PERPETUAL TRUSTEE CO LIMITED v CROOKS MICHELL PEACOCK STEWART PTY LTD SUPREME COURT OF NEW SOUTH WALES COURT OF APPEAL KIRBY P, PRIESTLEY and CLARKE JJA 9 July 1992, 19 August 1992 [1992] NSWCA 185 CONVEYANCING — leases — rent review clause — ambiguity — rental formula for business premises — artificial assumptions — no reduction for concessions or rent abatement to new lessees — calculation by reference to rent value of comparable premises held: (by maj) Rental value may have regard to concessions and rent abatement. CONVEYANCING — leases — rent review clause — determination of "annual rent" of business premises — construction of formulae in clause — specific requirement in one para that assumption to be made that no reduction allowable on account of any concession required to secure a tenant or any period of rent abatement — provision in another para requiring valuer to have regard to rental value of "comparable premises" — whether by "comparable premises" reference may be made to rental values determined with reference to concessions and abatement — held: (dismissing appeal) (per Priestley JA, Clarke JA concurring; Kirby P dissenting): The true construction of the rent review clause permitted the rental value of comparable premises to be taken into account and therefore imported a consideration of concessions and rent abatement which consideration was also consistent with the determination of the "open market rental of the premises". Kirby P This appeal from the Equity Division of the Supreme Court (Brownie J) concerns a challenge to the construction given to a rent review clause in a lease of business premises. Commercial context of rent review clauses Rent review clauses have given rise to a number of disputes. See eg Modifications Pty Ltd v Doyle and Anor (1991) NSW Conv R p55-578 (CA) and Ropart Pty Ltd v Kern Corporation Ltd and Ors (1991) NSW Conv R p55-594 (SC); p55-598 (CA). McCafferty v Queensland Treasury Corporation, noted (1992) 66 ALJ 222 (QFC). Their resolution is usually unrewarding. Their outcome typically depends upon the construction given to ambiguous language by which the parties seek to impose upon an appointed person an obligation to define the rent of premises in future, unforeseeable events by reference to specified circumstances, many of them artificial or hypothetical. The present is a case of that kind. Perpetual Trustee Company Ltd, the lessor (the appellant) leased business premises to Crooks Michell Peacock Stewart Pty Ltd, the lessee (the respondent) for a term of ten years. In earlier times, for such a term, the lease would itself have provided a formula to allow for the adjustment of the rent at intervals during the term by reference to criteria expressed in the lease and readily calculable. This was possible in times of predictable rents, comparatively stable, rising markets and a predictable inflation rate. When these elements of stability disappeared, along came rent review clauses bringing in their train numerous problems such as the one presented in this case. The obligation to give a sensible construction to a commercial contract, such as a lease of business premises containing a rent review clause, really needs no authority. However, if the reader will feel more comfortable to be reminded of the 2 UNREPORTED JUDGMENTS applicable legal principles, a recent illustration of this Court's approach is found in Modifications Pty Ltd v Doyle and Anor (above) and Ropart Pty Ltd v Kearn Corporation Ltd and Ors (above) at 59, 375f. See also Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337 at 350ff, Enacon Ltd v Abigroup Ltd and Ors, Court of Appeal, unreported, 4 August 1992. In Hide and Skin Trading Pty Ltd v Oceanic Meat Traders Ltd (1990) 20 NSWLR 310 (CA), 313 my own approach to such matters is expressed. The practical circumstances, against the background of which the instant rent review clause is to be given meaning, were explained to the Court. It appears to be uncontroversial. They are, in any case, sufficiently identified by the provisions of CL4.5.8(d) at the centre of the present controversy. That clause refers to a "concession... required to secure a tenant" or "any period of rent abatement". It was explained that, in the current significant over-supply of business premises, with the well-known predicament of empty buildings and undeveloped building sites in Sydney and its surrounds, lessors have been required to provide competitive inducements in order to attract lessees. Those inducements have taken the form of incentives of various kinds such as: (a) An abatement of rent for a period, relieving the lessee of the obligation to pay rent during such period; (b) Concessions of various kinds, such as the free fit-out of the premises; and (c) Other forms of concession and rent abatement. Obviously, these inducements or incentives have a distinct economic value. They effectively reduce the nett financial return to the lessor. They provide the background against which business premises, such as those here in question, are now usually leased by lessors such as the appellant to lessees such