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On the wrong track?

12 February 07

Commercial practice in the context of leases has changed radically in recent times, but case law has failed to keep up

by Ian Quigley

I suspect that many Scottish lawyers, having read the various judgments of Lord Denning, particularly in the latter years of his career, felt a little smug that Scottish law was so predictable, based as it was on precedent and not subject to the equitable approach of the English courts, and in particular Lord Denning. Predictability and the straight lines of decisions are much prized in Scots law. However, as anyone who has ever tried to play golf or hit a tennis ball will know, a very small error in angle at the point of impact can result in the shot being so wide as to be out of play.

In the light of a number of recent cases involving Scottish property, I have come to the conclusion that the noble straight line of precedent is beginning to land property “out of play”, in the sense that some of the dicta in these decisions are diverging from the commercial reality of property development and investment.

The difficulties in my view are caused partly by a strict reliance on precedent and partly because there is insufficient judicial awareness of what is custom and practice in property law. In respect of this latter point, it is not helpful simply to say that the judges should be aware of the practice of property law. It is up to the lawyers litigating these cases, and probably even more so the lawyers whose area of expertise is the practice of commercial property law, to make sure that there is a wider knowledge and appreciation of custom and practice.

I think that the position is well illustrated by recent cases on what is or is not “inter naturalia” of a lease.

1898 and all that

The starting point was Bisset v Magistrates of Aberdeen (1898) 1F 87. In this case, a lease for 999 years contained a provision whereby the grantor bound himself to deliver to the lessee and his executors and successors at any time upon request a feu charter of the subjects let on the conditions contained in the lease. It was held that if it had been averred that the obligation was “customary and usual” in leases of such duration, the pursuer might have been successful in arguing that this obligation was inter naturalia of the lease. However this was not averred and the judge therefore held the obligation as being an unusual condition in the contract of lease and hence unenforceable against singular successors of the landlord. Lord Moncreiff said: “it is an obligation to alter the tenure from one of lease to one of feu. This can scarcely be said to be inter naturalia of a lease and if it is not it will not affect singular successors”.

When one considers this judgment one can see that it is technically correct, but as a judgment it makes absolutely no commercial sense, since there is no commercial difference between a lease of 999 years and a feudal title. However the case has been quoted in all the leading textbooks and has formed the basis of all subsequent decisions.

In many of the cases following on Bisset, the statement has been made that a certain provision is not “inter naturalia of a lease”.

But what is a lease?

The point I would make is that in modern commercial property practice there is no such thing as “a lease”, and that there are many different types of leases depending on the commercial circumstances of each case. For example, there is obviously a huge difference between a three-year lease at a fixed rent where the landlord is responsible for the maintenance of the structure of the building, and a 20-year institutional FRI lease with five-yearly rent reviews where the tenant is responsible for the repairs. Even more so, there is a difference between an institutional lease where the landlord has paid for the capital value of the land and the buildings on it and seeks a return on his investment, and a lease which is essentially a ground lease where the landlord has not supplied the buildings.

Furthermore, at the time when the earlier cases were decided, leases did not need to be registered in order to be enforceable against singular successors of the landlords. It was perhaps therefore more reasonable to assume that a purchaser of a property subject to a lease would anticipate only what was at that stage normal in a lease, namely a date of entry, a date of expiry, a description of the property let and a rent.

That is very different from modern practice where, in order to be enforceable against singular successors, a lease for 20 years or more has to be registered in the Land Register and therefore its whole terms and conditions are a matter of public record.

If the fact that a lease was not necessarily a matter of public record was a factor in judicial decisions that anything which was not “inter naturalia” was therefore incapable of binding singular successors, such reasoning is no longer relevant in the context of leases of 20 years or more.

Exclusivity clauses

The case of Optical Express (Gyle) Ltd v Marks & Spencer plc 2000 SLT 644 was an interesting example of the approach. This case involved a back letter with an exclusivity clause which, although it did not contain a provision that the landlord should take its singular successors bound to grant a similar letter, did contain a sentence that “except in so far as hereby varied the whole terms of the lease shall remain in full force and effect”. The question raised was whether the singular successors of the landlord who granted that back letter could be taken bound to the terms thereof.

Lord Macfadyen considered that there were two issues that the tenant had to prove, namely (1) that the back letter formed part of the contract of lease originally entered into between the pursuers and the council (the landlords’ predecessors in title), and (2) that the obligation undertaken by the council in the back letter was of such a nature as to run with the land and thus transmit against the singular successors of the council as landlords. He concluded that the argument that the back letter constituted a variation of the lease, so that the exclusivity clause which it had contained became an integral part of the contract of lease, was not very strong. It was pointed out that the back letter was granted at the same time as the lease and was not a subsequent agreement intended to vary the lease; therefore it was a separate collateral obligation. One can well see the force of the judge’s argument on that. Another point made was that the back letter did not state that the landlord should take its successors bound to grant a similar back letter which, of course, a tenant’s solicitor would normally seek to include if that was the commercial deal agreed. The court held that the back letter containing the exclusivity clause was effectively nothing to do with the actual lease of the unit.

