferred from the lease instrument in this case read as a whole:
The purpose has been referred to in several recent cases, and is not in doubt. Sir Nicolas Browne-Wilkinson VC expressed it in these terms in British Gas Corp v Universities Superannuation Scheme Ltd [1986] 1 All ER 978 at 980 - 981, [1986] 1 WLR 398 at 401:
'There is really no dispute that the general purpose of a provision for rent review is to enable the landlord to obtain from time to time the market rental which the premises would command if let on the same terms on the open market at the review dates. The purpose is to reflect the changes in the value of money and real increases in the value of the property during a long term.'
To the same effect Dillon LJ said in Equity and Law Life Assurance Society plc v Bodfield Ltd [1987] 1 EGLR 124 at 125:
'There is no doubt that the general object of a rent review clause, which provides that the rent cannot be reduced on a review, is to provide the landlord with some measure of relief where, by increases in property values or falls in the real value of money in an inflationary period, a fixed rent has become out of date and unduly favourable to the tenant. The exact measure of relief depends on the true construction of the particular rent review clause.'
The means by which rent review clauses afford landlords relief in respect of increases in property values or falls in the value of money is by providing, normally, for a valuer, in default of agreement, to assess the up-to-date rent for the demised premises at successive review dates.
60 Nevertheless, each rent review provision must be construed according to its terms and within the context of the lease instrument of which it is a part. The following observations may be made as to the terms of the particular rent review clause in dispute which, it may be accepted, is susceptible to more than one meaning.
61 First, in confining the determination of 'Fair Market Rent' to the specific use to which the Leased Premises were put at the relevant review date, ie, for showrooms, offices and, by subletting, for retail, the parties were evidently intending to preclude a rent review based on any other use, including (if it were different from the actual use) the highest and best use of the property. Had a provision to that effect not been inserted, and had the agreement for the determination of 'Fair Market Rent' been left merely on the basis that the Leased Premises were available to be let on the same terms as the lease instrument, then bearing in mind cl 4(j), the effect may have been to allow the rent to be determined on the basis of any lawful use of the premises at the relevant time: cf Basingstoke & Deane Borough Council;18Pacific West Systems Supply Ltd v BC Rail Partnership.19
62 Secondly, in the definition of 'Fair Market Rent' the hypothetical demise is not of 'vacant land', or 'a bare site',20 ie, land without any improvements and buildings on it. The definition of 'Leased Premises' makes it plain that rent is to be determined on the basis that under the hypothetical demise, both the land and the buildings and improvements on it 'were vacant and available to be let'. Also, the lease instrument (the terms of which are applicable to the hypothetical demise) contains numerous provisions for the upkeep and operation of the buildings on the Leased Premises (see, eg, cl 4(d) - (g)), and there is no provision in the lease instrument requiring the lessee, and thereby the hypothetical tenant, to erect any buildings or improvements on the land forming part of the Leased Premises.
63 Thirdly, the term in (c) of the component parts of the provision referred to earlier requires the rent to be determined by ignoring any value attaching to permanent structural or other improvements for the leased premises 'made at the lessee's expense'. In the event that any structural improvements are made at the lessor's expense prior to the relevant review date, those improvements are not to be ignored for the purposes of determining the hypothetical rent.
64 Fourthly, it is the rental value attributable to the lessee's buildings and improvements on the land, and the rental value attributable to the goodwill created by the occupation of the Leased Premises, and the rental value attributable to any licence or permit in respect of the businesses carried thereon, which are to be 'ignored'.
65 Accordingly, in effect, what is to be determined is the hypothetical rent which would be payable by the hypothetical tenant:
(a) where the lessor offers, and the hypothetical tenant is prepared to accept, a lease of the site, commencing as at the relevant review date, on the terms of the lease instrument, including its Term;
(b) where the hypothetical tenant could only ever use the site, under the hypothetical lease, for showroom, office and retail purposes; and
(c) where the lessee's buildings are treated as existing and available for occupation by the hypothetical tenant, but where the hypothetical rent which is payable excludes any value attributable to, or derived from, any of the lessee's buildings.
66 The last mentioned feature of the transaction presumably reflects the fact that the lessee had erected the buildings under the previous lease at its own expense.
67 It follows that in the hypothetical demise for rent review purposes, the hypothetical tenant neither pays any hypothetical rent for, or in respect of, the lessee's buildings, nor is it required, itself, to construct a hypothetical set of buildings in replacement of the lessee's buildings.
68 Accordingly, on the first issue, in my respectful view, the learned trial judge erred in his reasons at [48], in finding that the definition of 'Fair Market Rent' required the hypothetical tenant to, in effect, build, at its own cost, the buildings and improvements which, as at the rent review date, formed part of the Leased Premises.
69 The second (and related) matter ventilated before the primary judge and on appeal concerned the meaning of the word 'Term' in the definition of 'Fair Market Rent'.
70 It may be noted at the outset that the relevant provision in the lease instrument differs from that considered in Basingstoke & Deane Borough Council. In Basingstoke & Deane Borough Council, in a long-term (99 year) ground lease, rent reviews were to be every five years on the basis that the demised premises were available at the date of assessment for letting for a term 'equal to the unexpired portion of the term … or a term of twenty years (whichever shall be greater)'.21 In other words, in that case, even for rent reviews towards the end of the 99 year term, the determination of 'current ground rental value' involved an assessment based on at least a 20 year horizon.
71 I have set out earlier the definition of the word 'Term' in the lease instrument.
72 Clause 8, to which the definition of 'Term' refers, includes cl 8.1:
The Lessee has two separate options of renewal (each an 'Option'):
(a) the first for a first further term of five years commencing 2 January 2021; and
(b) the second for a second further term of five years commencing 2 January 2026.