as the respondent. They help to explain the commercial background of the instant lease with its rent review clause. Courts must stop interpreting such clauses in a vacuum of commercial unreality. The concomitant of the modern approach to the construction of legislation evidenced in such decisions as Kingston and Anor v Keprose Pty Ltd (1987) 11 NSWLR 404 is a like approach to the construction of commercial instruments such as the present lease. Only if courts adopt a commonsense approach to such problems of construction as arise in such instruments will their opinions be sought and respected by the business community. See the note by the editor (1991) ANZ ConvR 353; cf (1992) 62 ALJ 479. I approach the present task of construction with a determination to give effect to the purpose of the rent review clause as it appears in the language chosen by the parties. The present rent review clause The terms of the present review clause are set out in the reasons of Priestley JA. It is necessary to have regard to the whole clause. But for my immediate purposes, it is sufficient to lay particular emphasis upon the opening words and the juxtaposition between para(d) and para(e). Notice, therefore, the following instruction which is given, relevantly, to the umpire here: "4.5.8 In determining the Annual Rent of the Premises any... umpire shall acting as an expert and not as an arbitrator determine the open market rental of the Premises as at the market review date taking into account all relevant valuation principles and having regard to the terms and conditions of this Lease and without limiting the generality of the foregoing: (d) Shall assume that the Lessee is being offered vacant possession and make no reduction on account of any concession otherwise UWHERPETUAL TRUSTEE CO LIMITED v CROOKS MICHELL PEACOCK STEWART PTS LTD (Kirby P) (Kirby P) required to secure a tenant or any period of rent abatement or any concession or abatement actually received by the Lessee under this lease; (e) Have regard to the rental value of comparable premises." The ultimate question which is posed by the appeal as I approach it is whether, on its true construction, it is necessary to interpret the reference to the rental value of comparable premises' in para(e) by applying to those premises the protocol laid down in para(d). In other words by assuming that the comparable premises referred to have a rental value which has not suffered a reduction on account of a concession otherwise required to secure a tenant or any period of rent abatement. It must be conceded that CL4.5.8 is ambiguous. Otherwise, it would probably not be troubling this Court. Various reasons can be mustered to support the construction which Brownie J gave. Thus the opening words of the clause draw attention to general valuation principles. The reference to the special protocol appears in terms only within para(d). There is no similar artificial protocol expressed in clear language in para(e). Nor does para(e) contain any formula to link it to para(d) such as "calculated in a like manner" or "similarly". Furthermore, para(e) follows and does not precede para(d). Were it otherwise, it would more readily be seen to be modified by the formula at issue. I concede the force of these indicia of a contrary construction, so long as I keep my eyes fixed steadfastly upon the words of the clause and forget the commercial purpose which it is to serve. But when I remember that purpose, the proper construction of the clause falls into place. With every respect to those of the contrary opinion, it would be ridiculous if the umpire were instructed to have no regard to special concessions for tenants and rent abatements in calculating the rent (by para(d)) only to have those inducements or incentives finding their way back into the formula for calculation of the rent by way of para(e). That simply does not make commercial or any sense. Para(e) must therefore be construed in such a way as to live comfortably with para(d). Otherwise the injunction against taking into account special inducements, which para(d) has gone to the trouble of expressing, is effectively written out of the rent review clause, or certainly rendered well nigh impotent for doing the work that was obviously intended by its inclusion. In my respectful view, construing a commercial agreement in such a way does little credit to a court. When, therefore, I look at the opening words of para4.5.8 I see words of generality which could find their way into virtually any rent review clause. Invoked are the general principles of valuation. Para(e) is in the same class. Amongst the general principles of valuation are the injunction to have regard to the rental value of comparable premises. Likewise, para(f). Amongst the general principles of valuation is the injunction to treat the lessor as a "willing but not anxious" lessor and the lessee as a "willing but not anxious lessee". In this sense para(e) and para(f) fall into the same category of general principles which are found in this rent review clause in its opening words. They provide the envelope