The Judicial Committee of the Privy Council Decisions

Privy Council Appeal No. 1 of 1996

 

Board of Trustees of the National Provident Fund Appellant

v.

Brierley Investments Limited Respondents

 

FROM

 

THE COURT OF APPEAL OF NEW ZEALAND

 

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JUDGMENT OF THE LORDS OF THE JUDICIAL

COMMITTEE OF THE PRIVY COUNCIL,

Delivered the 24th June 1996

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Present at the hearing:-

Lord Goff of Chieveley

Lord Browne-Wilkinson

Lord Nolan

Lord Hoffmann

Sir Ralph Gibson

  ·[Delivered by Lord Hoffmann]

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This appeal raises a short point of construction on an agreement in correspondence for the assignment of the benefit of an agreement for a lease.  On 15th December 1986 Brierley Investments Ltd ("Brierley") entered into an agreement ("the lease agreement") to take a lease of part of a projected office building in the central business district of Wellington which was to be called City Tower.  The intended lessor was a company called Shortland Securities Limited ("Shortland") which held a perpetually renewable 21 year ground lease from the Wellington City Council. 

For present purposes it is necessary to note only a few provisions of the lease agreement.  The lease was to be in accordance with a standard form of commercial lease published by the Building Owners and Managers Association of New Zealand ("BOMA"), a copy of which was attached to the agreement (clause 7.3).  The term was to be 15 years from the date of practical completion, with one right of renewal for 9 years (clause 7.1(a)).  The rent payable for the first three years was specified in  Part A  of the  Second Schedule and clause 7.1(c)

[34]   said that:-

"Rent for the Premises for subsequent three yearly periods shall be subject to review as provided for in the Boma form of lease."

1. The first review was due to take place on 1st June 1991, three years after the contractual date for completion of the building.

 

2. The BOMA form dealt with rent in clause 3.  Clause 3.01 said that:-

"The Lessee shall pay to the Lessor during the term of this lease rent (hereinafter called "Base Rent") at the rate specified in Item 9 of the First Schedule [the original rent] or where increased in accordance with the express provisions of this Lease at the increased rent."

 

3. By clause 3.03, the Lessee was required to pay a proportion of the Lessor's "Operating Expenses" in addition to the Base Rent.  Operating Expenses were defined by 7.1(g)(iii) of the lease to include a pro rata share of the ground rent payable by the lessor to the Wellington City Council.

 

4. Clause 3.05 dealt with reviews.  Subclause (a) provided that not earlier than 4 months before each three-yearly rent review date, "the Lessor may give notice in writing to the Lessee" to initiate the procedure for reviewing the rent by substituting the current market rent for the previous Base Rent.  There was no provision for the initiation of a review by the lessee.  Subclause (b) contained a procedure for determination of the current market rent by independent experts if the parties were unable to agree.

 

5. The original edition of the BOMA form, which had been published in 1981, also contained further subclauses (c) and (d).  These included as subclause (c)(i) a provision which was known in property circles in New Zealand as a "ratchet clause":-

"Notwithstanding the foregoing provisions of this Clause the base rent payable by the Lessee following the review date shall not in any circumstances be less than the base rent payable immediately prior to the review date."

 

6. It seems, however, that in the course of a revision of the form in 1982, a wordprocessing mistake accidentally deleted the whole of subclauses (c) and (d).  The omission was not noticed when the revised edition was published.  It was this corrupt variant of the BOMA form which the parties attached to the lease agreement.

 

7. In June 1987 Brierley decided that it did not want to occupy the  offices  in  City Tower and instructed an associated company

 

called Brierley Cromwell Properties Ltd ("BCPL") to try to dispose of its interest.  It expected no difficulty because Wellington was in what turned out to be the last stages of an unprecedented commercial property boom.  But in October 1987, when a world-wide stockmarket crash heralded the end of the boom, a new tenant had not yet been found.  By January 1988, when Brierley commenced the negotiations with the appellant, the National Provident Fund ("NPF"), which led to the agreement in issue in this case, rental values were falling. The building was not yet complete and the lease had therefore not been completed but practical completion was estimated to be about three months off.

 

8. Negotiations on behalf of Brierley were carried on by Mr. Barry Smith, executive director of BCPL.  On 27th January 1988 he wrote to a Mr. Wilderspin, the Superintendent of NPF, offering an option to take an underlease of almost all of the premises comprised in the proposed lease to Brierley for the same term and at a small rental premium.  The letter included the following paragraph:-

"Rental reviews are to be at three yearly intervals and the rental upon review relating to the sublease is to be set on the basis of a 5% premium over and above the rental agreed on the floor between the owner and ourselves as Head Lessor."

 

9. After dealing with immaterial matters, it went on:-

"The other lease terms and conditions will have to be in accordance with the Head Lease [sc. the lease to be granted by Shortland] that has already been negotiated between Brierley Investments Limited and the owner of the property with the necessary amendments to reflect the terms and conditions contained within this letter.  Consequently the terms and conditions of this lease are not open to negotiation. For your information I attach to this letter a copy of the lease form that has been agreed and as you will see it is largely in accordance with a standard BOMA net lease."

 

10. Mr. Wilderspin, to whom the letter was addressed, left his employment on some date in January 1988.  The judge found that he or his office probably also succeeded in losing the lease form enclosed with the letter.  It did not find its way to his successor Mr. Perham.  Nor was it passed on to Mr. O'Regan, the responsible partner in NPF's lawyers, Messrs. Chapman Tripp, when Mr. Perham asked them to act.

