What You Should Know About Market Rent Reviews & Changing The Lease Type.

Tenants will often find themselves asking what they can do to get a rent reduction, especially when times get tough and it is not business as usual. Likewise commercial landlords are seeking to increase their return on investment.

Rent often plays a big factor in determining the success or failure of a business and striking the right balance is paramount.

During a rent review there could be disagreements and questions around ratchet clauses, valuations and whether the lease is a retail lease or not.

Rent reviews, ratchet clauses and retail and non-retail leases

This has become a hot topic of conversation amongst tenants and the wider business community who are trying to stay afloat during times of uncertainty. Lawyers have been inundated with enquiries regarding rent reductions and ratchet clauses. Commercial lease lawyers have had to get creative with strategising a way forward for both landlord and tenant clients.

Landlords typically want to establish or maintain a “commercial” or “non-retail” lease with their tenants. A non-retail lease has less obligations for landlords and protections for tenants than retail leases provided under the Retail Leases Act 2003 (VIC) (“the Act“). This allows landlords to exert far more power over their tenant and flexibility with what a landlord is permitted to do.

A non-retail lease, whereby the Act does not apply permits a landlord to establish and enforce what is commonly referred to as a “ratchet clause.”

What Is A Ratchet Clause?

A ratchet clause is like a gold nugget for a landlord and takes it’s name from an everyday tool as it works similarly. It means that a landlord can insist that the rent payable by the tenant after a rent review must not be less than the rent payable immediately before the rent review, even if the market indicates that it should be.

Essentially, with a ratchet clause a landlord can guarantee themselves frequent rent increases and eliminate the uncertainty of a potential rent decrease during the term and any options.

With a retail lease, your landlord is prevented by section 35 of the Act from establishing and enforcing a ratchet clause.

As a tenant a retail lease has extensive safeguards under the Act. Your landlord has a higher level of accountability and more stringent obligations when it comes to repairing and maintaining the premises and reviewing the rent.

Even if your retail lease contains a ratchet clause it will be void and unenforceable as such a clause will be in conflict with the legislative requirements. If a lease is inconsistent with the law, the law prevails and supersedes the terms of the lease.

For some tenants there can be uncertainty to whether they are a retail lease or a commercial lease. Even if you have signed a commercial lease, it could in fact be a retail lease and these protections could be available to you, notwithstanding that the schedule says it is non-retail.

It is important if you are in the process of a rent review or commercial lease dispute to get the right legal advice on this point. Read more here on Commercial v Retail Leases.

The Difference Between Market, CPI And Fixed Rent Reviews And How They Are Calculated

A rent review is a review of the rent payable under a lease. Generally, a lease states when the review is to take place and the basis or formula on how the new rent is to be determined.

With a retail lease the Act provides for three methods by which rent can be increased.

This is done by one of the following:

1. A Market Review

   These often commence at each further term, the rent is determined based on the current market value. This may sometimes result in a decreased rent. This is more the norm that landlords and tenants are experiencing this in the current market. This is resulting in more lease disputes between the landlord and tenant and is a classic hallmark of a softer rental market.

   If the landlord and tenant cannot agree on the market rent when a market review is due, the Act specifies that they must jointly appoint a valuer and if the parties cannot agree on the appointment of a valuer, they should request that the Victorian Small Business Commissioner appoint one.

2. CPI Review

   Where a CPI or consumer price index is specified as the rent review mechanism, the rent is determined based on a measure of inflation. If CPI is negative the rent will decrease and If CPI is positive the rent will increase.

3. Fixed/Percentage Increase

   With a fixed/percentage review, the lease will simply just contain a fixed amount or percentage by which the rent increases on certain dates.

With a non-retail lease, the landlord is free to determine what mechanisms should be used to increase the rent. Ratchet clauses are often employed in non-retail leases with the sole purpose of preventing the rent from being decreased when a market review or CPI review occurs.

Review Dates And Early Rent Reviews

Rent reviews should be conducted and the changes to the rent should be applied within the time provided by the lease. Under the Act stipulates if the landlord hasn’t initiated the review within 90 days after the end of the period prescribed in the lease, the tenant may initiate the review.