around the particular hypothetical assumptions which the valuer or umpire is then enjoined to take into account in this particular case. It is therefore those assumptions which must be given the predominant operation. They represent the heart of the commercial "deal" which the parties have struck. Relevantly, that deal can be bluntly stated. It was that the valuer or umpire should, in fixing the prospective annual rent, make the thoroughly artificial but nevertheless obligatory assumption that: 4 UNREPORTED JUDGMENTS "... No reduction [should be allowed] on account of any concession otherwise required to secure a tenant or any period of rent abatement." Full force and effect should be given to this express and specific term of the parties' agreement. The words of generality contained in para(e) should have no more effect in neutering this specific agreement than the opening words of generality contained in the commencing provisions of CL4.5.8. The specific must have priority over the general. The particular and artificial assumption which the parties agreed to must predominate over the general consideration of the rental value of comparable premises. Only in this way can para(d) be given a commercially sensible and practical construction. That is what the parties agreed to. The respondent should be held to that agreement. Orders The result is that I have come to a view different from that reached by Brownie J and the majority in this Court. The orders which I would therefore favour are: 1. Appeal allowed; 2. Set aside the order and declarations of Brownie J dated 12 March 1992; 3. In lieu thereof: (a) declare that on a true construction of CL4.5.8 of the sublease from the first defendant to the plaintiff of levels 1 to 6, 67 Albert Street, Chatswood, the annual rent of the demised premises should be determined under CL4.5.8(e) by reference to the rental value of comparable premises to be determined in accordance with the same valuation protocol as is applied by CL4.5.8(a), CL4.5.8(b), CL4.5.8(c), CL4.5.8(d) and CL4.5.8(f) to the valuation of the demised premises; and (b) order that the plaintiff pay the first defendants costs and the costs of the second defendant of the summons. 4. Order the first respondent to pay the costs of the appeal of the appellant and of the second respondent (the latter as a submitting party) and to have, if otherwise so qualified, a certificate under the Suitors' Fund Act 1951 in respect of such costs. Priestley JA By a sub-lease dated 28 February 1990 ("the lease") Perpetual Trustee Company Ltd ("the Lessor") leased premises known as levels | to 6 in a building known as South Interchange Tower to Crooks Michell Peacock Stewart Pty Ltd ("the Lessee") for a term of ten years commencing on 1 July 1989. The lease was subject to the covenants and provisions set forth in Schedule 2 to it. Pt4 of Schedule 2 dealt with annual rent, holding over and reduction of term. By CL4.1, read with the definitions in Pt! of the Schedule, the Lessee covenanted to pay to the Lessor annual rent of $1,585,615.50 by monthly instalments of $132,134.62. CL4.4 provided for a market review of annual rent to take effect on every second anniversary of the lease's commencement date. Broadly speaking, this meant that every two years there would be substituted for the annual rent stipulated at the commencement of the lease a different figure arrived at after a review of current market rents. A detailed procedure was laid down in Pt4 for arriving at the new annual rent to be substituted on each market review date in place of that applicable in the immediately preceding period. Part of the procedure was governed by CL4.5.8, in the following terms: "4.5.8 In determining the Annual Rent of the Premises any valuer or valuers (including the umpire) shall acting as an expert and not as an arbitrator determine the open market rental of the Premises as at the Market Review Date taking into UWHERPETUAL TRUSTEE CO LIMITED v CROOKS MICHELL PEACOCK STEWART PTS LTD (Priestley JA) (Priestley JA) account all relevant valuation principles and having regard to the terms and conditions of this Lease and without limiting the generality of the foregoing: (a) shall take no account of: (i) the value of any personal goodwill attributable to the Lessee's business and the value of the Lessee's fixtures and fittings in the Premises; and (ii) any deleterious condition of the Premises if such condition results from any breach of any term of this Lease by the Lessee; (b) have regard to the length of the whole term of the Lease disregarding the fact that part of the term will have elapsed at the Market Review Date; (c) shall assume that all covenants on the part of the Lessee and the Lessor contained in this Lease have been fully performed and observed; (d) shall assume that the Lessee is being offered vacant possession and make no reduction on account of any concession otherwise required to secure a tenant or any period of rent abatement or any concession or abatement actually received by the Lessee under this Lease; [italics added for later reference] (e) have regard to