The need to avoid mixed rent review clauses in retail leases

Two recent cases in the Victorian Civil and Administrative Tribunal (VCAT) have held that the use of a ‘mixed’ rent review clause in a retail premises lease is not permitted under section 35(2) of the Retail Leases Act 2003 (Vic) (RLA). Where a rent review clause is not permitted under section 35(2), the rent must be determined by agreement between the parties or the current market rent under section 35(7).

Section 35 of the RLA:

Section 35 of the RLA provides that:

(2) The basis or formula on which a rent review is to be made must be one of the following –

1. a fixed percentage;
2. an independently published index of prices or wages;
3. a fixed annual amount;
4. the current market rent of the retail premises;
5. a basis or formula prescribed by the regulations.

…

(7) If a provision in a retail premises lease that provides for a review of the rent payable under the lease does not comply with subsection (2)…the rent is to be –

1. as agreed between the landlord and tenant; or
2. if there is no agreement…the amount determined by a specialist retail valuer appointed by the Small Business Commission as the current market rent of the retail premises.

What Happened:

In Q St Kilda Tenancy Pty Ltd v Kane (Building and Property) [2023] VCAT 75 (24 January 2023), a rent review clause allowed the rent to be increased by CPI (cost of living) up to a maximum of 4%. VCAT decided that the wording of the clause referred to more than one method – being, the application of the CPI and the application of a fixed percentage. Because a mixture of rent review methods was used, the clause was held to be outside the scope of section 35(2). Accordingly, section 35(7) applied and the rent was reviewed to market.

Similarly, in Roberts Family Enterprises Pty Ltd v Meddles Bekirofski and Reshat Bekirofski (Building and Property) [2023] VCAT 121 (7 February 2023), a rent review clause required the rent to be increased by CPI up to a maximum of 5% and a minimum of 1.5%. Again, VCAT decided that the imposition of a ‘cap’ and ‘collar’ introduced the application of a fixed percentage. This was held to be outside the operation of section 35(2) because it involved the use of more than one method for determining the rent on review. Consequently, the rent was reviewed to market under section 35(7).

Key Takeaways:

• The method of rent review for a retail premises lease must be one method only, not a mixture of rent review methods.
• Any variation to the method used could have the unintended consequence of including a mixture of rent review methods in contravention of section 35(2). For example, where the rent is to be increased by CPI, the use of a ‘cap’ could introduce the application of a fixed percentage.
• Where a rent review method does not comply with section 35(2), the rent must be determined by agreement between the parties or the current market rent under section 35(7). With rising inflation, this could provide a strategic opportunity for retail tenants that are subject to CPI rent increases to consider the particular wording of their rent review clause. At the same time, it serves as a practical reminder for retail landlords and legal practitioners to pay careful attention to the specific wording used when drafting such clauses.

Retail landlords are entitled to withhold consent to an assignment of lease where there is a proposed change in permitted use

The Victorian Civil and Administrative Tribunal (VCAT) recently confirmed that a landlord may withhold consent to an assignment of lease pursuant to s.60(1)(a) of the Retail Leases Act 2003 (Vic) (RLA) if the proposed assignee proposes to use the premises in a way that is not permitted under the lease. It was held that the question of what is permitted under the lease is to be determined objectively by looking at the terms of the lease, and the landlord is not obliged to exercise any implied obligation of reasonableness in withholding consent.

Section 60 of the RLA:

Section 60 of the RLA sets out clearly those grounds on which a landlord may refuse a tenant’s request to assign a lease:

(1) A landlord is only entitled to withhold consent to the assignment of a retail premises lease if one or more of the following applies –

1. the proposed assignee proposes to use the retail premises in a way that is not permitted under the lease;
2. the landlord considers that the proposed assignee does not have sufficient financial resources or business experience to meet the obligations under the lease;
3. the proposed assignor has not complied with reasonable assignment provisions of the lease;
4. the assignment is in connection with a lease of retail premises that will continue to be used for the carrying on of an ongoing business and the proposed assignor has not provided the proposed assignee with business records for the previous 3 years or such shorter period as the proposed assignor has carried on business at the retail premises.

What Happened:

In Southern Restaurants Pty Ltd v United Petroleum Pty Ltd (Building and Property) [2022] VCAT 666 (15 June 2022), the tenant (Southern Restaurants) proposed to assign the lease to an assignee (Oporto). The landlord (United Petroleum) refused consent under s.60(1)(a) on the basis that Oporto intended to use the premises in a way that was not consistent with the permitted use under the lease, which was limited to:

“Restaurant and takeaway food outlet with associated car parks, drive thru, loading bay and yard, including all ancillary retail and service offerings developed by the Tenant. The preparation, retail sale and home delivery of (as eat in and takeaway) food items usually sold in a KFC outlet from time to time. The menu shall otherwise include all items at KFC outlets throughout Australia from time to time, including special promotional items”.

VCAT held that Oporto’s intended use of the premises did not involve the sale of KFC products or use of the KFC menu. The terms of the lease clearly contemplated the use of the premises only as a KFC outlet and not an Oporto outlet. If the lease was assigned and Oporto commenced trading as it intended, Oporto would be in breach of the lease. In such circumstances, VCAT decided that United Petroleum was entitled to withhold consent under s.60(1)(a).

Additionally, VCAT held that there is nothing in the language of s.60(1)(a) that invokes any element of reasonableness. Either the proposed assignee intends to use the premises in a way that is permitted under the lease, or it does not. This is in contrast to the position under s.60(1)(b) in which the obligation of the landlord not to unreasonably withhold consent exists (see AAMR Hospitality Group Pty Ltd v Goodpar Pty Ltd & Anor (Retail Tenancies) [2009] VCAT 2782 (13 February 2009)). In the present case, Oporto’s intended use was outside the scope of the permitted use, and United Petroleum was entitled to withhold consent without exercising any judgment or forming any opinion about Oporto.

Key Takeaways:

• A landlord may withhold consent to an assignment of lease if the proposed assignee intends to use the premises in a way that is not permitted under the lease. Although the RLA was enacted to enhance the protection of retail tenants, the language of s.60(1)(a) is clear in its terms that a tenant is not entitled to derogate from the permitted use under a lease as negotiated and agreed by the parties.
• Unlike s.60(1)(b), there is no implied obligation of reasonableness in s.60(1)(a). Either the proposed assignee’s intended use falls within the scope of the permitted use, or it does not. If not, the landlord may withhold consent to the assignment.
• Retail landlords and tenants are reminded to carefully consider the narrowness of the scope of the permitted use at the negotiation stage. As in the present case, a narrowly defined permitted use clause minimises the scope of the tenant’s use of the premises and the assignability of the lease. From the perspective of a landlord, a narrowly defined permitted use clause gives greater control and certainty over the use that the premises can be put by a tenant and any assigns.