Australia: Market rent reviews and expert determinations
Landlord and Tenant alert

Focus: TX Australia Pty Limited v Broadcast Australia Pty Limited (2012) NSWSC 4
Services: Property & Projects Industry
Focus: Property

Your lease provides for a market review of the rent. You go through the process with valuers and an umpire. The resulting determination is, in your (very reasonable) view, unexpected, uncommercial and unfair. Will you be successful in having a Court overturn the rental determination? In most cases, no.

The decision of Justice Brereton in TX Australia Pty Limited v Broadcast Australia Pty Limited (2012) NSWSC 4 on 16 January 2012 illustrates the difficulties in having an expert determination set aside. In that case, the plaintiff sought a declaration that an expert determination as to the fees payable under agreements relating to broadcasting transmission towers and associated facilities was not final and binding on the parties for a number of reasons including that:

• the expert misconceived his function by applying an objective rather than a subjective test (the agreements provided for the determination of a reasonable fee rather than "market value" or "fair market value")
• the expert failed to consider relevant considerations and in particular the special value to the defendant of access to the transmission towers
• the expert wrongly gave no weight to the fees payable by the defendant during the initial term under the agreements which were being renewed
• in his choice of the most relevant comparable evidence, the expert was manifestly erroneous and erred in law
• the expert failed to satisfy his obligation to give detailed reasons in a number of respects
• the determination was manifestly unreasonable and provided the defendant with a "windfall" gain.

Each ground of complaint advanced by the plaintiff failed and the summons was dismissed with costs.

Expert determination is a cost effective way of settling a price where parties cannot reach agreement between themselves. In relation to leases, market rental reviews by an expert valuer enable the rental to be varied to reflect changes in the market between the date on which a lease commences (or when the rent was last reviewed) and the relevant review date. This allows a landlord to obtain a rental increase that it might not otherwise achieve under a fixed percentage or CPI review, and enables a tenant to avoid paying too much rent in a falling market. Careful consideration needs to be given to the basis on which the market review is to take place. In particular, the parties need to agree whether the rental determination is to be carried out on a "face" or "effective" basis. The use of ratchets, caps and collars might be used to mitigate the effect of a market review. However, despite careful negotiation and drafting, it is not uncommon for the parties to be disappointed by the results of the market rent review process.

A rental assessment by a landlord's valuer is often far apart from the assessment of the tenant's valuer. This occurs even though both valuers may be skilled and experienced professionals looking at the same lease and using similar methodology. Differences may arise from the way in which the valuers treat the comparable evidence and the weighting given to the various factors taken into account. Where the applicable rental is determined by a third valuer, acting as umpire, it is almost certain to disappoint one or other, if not both, of the parties.

A disappointed landlord or tenant will generally complain that the determining valuer made a mistake and that court proceedings should be commenced to set aside the determination. However, this misses the point. As long as there has been no fraud or collusion, the question is not whether or not the valuer got the valuation right but whether he or she performed the valuation in the manner required under the lease.

Clearly the terms of each lease need to be considered carefully but most market rent review clauses will provide for the valuer to act as an expert in determining the market rent and that such determination will be final and binding on both parties.

It is unlikely that there will be any express term that the valuation will be made without error in the valuation process, or that it will be made without negligence or that it will not be unreasonable. Furthermore, it would be difficult to imply such a term because the parties have chosen to rely on the skill and judgement of an impartial expert and have agreed that the expert's decision will be final and binding.

It will be readily implied that a valuation procured by fraud or collusion would not be one made in accordance with the terms of the lease and the parties would not be bound by it, but to rely upon a valuer's errors as a ground for setting aside a determination would require the errors to be such as to show that the valuation had not been made in accordance with the contract.

These days most leases contain a list of the criteria agreed by the parties (often after prolonged negotiation) which the valuer should take into account in determining the market rent, and a requirement for the valuer to give written reasons for his or her determination including an explanation of the methodology used and the weighting applied.

Any statement by the valuer that satisfies those requirements would be in accordance with the lease even if it falls short of the standard that would be required from a judge (as inherent in the judicial process) or under the statutory obligations of an arbitrator.

Under most standard leases, the parties will be bound by the expert determination of the valuer (whether acting as the sole valuer or as an umpire) where the valuer has addressed the correct questions (even if the answer is wrong), complied with the agreed procedure and explained what he or she did to the extent required under the lease.

In these circumstances, it will be difficult to have a determining valuation set aside. Even so, the instigation of court proceedings, even where the valuation is ultimately upheld, will be distressing for any valuer. The valuer will need to report the potential claim to his or her insurer, and there will be a cost in time and money in attending court and giving evidence. Accordingly, most valuers in acting in a determining role will require, as a condition of their appointment, an indemnity from both the landlord and the tenant. A tenant who is concerned that the rental will almost certainly increase on a market review can frustrate the process by refusing to give such an indemnity. Some landlords now require as a condition in the lease that the tenant must give such an indemnity where required.

In agreeing to be bound by the expert determination of (and where applicable, to hold harmless) a valuer, the parties assume the risk inherent in handing control of the pricing decision to a third party. One or other or both of the parties may be justifiably unhappy with the result, but that is the risk that they take.

Market rent reviews will continue to provide an important mechanism for determining rental in leases and it is very important that landlords ensure that the provisions in their lease documents clearly and unambiguously stipulate the basis upon which the review is to take place. Similarly, tenants should seek specialist legal advice prior to entering into or varying a lease as to the way in which any relevant market rent review provisions will operate. Valuers and real estate professionals will need little encouragement to ensure that they properly fulfil their obligations under the relevant contractual terms. However, when an expert determination is found to be commercially disappointing, parties should not be in too much of a rush to get to court as the only beneficiaries from this course of action may be (speaking as a lawyer) the lawyers!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.