the rental value of comparable premises; (f) have regard to the fact that the Lessor is a willing but not anxious Lessor and the Lessee is a willing but not anxious Lessee." In the course of following the procedure for determining the Annual Rent for the two year period commencing | July 1991, a question arose between the lessor and the lessee about the meaning of para(e) when read in light of the whole of CL4.5.8, and particularly, in the light of para(d). To decide the question, the Lessor began proceedings by summons in the Equity Division, naming as defendants the Lessee and the valuer/umpire upon whom the duty to determine the Annual Rent of the Premises had fallen pursuant to the stipulated procedure. The substance of the answer given by the court (Brownie J) to the question dividing the parties was that the valuer, in having regard to the rental value of comparable premises pursuant to para(e) was to use rental values of such premises without making the assumptions required by para(d) in respect of the rent of the demised premises themselves, except to the extent that relevant valuation principles required. Declarations were made to embody Brownie J's conclusions. The defendant/Lessor appealed, seeking to have different declarations substituted for those ordered by Brownie J. The Lessor argued: (1) if para(d) and para(e) were read literally there would be conflict or tension between them which could only be resolved by reading them together so that the same matter required to be assumed under para(d) should also be assumed in determining figures of rental value of comparable premises pursuant to para(e); (2) the construction proposed by the Lessor would make the "comparable premises" of para(e) truly comparable; (3) that to read para(e) in the way Brownie J did was to deprive of any practical effect that part of para(d) which required the valuer to make no reduction in the rent of the demised premises for the inducements described in that paragraph to the Lessee to enter into the lease. To understand the matters argued in the appeal it is necessary first to see the part played in the operation of CL4.5.8 by para(d). The opening words of the clause require the valuer to "determine the open market rental of the premises" at the stated date. This is to be done upon usual valuation principles "having regard to the terms and conditions of this Lease". 6 UNREPORTED JUDGMENTS That is, the opening and general part of the clause asks the valuer to determine what a willing but not anxious Lessee would pay as rent to the Lessor being a willing but not anxious Lessor for a lease of the premises on the terms and conditions in the actual lease between the parties to the dispute. Para(a). para(b), para(c), para(d), para(e) and para(f) then go on to direct the valuer that in carrying out that task some things are to be done and some not done; to the extent that the doing or not doing of these things involves a departure from what would otherwise be the usual way of determining an open market rental then the valuer is to arrive at the valuation by the usual method varied as required by the paragraphs. Thus para(a) and para(b) seem to require the valuer in determining the open market rental at 1 July 1991 not only to have regard to the particular terms and conditions of the actual lease between the parties but also to determine the open market rental for that lease as if it was commencing its ten year term on | July 1991. Para(c) also contributes, although indirectly, to the same position. The opening words of para(d) also contribute to the same position; that is, para(a), para(b), para(c) and the words in para(d) "shall assume that the Lessee is being offered vacant possession", all play their part in requiring the valuer to determine the open market rental on the terms and conditions of the actual lease as if it were a ten year lease on those terms and conditions commencing on | July 1991 with the Lessee taking possession of the premises on that date, not yet having built up any good will in the premises, or done any fitting out of the premises, the premises being in the condition they would be upon the first day of the lease and, since the lease is assumed to be beginning on that day, no question yet having arisen of there being any breach of covenant either by Lessee or Lessor. In other words the valuer is asked to determine the open market rental of the premises upon the terms of the particular lease as if the actual Lessee were commencing a term of ten years from 1 July 1991 having just entered into possession of the premises for the first time. It was assumed by both sides in the argument in this court (and by the Bench), without any attention being directed to the question, that the valuer in having regard to the terms and conditions of the actual lease would need to consider as one of those terms and conditions the rent stipulated in the lease. After thinking about this aspect of the case I am not now sure that the assumption was correct. If the objective of para(a), para(b), para(c) and the opening part of para(d) was to require the