Introduction
The following commentary is adapted from a paper titled “Retail is Detail” presented by firm principal Shannon Davies on 20 September 2023. It explores the requirement under the Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA) (“Retail Shops Act”) relating to single basis reviews, and the prohibition in the Act against ratchet clauses in market reviews.
Importance of rent reviews
It is a rare thing to see a retail shop lease without any form of rent review machinery.
From a landlord’s perspective, there will be an understandable interest in ensuring that the rent payable by the tenant keeps step with the value of the premises, or if not with premises value, with the value of money over time. On the other hand, the tenant will be keen to ensure that the rent does not get too far ahead of the market. The concerns on both sides will be heightened in the case of a long-term lease.
Regulation of rent reviews in retail shop leases generally
Sections 11 and 11A of the Retail Shops Act regulate both reviews aimed at pinning the rent to the current value of the premises (market reviews) and those that are aimed at escalating the rent by reference to some figure, index or formula (for example, CPI and fixed percentage increases).[1] The amount of text in these sections that is devoted to the former review type suggests that this is the real focus of the Act.
Single basis rent review requirement
Of general application to rent reviews under retail shop leases is the requirement that “the lease specifies, in respect of each occasion on which the review is to be made, a single basis on which the review is to be made”.[2] This is sometimes known as the “single basis review” requirement, which was introduced by the Commercial Tenancy (Retail Shops) Agreements Amendment Act 1998 (WA) (“1998 Amendment Act”) and came into operation on 1 July 1999. Prior to that date, the only requirement under the Retail Shops Act was that “the lease specifies the basis on which or the formula by which the rent is to be made”.[3]
The current version of the prescribed form of tenant guide[4] describes the effect of the single basis review requirement as follows:
“At each review time the lease must set out a single basis on which the rent is to be reviewed, this can include:
- the market rent
- an increase by reference to the Consumer Price Index (CPI)
- a set percentage increase
- an agreed formula or combination, for example, CPI +2%.
The types of review may vary over the life of the lease (the lease may state that reviews are to alternate between CPI and market review). However, the lease cannot give the landlord the right to choose the greatest return from a range of rent types at any one review (for example, the lease cannot state that the increase is to be CPI or 5% whichever is higher).”
To the extent that a clause in a retail shop lease is inconsistent with the single basis review requirement, that clause will be void,[5] and may raise difficult questions about severability. The worst-case outcome for a landlord would be a long-term lease with no rent increases whatsoever (although a tenant might be perfectly content with that). Worth noting is that a clause in a retail shop lease that provides for review to the lesser of two methods of review will also offend the single basis review requirement.
The single basis review requirement was considered by the State Administrative Tribunal (“SAT”) in Head v Zimmermann Investments Pty Ltd.[6] In that case, the lease in question provided that “the Annual Rent … shall be calculated on the basis of the Consumer Price Index (‘CPI’) or three per cent (3%) whichever is the greater”. The SAT held that this provision was void.
Although the “single” aspect of the single basis review requirement is generally focused upon, the other important aspect relates to the word “basis”. This means, for example, that it is not sufficient to simply say that the rent under a retail shop lease is to be determined by an arbitrator without any indication of how the arbitrator is to do so.[7] On the other hand, a provision for appointment of a valuer to determine the rent based on market criteria, or even just “having regard to market rent” is sufficient.[8]
The potential scope of the single basis requirement becomes interesting where the rent is subject to review by reference to an independent index (usually CPI). With an index such as CPI, a landlord could generally have confidence that the general trend will be upwards. However, that is not always the case. For example, there were a number of occasions in the 1990s, and one occasion in 2020 during COVID-19, where the percentage change in the CPI All Groups Index for Perth for a given quarter (from the corresponding quarter in the previous year) was negative.
How then does a clause which provides that “with effect from each CPI Rent Review Date, if and only if the Current CPI exceeds the Previous CPI then the Rent shall be increased to the sum calculated on the basis of the formula” interact with the single basis review requirement? Is this type of provision not arguably a review to the greater of two bases: i.e. CPI increase and the status quo?
A clause to similar effect was considered by the Queensland Court of Appeal in Connor Hunter (A Firm) v Keencrest Pty Ltd & Ors.[9] In that case, the Court of Appeal concluded that “the subclauses do not provide for two bases for reviewing the rent … In the case of clause 2.3(a) there is also only one basis: index of inflation where the index for the year in question was greater than the index for the previous year”, and held that there was no contravention of the Queensland equivalent to the single basis review requirement, found in section 27 of the Retail Shop Leases Act 1994 (Qld).[10] However, the wording of the Queensland section is notably different and I think this decision should be approached with caution. Given the overall trend in the CPI indices and the rarity of a negative percentage change from quarter to corresponding quarter, it is worth considering whether the inclusion of upwards-only wording in a CPI review clause is worth the risk of an argument around the validity of that clause.