The judge held that the effect of the back letter was to restrain the way in which the council as owners of other units in the centre might let those other units, and accordingly in his opinion such an obligation was prima facie not inter naturalia of a lease. It appears therefore that even if the wording had been contained in the lease itself, it would have been held unenforceable against singular successors of the landlord because it was not inter naturalia.

The commercial reality is that in many if not all shopping centres there will be some tenants, e.g. chemists or opticians, who will not take a unit unless they can be guaranteed at least some years of exclusivity.

The type of lease under consideration in Optical Express simply did not exist at the time of Bisset, nor did the type of commercial arrangement to which it applied. It is therefore in my view inappropriate to decide a case such as Optical Express on the basis of a decision made in 1898 where the type of commercial leasing arrangements which now exist were never contemplated. I am not saying that Optical Express was wrongly decided, because the back letter was not expressed in such a way as would take a landlord’s successor bound and I do not think the remedy sought was appropriate, but I do consider that the statements made by the court in the context of the “inter naturalia” debate do not have sufficient regard to commercial reality.

In passing, it is worth observing that even if the court had found in favour of Optical Express that the obligation was enforceable, that would still have left open the question of what remedies are available. Optical Express asked for reduction of a lease granted to a competing user. I do not see how this could ever have succeeded because there is no way in which a prospective tenant of a new unit could be bound by lease conditions which apply to an existing unit, and at best the remedy would have been one of damages for breach of contract.

Options to purchase

From there one can move on to the question of whether or not an option to purchase as contained in a lease is enforceable against singular successors. Bisset would be relied on by a party who is a successor to the original landlord, seeking to defeat a claim by a tenant to exercise an option to purchase contained in a lease; but even Bisset left open the argument of custom and practice. Again we are today dealing with a situation which is very different from those circumstances which pertained in 1898.

The whole question of “inter naturalia” in the context of leases was fully discussed in a very interesting decision by Lord Drummond Young in The Advice Centre for Mortgages Ltd v McNicoll [2006] CSOH 58.

In this case, which also involved the question whether or not a lease had been properly constituted, there seems no doubt that the option to purchase should not be enforceable against singular successors of the landlord. However, in the course of his judgment Lord Drummond Young did state that an option to purchase as contained in the lease is not inter naturalia and will not be enforceable against singular successors, unless, he went on to say, there is law and practice to the contrary. This statement is in a straight line from Bisset, but there is a considerable difference between the commercial use of leases as applied in 1898 when Bisset was decided and current commercial use and practice.

I return to the point made above, that whereas a statement is often made that certain things are not inter naturalia of “a lease”, there is really no such thing as “a lease” in modern commercial property transactions.

When options are normal

Given the demise of the feudal system, the owners of land who wish to procure development on that land by another can no longer rely on the relationship of superior and vassal, and more and more are relying on the contractual provisions of a long ground lease. Typically the arrangement is that the tenant is obliged to carry out development obligations on the land, such obligations being given teeth by the contractual relationship of landlord and tenant, and the provisions of the lease which arise on breach. The advantage of such an arrangement for the tenant when compared to a simple contractual obligation and a licence to occupy is that it gives the tenant sufficient interest in the land, and sufficient protection, as to justify the tenant’s expenditure on the development.

It is not at all unusual for such ground leases to contain an option in favour of the tenant to purchase the heritable interest for a nominal payment on completion of development to a specific stage.

I would strongly suggest that usage and practice in such a commercial situation means that such an option to purchase is inter naturalia of that type of lease and therefore enforceable against singular successors of the landlord, but because of judicial comment in cases following Bisset that is not a view which is universally held.

Because of the uncertainty, many solicitors are not prepared to risk relying simply on an option to purchase provision contained in a lease, and seek to reinforce the tenant’s position by specific provisions in that lease making it clear that the option is intended to bind singular successors (which, when the lease is registered in the Land Register, will by definition become known to any third party purchaser from the landlord of his interest), and occasionally by the obtaining of a standard security ad factum praestandum over the heritable interest of the landlord. These additional steps all make what is essentially a simple transaction more complicated than it should be in an ideal world.

By contrast, I think that it would be unusual to have an option to purchase in an occupational lease of a completed building, and any option to purchase required in that situation would have to be reinforced as much as possible, but because of the fact of registration, it would be difficult for a purchaser of the landlord’s interest to claim that he was unaware, and could not reasonably have become aware, of the provision in the lease.

Ball in our court

My main concern is that Scottish property law should be developed in a way which is meaningful in the context of the property industry as it is today. It is worth noting that it was probably only about 30 or 35 years ago that property started to be treated as a separate asset class and occupational leases and the yields generated by them became a matter of importance.

In order to avoid any misunderstanding, I am not casting or attributing any blame on judges or sheriffs, or advocates, or even specialist litigators in law firms, for the way in which decisions have developed, because one would not expect them to have an in-depth knowledge of commercial property development and practice and it is up to those of us who do have that knowledge to make it available to the court in the context of disputes. It is also important that lawyers and surveyors work together to discuss what the practice in the commercial property industry should be in order to reflect commercial shifts, and the discussions surrounding the proposed new code of practice for leases in England is a good example of this.

    Ian S Quigley is a partner in Maclay Murray & Spens