Herbert Smith Freehills LLP v Fitzwilliam Trustees No 1 Ltd, Fitzwilliam Trustees No 2 Ltd

Factual and Procedural Background

The case concerns an appeal against a decision of the Lands Tribunal for Northern Ireland dated 4 May 2023. The dispute arose from works carried out by the tenant, a law firm, to an office building known as Cylinder Buildings located at 3 Cromac Quay, The Gasworks, Belfast. The tenant held the premises under three leases dated between 2010 and 2014 and had entered into corresponding agreements for works to fit out the premises from "shell and core" to a full grade A office specification at the tenant's expense.

The landlord acquired the reversionary interest in the premises in 2014. The tenant applied to the Lands Tribunal for new tenancies under the Business Tenancies (Northern Ireland) Order 1996 ("the 1996 Order"), which requires rent to be assessed at open market value disregarding improvements made by the tenant unless those improvements were carried out pursuant to an obligation to the landlord.

The central dispute was whether the tenant's works were carried out pursuant to an obligation to the landlord, impacting whether the works should be disregarded for rental valuation purposes. The Lands Tribunal held the works were permissive and not pursuant to an obligation, thus to be disregarded for rent assessment. The landlord requested a case stated, which led to this appeal in the Court of Appeal.

Legal Issues Presented

1. Whether the Lands Tribunal correctly and lawfully construed the leases and agreements for works ("the construction issue").
2. Whether the Lands Tribunal was entitled to find on the evidence that the lease and agreements for works amounted to a "very poor deal" for the tenant ("the evidential issue").
3. Whether the Lands Tribunal erred in seeking consistency between the contractual rent review provisions and the provisions of Article 18 of the 1996 Order (linked to the construction issue).

However, the landlord abandoned reliance on the evidential issue, leaving only the construction issue for determination.

Arguments of the Parties

Landlord's Arguments

• The tenant's works were carried out pursuant to an obligation to the landlord under the leases and works agreements, so the "disregard" for tenant improvements should not apply.
• Clause 2.1.6 of the lease created a "carve out" from the usual disregard, demonstrating an intention that the tenant’s works were obligatory and thus rentalised.
• The absence of a deeming provision excepting the tenant’s works in clauses like 2.2.7 and clause 22 implied the tenant’s works were under an obligation.
• The works agreement constituted an enforceable contract obliging the tenant to carry out the works, not merely a permissive licence.
• Mandatory language in the works agreement, especially clause 2.2.1 and clause 3, imposed enforceable obligations on the tenant to complete the works.
• The landlord rejected the tenant’s contention that the works agreement was a licence and argued the context and language showed an obligation.
• Commercial common sense did not preclude the landlord’s interpretation, and any "yo-yo" effect on rent between lease renewal and subsequent rent reviews was not a reason to reject their construction.

Tenant's Arguments

• The lease and works agreements did not contain clear and unambiguous language showing the tenant’s works were carried out pursuant to an obligation to the landlord.
• Clause 2.1.3 of the lease required rent to be assessed on a shell and core basis, which would be unworkable if the landlord’s construction prevailed.
• The provisions relied upon by the landlord were ambiguous or open to competing interpretations and did not meet the high threshold to disapply the tenant’s disregard.
• The works agreement was in effect a licence permitting works otherwise prohibited by the lease, not an enforceable obligation.
• Mandatory language in the works agreement related only to how and when works were to be carried out and were "subsidiary" or "parasitic" on the permission to carry out the works, not obligations to do them.
• Commercial common sense pointed to the tenant’s works being permissive because the landlord’s construction would produce a commercially irrational "yo-yo" effect on rent at renewal and subsequent rent reviews.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Arnold v Britton [2015] AC 1619	Principles of contract construction focusing on the objective meaning of language in its commercial context, disregarding subjective intentions.	The court applied Arnold v Britton to interpret leases and works agreements objectively, rejecting subjective evidence and emphasizing the need to identify the parties' intentions through the language used.
Historic Houses Hotels Ltd v Cadogan Estates [1993] 2 EGLR 151; [1995] 1 EGLR 117	Tenant’s improvements are disregarded for rent review unless carried out pursuant to an obligation to the landlord; clear and express language is required to override this disregard.	The court relied on this precedent to affirm the high threshold for disapplying the tenant's disregard and to explain the economic rationale underpinning the disregard.
Daejan Properties Ltd v Holmes [1996] EGCS 185	Clear language in an agreement can override the tenant’s disregard, even if commercially unattractive.	Used as an example of clear and unambiguous language ("the works shall be deemed to be carried out pursuant to an obligation") necessary to disapply the disregard, which was absent here.
Ridley v Taylor [1965] 1 WLR 611	Mandatory language regulating how works are done does not create an obligation to carry out the works.	The court found that mandatory clauses relating to manner and timing of works are subsidiary to permission and do not impose positive obligations on the tenant.
Godbold v Martin The Newsagents Ltd [1983] 2 EGLR 128	Similar to Ridley, mandatory language in licences relating to works does not impose obligations to carry out works.	The court applied this principle to the works agreement’s mandatory clauses, concluding they did not create obligations but were subsidiary to permissive licences.
Gold v Brighton Corp [1956] 3 ALL ER 442; O’May v City of London Property Co Ltd [1982] 1 ALL ER 660	Presumption that existing lease terms, including rent review provisions, carry over into new leases.	Used to support the argument that the parties would not have intended a commercially irrational "yo-yo" effect on rent between lease renewal and rent review.

Court's Reasoning and Analysis

The court analysed whether the tenant’s works were carried out pursuant to an obligation to the landlord, focusing on the true construction of the leases and works agreements. It applied established principles of contract construction, emphasizing an objective approach and disregarding subjective intentions as per Arnold v Britton.

The court examined the relevant lease provisions, notably clauses relating to rent review and disregards for tenant improvements. It found that the landlord’s proposed interpretation created internal inconsistencies and an unworkable position whereby the rent would be assessed on a shell and core basis yet the tenant’s works would be rentalised, contradicting the valuation assumptions. This undermined the landlord’s argument.

Regarding the works agreements, the court considered whether they imposed enforceable obligations on the tenant. It noted the absence of clear, unambiguous language imposing such obligations. The agreements were not described as licences but lacked express language indicating the tenant was obligated to carry out the works. The court found clauses imposing mandatory standards and timing were analogous to those in Ridley and Godbold, which were held to be subsidiary to permission and not obligations.

The court also rejected the landlord’s argument that the works agreement was an enforceable contract obliging performance in exchange for the lease, finding no basis in the lease or agreements for such a bargain.

Commercial common sense further supported the tenant’s construction, as the landlord’s interpretation risked an anomalous "yo-yo" effect on rent at renewal and subsequent reviews, which the court found unlikely to have been intended without clear language.

Overall, the court concluded the landlord failed to surmount the high threshold required to disapply the tenant’s disregard under Article 18 of the 1996 Order, and the tenant’s works were permissive and not pursuant to an obligation.

Holding and Implications

The court DISMISSED THE APPEAL, affirming the Lands Tribunal’s decision that the tenant’s works were permissive and not carried out pursuant to an obligation to the landlord. Consequently, the tenant’s works are to be disregarded for rental valuation purposes under Article 18 of the Business Tenancies (Northern Ireland) Order 1996, meaning the rent should be assessed on a shell and core basis rather than a grade A category A fit-out basis.

This decision directly affects the parties by confirming the proper approach to rent assessment in this case but does not establish new precedent beyond the application of established principles. The parties were encouraged to agree on costs, with the court allowing submissions if agreement was not reached.