valuer to determine the open market rental of the premises on the terms of the actual lease varied as I have already described, it might well be a necessary implication that the figures relating to rent should have no place in the actual lease as so varied, since the general idea would appear to have been for the valuer to determine what figure the open market would arrive at for rent. However, it seems to me, fortunately perhaps, that whether the assumption made on all hands in the course of the argument was correct or whether the second possibility I have now mentioned is the more likely one, the position from the valuer's point of view would be the same for practical purposes. In either case the valuer would want to know the rent of the premises immediately before the date at which he was required to determine the open market rental. This would be one of the figures relevant to his assessment of the open market figure on the relevant day. The importance of the figure to the valuer in arriving at his opinion as to the proper determination would vary in light of the particular facts concerning the premises and the market at the time; in some UWHERPETUAL TRUSTEE CO LIMITED v CROOKS MICHELL PEACOCK STEWART PTY LTD (Priestley JA) (Priestley JA) circumstances, the figure's importance might be comparatively slight, in others, considerable. But whatever weight the figure might carry in particular cases, quite extraordinary circumstances would have to obtain before it could be said that the figure was of no relevance at all; the result in my opinion must be that any competent valuer would always want to know what it was. If he were not able to obtain it from the lease itself (as in fact in this case he would, even if it should be notionally deleted for the particular rent determination), he would undoubtedly obtain it by enquiry. I can therefore leave aside the question whether the assumption I have mentioned as one made on all hands during the argument was correct, and return to the part played by para(d) in CL4.5.8. I have mentioned that the first part of the paragraph is dealing with the actual lease of the demised premises, subject to the stipulated changes. Passing over the second, italicised part, the third part is again dealing with the actual lease of the demised premises, this time without any artificial changes to the facts. Para(f) in terms applies to the parties to the lease. Para(e) equally plainly applies to other premises. The scheme of CL4.5.8 is thus to give directions to the valuer about how to approach matters relating to the demised premises in the valuation exercise, in para(a), para(b) and para(c), the first and third parts of para(d) and para(f). The valuer is told that the open market rental he is to determine as at the market review date is of a lease having the same terms and conditions as the Lease with the following variations: it is to be treated as a lease for a term of ten years; it is to be treated as if the Lessee taking possession under it will be taking possession under it for the first time; that the rent shown in the lease for the period preceding 1 July 1991 is to be taken as the rent stated in that earlier lease whether or not the Lessee had been induced to enter into it by inducements, which in a practical sense meant that the open market rental for the premises would have been less than the figure stated in the lease; and, finally, that if somebody were to argue to the valuer that at 1 July 1991 an intending lessee would have been able to bargain with the Lessor, because of prevailing market conditions, to reach a position where although the intending lessee agreed to a particular rental to be inserted in the lease, that lessee would also get the benefit of inducements from the Lessor which would have the practical effect of reducing the nominal rent figure so far as the Lessee was concerned, the valuer was to ignore any such argument. In one sense, the Lessor does not quarrel with this view. What the Lessor says is that the italicised middle part of Cl(d) should be treated as applying not only to the demised premises, but also to those comparable premises referred to in para(e). The language appears to me to be all against this submission. The italicised words in their ordinary meaning in their place in the clause seem to me to refer only to the same premises as the two parts of the paragraph on either side. It is only the presence of para(e) in CL4.5.8 which gives the Lessor's argument any foothold at all. The Lessor says that on the Lessee's approach para(e) adds nothing to the clause; all it does is require the valuer to have regard to something to which he is bound to have regard in any event when taking into account relevant valuation principles. The Lessor says that para(e) must have had some further purpose than that. 8 UNREPORTED JUDGMENTS The Lessor then says that that the only plausible purpose for inserting the paragraph must have been to indicate that the rental value of comparable premises should be approached on the basis indicated in the preceding paragraph. In effect, the submission