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Lawbite: Sharing is caring… of the rental element of a surrender premium under a development lease

  • United Kingdom
  • Litigation and dispute management
  • Real estate
  • Real estate litigation - LawBite

15-10-2020

3639 Limited v Renfrewshire Council 2020 CSOH 86

A win for the landlord and a loss for the developer…

The Outer House of the Court of Session recently held that the “Rack Rental Income”, which in short was defined under the lease as “the rents which the Tenants are entitled to receive from their several sub-tenants”, included the rental element of a surrender premium paid by a Sub-Tenant to the Tenants under a development lease. The case will now proceed to proof (trial) to determine the proportion of the premium that is attributable to future rent, and to which the landlord is now entitled.

The development lease

A property developer contracted with a land owner to develop a shopping centre in 1973. The developer, as tenant under the development lease, was to build the centre within 4 years and thereafter was to run, maintain and insure it. The landlord was to  receive the higher of (i) the ground rent (£7,210 p.a.); or (ii) 16% of the “Rack Rental Income” received by the tenant from its sub-tenants. Unsurprisingly, the landlord was therefore to share in the success of the centre.

The renunciation premium

One occupant of the centre was a sub-tenant under a 63 year sublease due to expire in July 2037 with annual rent of £268,000 p.a.. 16% of that rent was paid to the landlord.

In 2019 the sub-tenant wanted to leave the centre and agreed to surrender the sub-lease at a price of £3,760,000. This sum was agreed with the tenant as broad brush figure, but it was accepted that an element was for “future rents”, which would otherwise have been due under the sublease. Other elements included were for items such as dilapidations and rates. The tenant did not share any of the surrender premium with landlord because, it argued, it did not fall within the definition of “Rack Rental Income”. It said “rent” should be given its ordinary meaning, i.e. payment for occupation of land. This payment was for precisely the opposite. Also, it gave examples where it may pay reverse premiums to attract sub-tenants to let or remain, in which case the landlord would not have to put its hand in its pockets.

The decision

The Court disagreed with the tenant.

It said that the tenant’s argument had a “logical simplicity” but failed to account for the contractual structure. This was a development lease and the parties common intention was that the landlord and the tenant shared the risk and the reward. With that in mind it decided parties must have intended a wide interpretation of the “rent” so that “Rack Rental Income” included any rental element of the premium - otherwise the tenant could “defeat that [common] intention” or, as the landlord put it, the tenant could “cheat” the landlord, by swapping periodic rental payments for surrender premia. The Court stated it to be “well known” that payments by premium were open to abuse, and held that the tenant was accordingly not entitled to the full amount of the premium.

Does this case have wider implications to the Scottish market?

The short answer is, it could, but whether premiums will require to be shared will ultimately depend on the wording of the lease.  Development or ground leases could well be drafted similarly to the lease in this case, without specific clarification as to how premiums should be treated. 

Key points

  • when assessing the common intention of the parties for the purpose of interpreting a lease provision the court will consider the lease as a whole.
  • the court also takes into account the commercial impact on the parties. Might the outcome have been different if, for example, the Court considered that the landlord was securing a windfall?
  • developers under development leases should carefully assess the wording of a lease before agreeing any renunciation/surrender provisions; tenants should do the same before agreeing any premium with a sub-tenant.