(each a 'Further Term').
73 The lessee's right to quiet enjoyment applies during the 'Term' under cl 5 of the lease instrument. Clause 5 provides:
The Lessor agrees with the Lessee that if the Lessee pays the Rent and complies with the Lessee's Obligations, the Lessee is entitled to peaceably and quietly hold and enjoy Leased Premises during the Term without any interruption by the Lessor or any person rightfully claiming under or in trust for the Lessor.
74 It would seem to be difficult to read the word 'Term' in the definition of 'Fair Market Rent' as applying to a period of tenure prior to the entry into the hypothetical demise as at the relevant rent review date. It might be expected that clearer words would have been used if the intention were that the hypothetical demise involved backdating the tenure of the hypothetical tenant to 1 January 2004. Also, the terms of the instrument such as the covenant for quiet enjoyment would be difficult to apply sensibly to the hypothetical tenant if the hypothetical tenant's tenure commenced some years prior to the hypothetical demise.
75 It is equally difficult to see that the parties could objectively have intended that the word 'Term' should be read as denoting a period of 17 years plus two five year options commencing on each relevant rent review date. That construction, applied for example to the last rent review date (1 January 2026) would posit a hypothetical demise for a period of 27 years, up to 2053. Again, clearer words might have been expected to have been used if that were the intention.
76 The third possibility is that the word 'Term' in the definition of 'Fair Market Rent' denotes (broadly speaking) the unexpired term of the lease as at each relevant rent review date. It is to be noted that the definition of 'Term' includes a reference to 'the term of this document' and the renewals under cl 8. Clause 8.1 refers to a 'further term' of 5 years followed by a 'further term' of another 5 years. The task, of course, is not to construe the word 'Term' in isolation, but to read it within the definition of 'Fair Market Rent' for the purpose of the operation of rent review provisions under the lease. Read in context, it is an aspect of an agreement which requires the next tranche of rent to be determined by, inter alia, reference to a hypothetical rent as at the relevant rent review date, on the basis that the Leased Premises were, as at that date, 'vacant and available to be let'. In its ordinary meaning, the language would appear to be apt to denote, broadly speaking, the unexpired period of the lease instrument. That construction would also have a degree of commercial sense about it which appears to be absent from the other two possible constructions.
77 The learned trial judge declared that:
'[T]he Term' means the period from the Review Date to 31 December 2020 and any extension thereof consequent upon the exercise of the first, alternatively the first and second options pursuant to cl 8.
78 I would think that strictly speaking, the appropriate declaration, on this aspect of 'Fair Market Rent' would be along the following lines:
The reference to 'Term' in the phrase 'the same terms as are contained in this document (including its Term)' in the definition of 'Fair Market Rent' means, in respect of the Review Date of 1 January 2012, the period from the Review Date to 31 December 2020 on the basis that the hypothetical lessee has options to renew for a period up to 10 further years in accordance with the provisions in cl 8 of the lease instrument.
1Reardon Smith Line Ltd v Hansen-Tangen [1976] 3 All ER 570; [1976] 1 WLR 989, 995 - 996 (Lord Wilberforce); cited with approval by Mason J in Codelfa Construction Pty Ltd v State Rail Authority of NSW [1982] HCA 24; (1982) 149 CLR 337, 350 and in the unanimous judgment of the High Court in Pacific Carriers Ltd v BNP Paribas [2004] HCA 35; (2004) 218 CLR 451 [22].
2Homebase Management Pty Ltd v City of Subiaco [2013] WASC 419 [27] (Reasons).
3 Citing Burns Philp Hardware Ltd v Howard Chia Pty Ltd (1987) 8 NSWLR 642, 644, 657 - 658; Ricciardello v Caltex Oil (Australia) Pty Ltd [1991] ANZ Conv R 445.
4 [40] - [42].
5 Reasons [47] - [48].
6 Reasons [61], citing ADC Buildings Pty Ltd v Barana Properties (No 1) Pty Ltd [2005] NSWCA 224; (2005) 12 BPR 23,717 [21] - [23]; BBC Hardware Pty Ltd v Payce Properties Pty Ltd [2000] NSWCA 262; (2000) 50 NSWLR 66, 72.
7 Reasons [40].
8 Unless it is assumed that the buildings and other improvements are to be exactly as they exist on the land at the relevant Review Date, in which case:
(a) nice questions would arise as to appropriate allowances for depreciation, given their age, and, in any event,
(b) the assessment of rent on the assumption that the same premises are reconstructed, new every three years seems, with respect, entirely unreal.
9 See, for example, Bartlett v Salmon (1855) 6 De GM & G 33; 43 ER 1142; and Hinchcliffe v The Earl of Kinnoul (1838) 5 Bing N C 1; 132 ER 1004.
10 As I have already noted, the assumption that the buildings and improvements are to be exactly as those on the land at the Review Date carries its own uncertainties, given their current age, including the extent to which provision should be made for depreciation.
11Homebase Management Pty Ltd v City of Subiaco [2013] WASC 419 ('Homebase') [27].
12Homebase [3].
13Homebase [4].
14Homebase [6].
15Homebase [7].
16Homebase [6].
17 [1988] 1 All ER 824, 828 - 829.
18 (828, 831).
19 [2004] BCCA 247 [13] - [14].
20 Compare the relevant clause in Basingstoke & Deane Borough Council where the hypothetical demised premises were 'a bare site only', but with an added 'gloss' excluding a rent free or reduced rent period during the development of the demised premises as might otherwise reasonably be claimed if the premises were, in fact, clear of all buildings: Basingstoke & Deane Borough Council (826), (831).
21Basingstoke & Deane Borough Council (826) (emphasis added).
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