was that para(e) should be read as if before the word "have" in the paragraph the words "upon the same assumptions as h the preceding paragraph" were inserted. In aid of the same argument it was said that unless the Lessor's construction was adopted the valuer would not be having regard to the rental value of premises which were truly comparable. In support of the submissions on either side, counsel pointed to the practical consequences of one construction or the other. On the Lessor's construction the valuer would be making his determination by taking into account rentals both of the subject premises and of comparable premises simply by reference to the amount of rent actually stated in them, in circumstances where the nominal rental figures might be higher than actual open market rentals, and would be prevented by the terms of CL4.5.8 from taking whatever steps might otherwise be taken to arrive at true rather than nominal figures. On the construction adopted by Brownie J the valuer would only be obliged to take the nominal rental figure rather than the actual one in the case of the subject premises; in regard to all comparable premises the valuer would be left to take whatever steps were open in the ordinary way to obtain all the figures relevant to a particular lease necessary for ascertaining the actual rental figure for that lease. On the Lessor's construction of CL4.5.8 a lessor who had bargained with a lessee to enter a lease on the terms and conditions of the Lease and who had obtained agreement for the use of a rental figure in the lease higher than the market figure at the time of entry into the lease and had achieved this position by inducements to the lessee, would be in a position at two yearly intervals to have the rent increased by reference to artificially high figures (if the era of inducements continued) without at the later rent review dates having to provide inducements corresponding to those handed over at the time entry into the lease. It is quite possible that a bargaining process of this kind took place in the present case; the Lessee, to mention just one consideration, may have reckoned that the possibilities of the era of inducements continuing for very long was not worth worrying about. A very wide variety of considerations relevant to such a bargain can be imagined on the part of both Lessor and Lessee. The Lessor's submissions attempted to overcome the last consideration mentioned in a way that can be summarised as saying that any result other than the one it contended for would not make commercial or logical sense and would produce an unfair result. I do not think the court is in a position to make any of these judgments. Indeed, for the court to act on any of the three bases would be, it seems to me, to make an assumption which would decide the question before the court, when there is no foundation available to the court for the assumption. My view is related to my earlier remark about the wide range of bargaining considerations possibly present in the minds of Lessor and Lessee at the time of making the lease. The Lessor's arguments do not give any weight to this factor. The court has not before it any evidence of circumstances special to the demised premises that might affect the construction of the clause. The court can take judicial notice of the general position that the commercial leasing market was in an unusual state of flux at the time the lease began, and innovative arrangements UWHERPETUAL TRUSTEE CO LIMITED v CROOKS MICHELL PEACOCK STEWART PTY LTD (Clarke JA) (Clarke JA) were being made between landlord and tenant, but the court knows nothing more, certainly nothing about the actual commercial reasons the parties to this lease had for agreeing to its particular terms. It seems safe to assume that before the parties entered into the lease at the significant rental it required they both received legal advice. The formula of CL4.5.8 is workable, and there is nothing before the court to suggest that it does not represent a bargain struck between people who knew what t hey were doing. These considerations in my opinion rebut the complaints of illogicality, uncommerciality and unfairness. In my opinion Brownie J was substantially right in his conclusions, and I think the appeal fails. However, there was some discussion in argument whether, in the event that the court reached this view, it might not be preferable to frame the declarations somewhat differently. The court made some provisional suggestions about this. It seems to me now it would be better for the court's reasons to be published and short minutes of declarations and orders then to be brought in. I suggest that that course be followed. Clarke JA I agree with the reasons of Priestley JA. The parties to bring in Short Minutes of declarations and orders to give effect to the reasons of the Court. Counsel: Appellant: M Tobias QC/G K Burton Ist Respondent: P M Biscoe QC 2nd Respondent: M Bowen, Solicitor (submitting) Solicitors: Appellant: Mallesons Stephen Jaques 1st Respondent: Marshall Marks Kennedy 2nd Respondent: Duffield and Duffield