Further, there have been some beneficial changes for tenants who have retail leases, brought about by the Retail Leases Amendment Act 2020 (“the Amendment Act”) Act. The Amendment Act provides that when a lease contains a market review at the start of a further term, the tenant may request an early rent review within 28 days. This is after the landlord gives the tenant all of the information required in respect of the option to renew.

In summary, the landlord is required to provide the tenant with the following information:

• the last date by which the option to renew may be exercised;
• the rent payable for the first 12 months under the renewed lease term;
• the availability of an early rent review under the Act if a market rent review is to take place at the start of a further term;
• the availability of a cooling-off period under the Act; and
• any changes to the last disclosure statement given to the tenant.

If the tenant requests an early rent review this impacts the timeframe in which the tenant can exercise their option to renew the lease. The last day the tenant to exercise their option is extended to 14 days AFTER the tenant receives written notice of the valuer’s determination of the market rent. Section 37 of the Act dictates that the cost of the valuation must be shared equally between the landlord and tenant.

The option of electing an early rent review is only available to the tenant at the commencement of a further term. This does not apply to rent reviews which occur during a term of the lease.

Understanding Your Lease And Your Obligations And Rights

Understanding the type of lease you have is imperative to understanding what each parties’ obligations and rights are. This is critical in determining whether you have the correct type of lease in place.

Landlords

Landlords should seek certainty about their obligations and they can maximise their income and minimise expenses. If the circumstances permit landlords to evade the Act’s application and have a non-retail lease in place, this is generally better for a landlord. There are many advantages that flow from the lease being outside the parameters of the Act h as being able to pass on outgoings such as land tax and legal costs, as well as capital repair and maintenance costs. It should be noted, however, that the premises are what are actually are, not what the lease names them to be necessarily.

Importantly commercial lease landlords could enforce a ratchet clause preventing in rent at each review. This has a direct positive impact to the valuation of your property.

Tenants: Can my landlord change the type of my lease?

Landlords also look to reclassify leases from retail leases to non-retail Leases to avoid obligations and expenses.

The correct classification of your lease is especially important when it comes to minimising your expenses and exposure to other costs which a non-retail lease may attract. In particular, a retail lease protects you from the application of ratchet clauses and exposure to additional costs and expenses such as:

• land tax;
• capital repair and maintenance costs; and
• landlord’s legal fees in some cases.

Tenants with a non-retail lease in place may wish to obtain advice to re-evaluate if your lease may be deemed a retail lease. If so, you are protected under the Act. Whether you have a retail or non-retail lease is a matter of law and not an agreement between the parties.

Tenants can take comfort in knowing that if they have a retail lease, it cannot be converted to a non-retail lease for the landlord to avoid the application of the Act. In Richmond Football Club v Verraty [2019] VSC 597 the Supreme Court ruled on an appeal from the Victorian Civil and Administrative Tribunal. It found that a retail lease, within the meaning of section 11 of the Act, when it is entered into cannot cease to be such a lease during its term and therefore, cannot be converted into a non-retail lease.

This precedent infers two things:

1. That a retail-lease cannot be converted into a non-retail lease upon the exercise of an option to renew it.
2. At the time it was entered into it qualified as a retail lease it will REMAIN a retail lease and the Act will continue to apply during the term and any further terms.

Even though a retail lease cannot convert into a non-retail lease, a non-retail lease is not precluded from becoming a retail lease in circumstances where it meets the requirements of section 11 of the Act. It is possible to convert a misclassified non-retail lease into a retail lease as the law automatically provides for this.

A misclassification of a retail lease as a non-retail lease when it is entered into will likely entitle a tenant to assert rights in the future and potentially clawback payments made in error. This would evidently lead to dire consequences for landlords.

To determine whether your lease is a retail lease or a commercial lease you should seek legal advice for clarity.

At PCL Lawyers our commercial lease lawyers have extensive experience in handling a wide range of commercial lease matters. We can provide clear and commercially minded advice regarding rent reviews and changing the type of lease for both landlords and tenants.

If you require advice or assistance regarding commercial leasing, please contact us on 1300 907 335. Alternatively, complete an online enquiry form and we will be in contact with you promptly.

About The Author - Joanna Shaft

Joanna is an experienced Senior Associate at PCL Lawyers. She has a depth of experience across many areas of law. She has strong experience in; general commercial litigation and dispute...