Prohibition against ratchet clauses in market rent reviews
In the context of market reviews specifically, the prohibition on the use of “ratchet” clauses is well known.[11] As with the single basis review requirement, this prohibition was introduced by the 1998 Amendment Act. The terms of the prohibition are that “a provision … purporting to preclude the increase or reduction of … market rent or to limit the extent to which that market rent may be increased or reduced is void”. In other words, not only will it always be possible for the rent to increase or decrease following a market review under a retail shop lease, but caps and collars are also unenforceable. The intent is clearly that a market review results in a market rent.
But what about the possibility of a “de facto” ratchet in circumstances where the market review provision only entitles the landlord to initiate the review? What if a landlord, who is apprised of the market and currently enjoys an above-market rent, either elects not to initiate the review process, or purports to waive rights to the review? What remedies, if any, might the tenant have in such a scenario?
In Beba Enterprises Pty Ltd v Elle Pty Ltd,[12] the tenant under a retail shop lease referred a total of 11 questions to the SAT for determination, which were primarily concerned with the ability of either party to call for a market review following the extension (by agreement) of the lease. Among other things, the tenant argued that the provision in the lease that only allowed the landlord to initiate the review was void by virtue of the prohibition on ratchet clauses. The relevant clause provided as follows:
“The Landlord may elect to review the Base Rent at each Market Review Date. If the Landlord wishes to review the Base Rent on a Market Review Date then, subject to the Commercial Tenancy Act (if applicable to this document), the following clauses … shall apply on each occasion.”
The tenant submitted that:
“By giving the respondent the sole right to elect a review of the amount of rent payable under the lease having regard to the market rent, clause 3.2 allows the respondent to preclude the increase or reduction of the market rent by choosing not to elect a market rent review. By giving the landlord the sole discretion to elect a market review, clause 3.2 precludes the increase or reduction of the rent if the landlord does not elect to review the rent. A provision that precludes the increase or decrease in market rent, even if subject to a pre-condition, such as the landlord’s election, still operates to preclude that increase or decrease.
…
… clause 3.2 allows the respondent, prior to electing a market rent review, to unilaterally obtain a market rent valuation of the property and, if that market rent valuation indicates that a market rent review would reduce the rent payable by the applicant, preclude the reduction of the market rent by choosing not to elect to undertake a market rent review.”[13]
However, the SAT found that the prohibition on ratchet clauses was not offended by the market review clause in the lease:
“It is true that, by exercising its right to elect not to review the rent to market, a landlord is, in relation to that market review date, precluding both an increase and reduction in rent. That preclusion arises from the agreed ability of the landlord not to proceed with a market rent, not, in my opinion, by reason of any ‘provision in the retail shop lease purporting to preclude the increase or reduction of’ the market rent.”[14]
In addition, the SAT’s view was that section 11(2)(b) of the Retail Shops Act was of no assistance to the tenant. That section provides that “unless specific provision is made in the retail shop lease for the time at which a review may be initiated, a party to the retail shop lease may not more than 3 months before the date on which that review is to be carried out and not more than 6 months after that date, initiate the review by notice in writing served on the other party”.[15] The SAT found that this section only “applies where no specific provision is made for the time at which a review may be initiated. Where that is the case, the provision states that ‘a party’ may initiate the review within a certain period by notice. Although it is unnecessary for me to decide, it is highly questionable whether the provision operates … by giving a right to initiate a review to either party, including a party who does not otherwise have that right”.[16]
Only a few months after Beba Enterprises, the SAT delivered its decision in Flyer Services Pty Ltd v Marshall.[17] This was another case that involved, in part, a question of whether the landlord was obliged to initiate a market review, or whether the right to initiate was discretionary. The relevant clauses provided as follows:
“7.1 Rent Review
On each Rent Review Date, the Rent, calculated on an annual basis, with effect from that Rent Review Date will be reviewed so that:
(a) on each Fixed Percentage Rent Review Date it is the Rent payable for the month immediately preceding that Rent Review Date multiplied by twelve (12) and multiplied by a factor of 1.04;
(b) on each CMR Review Date it is the Current Market Rent.
7.2 Rent Review Notice
(a) The Lessor may between the period of three (3) months prior to and six (6) months after each CMR Review Date, by notice in writing to the Lessee, review and fix the Rent calculated on an annual basis at an amount which in the opinion of the Lessor is the Current Market Rent but failure to give a Rent Review Notice in respect of a CMR Review Date will not affect the right of the Lessor to give a Rent Review Notice at any time in respect of that CMR Review Date.”
