Valuing The Retail Jungle: WH Smith Retail Holdings Limited v Commerz Real Investmentgesellshaft mbh

This is the second of two posts about the Winchester County Court’s determination in WH Smith Retail Holdings Ltd v Commerz Real Investmentgesellshaft mbh of commercial lease terms (where parties to the lease were unable to reach agreement) pursuant to the Landlord and Tenant Act 1954 (the Act), in relation to WH Smith’s renewal lease of units P201 and 1087/1088 (the Premises) situated within Hammerson’s Westfield Centre in Shepherd’s Bush (the Westfield Centre). Whilst the first post examined potential barriers to achieving carbon reduction commitments, this second post considers the prejudicial effect of the retail slump and COVID-19 on rental valuation and the inclusion of pandemic clauses, which are a new species of rent suspension clause to have evolved because of COVID-19.

Section 35 of the Act provides that where parties to the renewal of a business lease are unable to agree its terms, they are to be determined by the court having ‘regard to the terms of the current tenancy and to all relevant circumstances.’ Whilst a new five-year lease term had been agreed pre-trial between the parties, one of the tasks before the court was to determine the new level of rent. Section 34 of the Act imposes further direction in relation to valuation and the exercise before the court is to determine the rent at which the Premises might reasonably be expected to be let in the open market by the willing landlord, disregarding any effect on rent of WH Smith’s occupation. Valuation is traditionally by reference to comparable rental evidence.  The passing rent under the existing 10-year lease is £953,000. The parties were a considerable distance apart in their negotiations and extensive comparable valuation evidence (from PACT arbitration, lease renewals, and new lettings) was considered within the Westfield Centre in determining the new rental figure to be £404,666. This figure equates to an overall rent reduction of £550,000 per annum.  The intention of section 34 of the Act is to protect sitting tenants from over-inflated rent hikes, but in this economic climate it can be more difficult to agree the extent of reduction in a falling market, as comparable evidence may mask true rental values. This is more pronounced at the end of a long lease term where upwards only rent reviews have artificially sustained rental figures over a long period in a falling market. The buoying effect of the section 34 rental bubble is potentially perpetuating over-inflated rents. For instance, the task before HHJ Parkes QC was to determine the rent without obvious comparable evidence to draw on. Whilst WH Smith has the financial means to argue this point in court, many tenants will not have this ability, or will not be certain of recovering a sufficient rental margin. The outcome of this judgment will have a ripple effect within the retail market, but it will be fragmented for different tenants in different cities and towns across the country where there are fewer means to test the rent level. This may potentially leave smaller tenants in smaller cities and towns paying comparatively higher rents.

I turn now to the mechanics of the rental valuation. Westfield Centre is a physical space that is curated into central anchor locations, suburban extensions, and surrounding villages. HHJ Parkes QC patiently considered an array of comparable evidence and rental adjustments relating to factors that included: unit size; comparable location within this Westfield retail town; the impact of COVID-19; the pre-existing downward slump in retail market; timing of valuation; the effect of service charge caps and pandemic clauses; and fit out and rent-free periods. This list goes on in an attempt to establish a consistent rental baseline. Valuation methodology here, as noted by WH Smith’s expert valuer, is ‘an art and not a science’

The parties in this case had already in principle agreed the inclusion of a ‘pandemic clause’ before commencement of the trial that provided, in principle, for rent suspension during the pandemic. Pre-pandemic, business interruption would have been insured by the tenant, as a commercial risk. However, discussions in the judgment around rental valuation indicate that in the current market there would be a detrimental effect without inclusion of such a clause because pandemic clauses are now factored into market valuation.

Prior to the trial date the landlord had accepted the tenant’s proposed pandemic clause in principle save in relation to the trigger for suspension to commence, which the tenant argued should be the closure of non-essential retail, whereas the landlord sought to link the trigger to WH Smith’s forced closure. HHJ Parkes QC looked to section 35(1) of the Act and to Lord Hailsham’s judgment in O’May v City of London Real Property Ltd [1983] 2 AC 726 (O’May) who confirmed that ‘the burden of persuading the court to impose a change’ to the terms of the lease rests on the party proposing it. Furthermore, Lord Hailsham stated that:

There must, in my view, be a good reason based in the absence of agreement on essential fairness for the court to impose a new term not in the current lease by either party on the other against his will.

However, HHJ Parkes QC was persuaded by Mr Healey’s argument (for the tenant) in relation to the rent suspension trigger [at 18] that since both parties were proposing a change to the new lease the tenant bore no O’May burden of persuading the court to change the terms to accommodate its proposal. This interpretation of O’May suggests that the burden placed on a party to persuade the court to accept a change to the lease only applies where its proposed clause is rejected in full by the opposing party. This seems to be a slightly strained application of section 35. The significance is that where a lease term is introduced in principle, but the commercial terms and drafting are only in part agreed, then the judge can consider the new lease term as a standalone question without reference to the statutory requirement of section 35(1) to ‘have regard to the terms of the current tenancy’. This seems contrary to section 35(1) and the principles laid down in O’May by the House of Lords, which suggest that the correct approach should be for each party to put forward an argument to persuade the court to depart from the terms of the existing lease in their favour. The approach taken here may potentially hinder negotiation if parties would be (dis)advantaged by presenting partially agreed lease terms because the court may then regard the introduction of the new clause as an agreed matter. In a subsequent decision, 13 days later, the Brentford County Court confirmed in Poundland Limited v Toplain Limited that the introduction of pandemic clauses, where the tenant (Poundland) had been unable to negotiate the in-principle inclusion of pandemic clauses pre-trial, would not be fair and reasonable following the guidance in O’May. This is, in part, because the introduction of pandemic clauses alters the fundamental balance of risk between the contracting parties. These first-instance judgments will have ramifications for thousands of commercial leases across the country. It is important that the courts set out consistent principles that can be understood and applied in commercial lease negotiation, irrespective of a party’s covenant (and negotiation) strength in the market.

--

How to cite this blogpost (Harvard style): 

Carroll, E. (2021) Valuing The Retail Jungle: WH Smith Retail Holdings Limited v Commerz Real Investmentgesellshaft mbh. Available at: https://www.law.ox.ac.uk/research-and-subject-groups/property-law/blog/2021/10/valuing-retail-jungle-wh-smith-retail-holdings (Accessed [date])