Vacant possession and rent review

Out-Law Guide | 04 Aug 2011 | 10:32 am | 5 min. read

This guide was last updated in August 2011.

The obligation to provide vacant possession is the commitment to ensure that, at the relevant date, the subject property is in a state fit to be occupied and enjoyed both physically and legally. This 'relevant date' could be, for example, the completion of a contract for sale of land or the grant of a lease. Vacant possession is an essential element of any land transaction which includes the right to occupy the property, and the obligation will normally appear as an express term in the land agreement.

A situation where vacant possession will be particularly relevant in leased property is when assuming that the property is occupied for the purposes of a rent review valuation. Whether the premises, or a part of the premises, are deemed to be occupied can affect the reviewed rental value.

Rent review

Some leases are granted in return for a capital sum of money. More commonly, rent will be payable on commercial property - usually the market rent, which is also called rack rent. A commercial rent is usually an annual sum, payable in advance in four equal instalments usually once a quarter.

Most leases of commercial premises will also include a provision that allows the rent amount to change over time, to ensure the landlord continues to receive a rental value that fairly reflects the real value of the premises. Long leases which were granted for a premium or capital sum of money may also provide for the rent to increase over time, even though the change is less likely to be as linked to the market value of the property as with a commercial lease.

Assumptions and disregards

A standard rent review clause is likely to include a number of 'assumptions' and 'disregards'. An assumption is a clause stating a certain fact is to be assumed to exist – it is common, for example, for a rent review provision to state that a valuation of the property at a rent review should proceed on the basis that the tenant has complied with all its obligations under the lease. A disregard is a clause stating that a certain fact is not to be taken into account when determining the rental value of a property, such as works carried out by a tenant other than maintenance required under the lease.

Rent review generally assumes that, at the review date, the lease – including the rent review clause – does not exist. Any occupation by a tenant in possession therefore has to be disregarded. However, it does not follow automatically that it can therefore be assumed that there is vacant possession of the premises subject to rent review because there may be other third parties in occupation on this date, for example subtenants or those occupying under a license arrangement. Where the rent review clause does not, either expressly or by implication, assume vacant possession but does disregard the occupation of the tenant, there can then be a question over whether that disregard should extend to subtenants or whether it is simply a reference to the actual tenant itself.

This issue goes to the heart of the question of whether there can be an assumption of vacant possession on rent review.

Justification and consequences of assumption

When a landlord and a prospective tenant who is already in occupation are negotiating a new rent, the fact that the tenant is already in occupation could potentially induce the tenant to offer a sum greater than it would if it was not in occupation. This is logical if you consider that a tenant in occupation is likely to view the avoidance of moving expenses and business disruption as having a value that would not be apparent for a third party tenant moving in from elsewhere.

If vacant possession is assumed on rent review, the existence of any subletting must be treated as irrelevant. However, if vacant posession is not to be assumed then valuation becomes a central issue – the Rent Review Handbook points out that the fact that an upper part above a shop with no separate entrance is sublet can have a startling effect on value.

Lawful subletting

A number of cases deal with whether premises which are lawfully sublet can be vacant for the purposes of rent review valuation. Although in a 1967 case between Oscroft and Benabo it was held that premises which were partially sublet should be valued on the basis of vacant possession, the judge commented that 'all the circumstances of [a] particular case, including the fact of any existing subtenancy' should be considered. These comments clearly suggest that, in cases where there has been a lawful subletting, vacant possession cannot be assumed as a matter of course.

Subletting in breach of lease

While this decision suggests that in cases where premises have been sublet lawfully you cannot imply vacant possession as a matter of course, the Rent Review Handbook states that the opposite is true where the subletting was against the terms of the lease. Otherwise, the effect of the unlawful subletting would be to allow the tenant to decrease the rental value and thus benefit from its unlawful activity The Handbook also points out that this argument is further supported in cases where there is an express assumption, as above, that the tenant has complied with its obligations under the lease.

Previous occupation

As we have seen, rent review provisions tend to assume that the lease including the rent review clause does not exist and any tenant is not in occupation at the date of the review. However, this does not deal with a situation where the tenants have occupied the property previously. This issue can be overcome by express wording in the rent review clause.

Interpretation and best practice

The law covering vacant possession on rent review has its basis in the law of contract and consequent principles of interpretation through case law. This means that the usual principles will apply, including an emphasis on clarity when wording the provisions. For more information on contract interpretation, please see our separate Out-Law Guide.

In summary, rent review clauses will usually provide that the property will be valued on the basis that it is being let with vacant possession. As such, the tenant will be treated as having moved out – or as having never occupied the premises – and the rent will be calculated on the assumption that the tenant has removed its property from on the premises. Further, it may be assumed that the premises are ready for occupation by the tenant to avoid having to factor in a rent-free period for fit-out works.

Even if there is no express provision in the lease stating that the premises are to be valued on the basis of vacant possession, the normal assumption is that a lease should be valued on such a basis. A lawful sublease may be taken into account in the rent review valuation in appropriate cases, but a lease granted in breach of covenant should not be allowed to be.

Clear drafting and forward thinking are needed to ensure that the assumption of vacant possession does not have an unintended effect on the operation of a rent review clause some time in the future. Indeed, this is normally something that will only become apparent years after the lease is originally granted - when the rent review clause becomes operative. Express drafting when the lease is first drawn up is the best means of ensuring that there are no problems in the future.