Beware of Mixed Rent Review Formulas in Retail Leases!

By Nasiya Goldberg, Senior Associate

The Retail Leases Act 2003 (Vic)(“the Act”) in section 35 sets out the requirements for rent reviews under retail leases in Victoria. VCAT has clarified the limitations on CPI rent review under section 35, in two recent matters: Roberts Family Enterprises Pty Ltd v Meddles Bekirofski and Reshat Bekirofski (Building and Property) [2023] VCAT 121 (7 February 2023) and Q St Kilda Tenancy Pty Ltd v Kane (Building and Property) [2023] VCAT 75 (24 January 2023). These matters clarify that a retail lease must not set CPI rent reviews which are subject to either a “cap”(being a maximum percentage) or a “cap and collar” (being a minimum and maximum percentage).

Section 35 of the Act states as follows:

“(1) If a retail premises lease provides for a review of the rent payable under the lease or under a renewal of the lease, the lease must state—
(a) when the reviews are to take place; and
(b) the basis or formula on which the reviews are to be made.
(2) The basis or formula on which a rent review is to be made must be one of the following—
(a) a fixed percentage;
(b) an independently published index of prices or wages;
(c) a fixed annual amount;
(d) the current market rent of the retail premises;
(e) a basis or formula prescribed by the regulations…”

The above means that retail leases must only list a single form of rent review (usually a fixed percentage, CPI increase or market review).

Case Study 1: “CPI with a cap” – Q St Kilda Tenancy Pty Ltd v Kane (Building and Property) [2023] VCAT 75 (24 January 2023)

This case considered the retail lease of a serviced apartment, originally run as part of a Quest franchise. The lease provided for rent to be subject to CPI up to a maximum increase of 4%, as set out below:

“… during the first year of the Further Term the Rental payable by the Tenant will be a Rental determined by rental calculated by increasing in accordance with Clause 14.2 the annual rental payable during the immediately preceding twelve (12) month period to such extent as may be necessary to allow for any increase in the cost of living between the date of commencement and the date of expiration of the immediately preceding twelve (12) month period. PROVIDED THAT the rental determined by the review shall not be GREATER than an amount equal to the rental payable for the preceding twelve (12) month period increased by four per centum (4%)… Where in this Lease it is provided that rental (“the revised amount”) shall be an amount calculated by increasing the initial rental (“the base amount”) to such extent as may be necessary to allow for any increase in the cost of living between the two dates the revised amount shall be determined by multiplying the base amount by a fraction whereof the denominator shall be the All Groups Consumer Price Index Melbourne published by the Australian Bureau of Statistics in respect of the latest concluded quarter immediately preceding the earlier date and the numerator shall be the same index in respect of the latest concluded quarter immediately preceding the later date…”

VCAT determined that the above clause has two limbs to the determination of the new commencing rent for the renewed lease. Firstly, the rent is to be increased by CPI (cost of living) and secondly, such an increase is capped at 4%. Accordingly, this constitutes a mixed rent review covenant which contravened section 35’s requirement that a retail lease contains only a single form of rent review, and the rent review clause was deemed to be void. From this determination, we can now assume that a formula with a cap will be a contravention of the Act and should not be used in retail leases going forward. Subsequent to the VCAT orders, the landlord took possession of the premises due to a successful application for orders relying on breaches of the lease (which were unrelated to the disputed rent review formula).

Case Study 2: “CPI with a cap and collar”- Roberts Family Enterprises Pty Ltd v Meddles Bekirofski and Reshat Bekirofski (Building and Property) [2023] VCAT 121 (7 February 2023)

In this matter, a retail lease provided for rent to be subject to CPI up to a minimum increase of 1.5% and a maximum increase of 5%, as set out below:

“AT the expiration of twelve (12) months from the commencing date hereof and thereafter in each twelve months during the continuance of this lease or any renewal or extension thereof the rental payable hereunder shall be increased for the next ensuing twelve (12) months by such amount as shall be equivalent to any increase in the cost of living from the commencing date to the first adjustment date and thereafter to allow for any cost of living increase each twelve (12) months from the previous adjustment date. Any increase between the two dates shall be determined by multiplying the rental payable at the time of the review by a fraction whereof the denominator shall be the Consumer Price Index Weighted Average Eight Capital Cities issued by the Commonwealth Statistician current at the date of commencement of this lease or the immediately preceding rental review date (whichever is the later) and the numerator shall be -the same index current on the date of review… Any rental increase pursuant to this clause shall be a minimum increase of 1.5 % and a maximum increase of 5%.”

VCAT determined that the above clause contravened section 35’s requirement that a retail lease contains only a single form of rent review. Accordingly, the rent review clause was deemed to be void. From this determination, we can now assume that a formula with a “cap and collar” will be a contravention of the Act and should not be used in retail leases going forward.

In both of the above matters, VCAT determined that section 35(7) of the Act will apply to the ultimate rent review, with the result that rent under both leases was to be determined by market rent review by mutual agreement, failing which a specialist retail valuer was to be appointed to make a determination, as set out below:

“(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) or is void under subsection (6), the rent is to  be—
(a) as agreed between the landlord and tenant; or
(b) if there is no agreement within 30 days after the landlord gives the tenant, or the tenant gives the landlord, a written notice specifying an amount of rent for the purposes of the review, the amount determined by a specialist retail valuer appointed by the Small Business Commission as the current market rent of the retail premises.”

Key takeaways

• Retail leases must only list a single form of rent review (usually a fixed percentage, CPI increase or market review).
• Up until the recent VCAT cases, there was some uncertainty regarding whether a CPI increase could include a ‘cap’ (being a maximum percentage) or a ‘cap and collar’ (being a minimum and maximum percentage). This has now been clarified by VCAT – a formula with a “cap and collar” contravenes the Act and should not be used in retail leases going forward.
• With rising inflation, the opportunity to seek a market review could be good news for some retail tenants with leases that may be include mixed rent review formulas.
• What should you do if your retail lease contains a mixed rent review formula, such as a ‘cap’ or a ‘cap and collar’? The MST Property and Leasing team remain available to assist you with reviewing your lease and providing you with advice regarding the options available, which may include seeking a market rent review or negotiating a rent reduction. These recent VCAT matters are also a timely reminder to engage a specialist property lawyer to draft and negotiate commercial leases.

Links to the VCAT matters are set out below:

Q St Kilda Tenancy Pty Ltd v Kane (Building and Property) [2023] VCAT 75 (24 January 2023)
Roberts Family Enterprises Pty Ltd v Meddles Bekirofski and Reshat Bekirofski (Building and Property) [2023] VCAT 121 (7 February 2023)

The MST Property and Leasing team remain available to assist you with your property and leasing queries. Please contact Nasiya Goldberg, Senior Associate on (03) 8540 0727 or Evelyn Marcou, Principal on (03) 8540 0243.