Predictably, the parties adopted competing positions over whether the word “may” in clause 7.2 of the lease (which in isolation gives the landlord a discretion to initiate the market review or not) trumped the mandatory “will” language in clause 7.1. However, the SAT decided that “it is hard to envisage any more definitive statement of the required outcome of a rent review” and that “once it is accepted that the lease contains the mandatory provision for market rent review, the fact that the machinery provisions regulating how the review is to proceed are not expressly linked as in this case (leaving aside their immediate physical proximity) cannot detract from the compulsive nature of the term”.[18] The SAT also observed that the inclusion of discretionary market review provisions in a lease that have not been highlighted by disclosure may give rise to tenant remedies under section 6 of the Retail Shops Act:
“It is unnecessary for me to make definitive findings about the sufficiency of a disclosure statement which omits to mention that market rent reviews to which it refers are to be at the sole discretion of the landlord. Given my finding regarding the mandatory nature of the market rent review in the lease, this is not something that arises in the present case. I would however be surprised if a landlord would be fulfilling his disclosure obligation in relation to a market rent review which was to be at the sole discretion of the landlord, by omitting to mention that matter. The requirement that a disclosure statement not be incomplete, and not contain false or misleading information, is a serious one, notwithstanding the warnings to the prospective tenant, evidenced by the fact that non-compliance may result in termination of any resulting lease or a compensation claim.”[19]
In Seacress Nominees Pty Ltd and Kimbriki Nominees Pty Ltd,[20] the SAT was called on by a tenant to determine, among other questions, whether the landlord could “elect to skip a market rent review opportunity when the lease sets out alternating CPI, market rent reviews”. The lease in question provided that “the Base Rent shall be reviewed and adjusted on each Review Date” and that the landlord “shall … give to” the tenant review notices. The tenant argued that the mandatory nature of the word “shall” obliged the landlord to initiate each market review. The SAT agreed with the tenant, and held that the skipped market reviews should have been conducted.[21]
Interestingly, a similar fact scenario appears to have arisen in the much earlier Western Australian Supreme Court decision of Kidd Nominees Pty Ltd v Ferrall Nominees Pty Ltd & Anor.[22] In that case, the landlord declined to initiate a market review based on valuation advice that the reviewed rent would not be more than the current rent. In response, the tenant served the landlord with a notice setting out its own assessment of the market rent. It is not clear that the tenant had any entitlement to issue such a notice. For whatever reason, the issues ventilated by the SAT in Beba Enterprises and Flyer Services were not addressed in the Supreme Court’s decision. The Supreme Court ended up referring the matter to the Commercial Registrar.
Conclusion
From the above decisions, it appears that a market review clause that may be initiated only at the election of the landlord will not offend the Retail Shops Act’s prohibition against ratchet clauses. However, there must be clear wording to support the desired clause construction, and the landlord should also give serious consideration to flagging the discretionary nature of the market reviews in the tenant’s disclosure statement (or risk the tenant exercising remedies under section 6 of the Act). Further, except in the extremely unlikely scenario where a retail shop lease fails to specify a period for the initiation of a market review, the tenant has no statutory right to itself initiate (unless there are clear provisions in the lease that entitle the tenant to do so).
Disclaimer
This post has been prepared as a general summary only. It is not, and is not intended to be, legal advice with respect to any particular matter. This post should not be relied on with respect to any particular matter without taking legal advice. Stork Davies Legal Advisors disclaims liability to any person who relies on this post without taking legal advice from the firm.
[1] Section 11A of the Retail Shops Act deals with the disclosure of market review-related information, and is beyond the scope of this paper.
[2] Retail Shops Act s. 11(1).
[3] See for example O’Connor’s Management Pty Ltd v Kao Holdings Pty Ltd (1998) 19 WAR 87, in which a market review clause that “tacked on” a minimum 6.5% increase did not infringe s. 11(1) of the Retail Shops Act in the form then applicable.
[4] Prescribed under s.6A of the Retail Shops Act and r. 9 of the Commercial Tenancy (Retail Shops) Agreements Regulations 1985 (WA) (“Retail Shops Regulations”).
[5] Retail Shops Act s. 15(2).
[6] Head v Zimmermann Investments Pty Ltd [2009] WASAT 61.
[7] Morello Pty Ltd v Government Employees’ Superannuation Board CT 150 of 1990 at 11.
[8] West Australian Trustees Pty Ltd v Poon (1991) 6 WAR 72 at 78.
[9] Connor Hunter (A Firm) v Keencrest Pty Ltd & Or [2009] QCA 156.
[10] Connor Hunter at [72] per Chesterman JA, with whom Holmes JA agreed.
[11] Retail Shops Act s. 11(2)(c).
[12] Beba Enterprises Pty Ltd v Elle Pty Ltd [2013] WASAT 120.
[13] Beba Enterprises (SAT) at [20] and [23].
[14] Beba Enterprises (SAT) at [21].
[15] The second reading speeches for the Commercial Tenancy (Retail Shops) Agreements Amendment Bill 1997 (WA) do suggest that the legislature had in mind that “either party to the retail lease may initiate a rent review action”.
[16] Beba Enterprises (SAT) at [37].
[17] Flyer Services Pty Ltd and Marshall [2013] WASAT 188.
[18] Flyer Services at [28].
[19] Flyer Services at [45].
[20] Seacress Nominees Pty Ltd and Kimbriki Nominees Pty Ltd [2017] WASAT 95.
[21] Seacress Nominees at [50] to [54].
[22] Kidd Nominees Pty Ltd v Ferrall Nominees Pty Ltd & Anor [2003] WASC 73.