 

11. A problem known to both parties was that on 1st January 1989 the ground rent, which had been originally set at the concessionary rate of $11,000 a year, was due to be reviewed and increased to a market rent.  It was in fact increased to $850,000.  Under clause 3.03 of the BOMA form and clause 7.1(g)(iii) of the lease agreement, a substantial part of this increase would be passed on to the lessee.  Given the fact that market rents were falling, or at any rate not rising, the effect would be to take the total rental payable by the Lessee well over the market rate.  If the Base Rent could have been reduced at the first review on 1st June 1991, this would all have come out in the wash.  The new market rent would take the increased ground rent into account. On the other hand, the effect of the ratchet would be to maintain the rent indefinitely at a rate substantially above the market level. 

 

12. When Mr. O'Regan took up the negotiations on behalf of NPF, he made particular inquiry about the existence of a ratchet, which had not been mentioned in the letter of 27th January.  He did not have a copy of the draft lease and so on 4th February he spoke to Mr. Smith on the telephone.  Mr. O'Regan was very familiar with the BOMA form of lease.  His firm had helped to draft it in 1981.  He asked Mr. Smith whether the form attached to the lease agreement had a ratchet clause and Mr. Smith, after riffling through the document, said that it did not.  Mr. O'Regan knew that the standard form BOMA contained a ratchet clause and therefore took the answer to mean that Brierley had negotiated its deletion.  It did not occur to him that it might simply have been a mistake.

 

13. Mr. O'Regan then decided that his clients should take an assignment of the benefit of the lease agreement rather than an underlease from Brierley.  Accordingly, he drafted a letter which Mr. Perham sent to Mr. Smith on 9th February "to formally offer to take an assignment", subject to certain terms set out in the letter as "the basis of our offer".  Clause 2.7 said:-

"The lease negotiations will need to be completed by you on behalf of Brierley Investments Limited.  The form of lease submitted, being the BOMA form, is acceptable but must only be amended in accordance with the agreed changes made in your Agreement to Lease and must not contain a ratchet clause."

 

14. On the same date, Mr. Smith wrote confirming acceptance of the offer, setting out the terms in slightly different language and asking Mr. Perham to return a signed copy "to confirm our agreement to the terms and conditions that have been outlined".  Mr. Perham duly signed, but nothing turns on the differences in wording between clause 2.7 of his letter and the corresponding clause of Mr. Smith's letter. The  assignment  was completed  on 13th December 1988.  When the time came for Shortland to grant a lease to NPF, the omission of clause 3.5(c) of the BOMA form, with its  ratchet, was noticed.  Shortland refused to execute a lease without one and commenced proceedings for rectification of the agreement.  In the same proceedings, NPF claimed damages against Brierley on the ground that the introduction of a ratchet clause would put Brierley in breach of the agreement under which it took the assignment.

 

15. In a careful judgment which their Lordships have read with admiration, McGechan J. held that the claim to rectification succeeded. In consequence, Brierley was in breach of its undertaking that there would be no ratchet clause.  But he awarded only nominal damages on the ground that the breach had caused NPF no loss.  Even without the ratchet provided by clause 3.5(c)(i), the provisions of clause 3.01 (referring only to increased rent) and clause 3.05(a) (giving the Lessor a discretion as to whether to initiate a review) meant that in practice the rent would not go down.  An appeal by NPF to the Court of Appeal (Richardson, Gault and McKay JJ.) was dismissed.

 

16. Mr. Camp Q.C., in a lucid and able argument for the appellant, submitted that the reference in the letter of 27th January to "rent reviews ... at three yearly intervals" was an undertaking that such reviews would be mandatory and not merely at the option of the Lessor. This point was not taken before the Court of Appeal, it being there conceded that the letter was merely part of the negotiations and did not assist in the construction of the contract subsequently agreed.  Their Lordships think that this concession was rightly made.  In the first place, the letter of 27th January deals with the terms of a proposed underlease and the reference to three-yearly rent reviews is to a provision proposed to be included in that underlease.  It might be inferred that the superior lease also had three-yearly reviews, but the letter gives no assurance on the point. Secondly, their Lordships think that the letter means no more than that the rent review periods will be three years. It carries no implication as to whether the reviews will be mandatory or discretionary.

 

17. Mr. Camp's principal submission was that against the background of the facts known to the parties, the words "must not contain a ratchet clause" in clause 2.7 of the letter of 9th February 1988 must be read to exclude not only clause 3.5(c)(i) but any clause which in practice would have equivalent effect.  He says that it was known to both parties that unless the Base Rent could be reduced on 1st June 1991, the increase in ground rent due to take effect on 1st January 1989 would make the total outlay for which NPF was liable under the lease hopelessly uneconomic.  The parties could not therefore intended that the words "must not contain a ratchet clause" should have so narrow a meaning.  This  is  a powerful  submission but their Lordships think that the language which Mr. Perham used in his letter and to which Mr. Smith assented cannot bear such a construction.  The provisions of clause 3.01 may be put to one side.  If there had been no ratchet clause, they need have presented no obstacle to a conclusion that the Base Rent could be reduced: see Australian Mutual Provident Society v. Bridgemans Art Deco Limited (Court of Appeal, 3rd April 1996).  But their Lordships are unable to construe an undertaking that there shall be no ratchet clause as excluding the provision in clause 3.5(a) which gives only the Lessor the right to initiate a rent review.

 

18. The expression "ratchet clause" is well understood in New Zealand to mean a particular type of clause, namely a provision such as clause 3.5(c)(i) which prevents the reviewed rent from being lower than the previous rent. This is not the same as a clause giving the landlord an option to initiate review proceedings, even if in practice the economic effect is likely in most (though not necessarily all) cases to be the same. McGechan J. said:-

"[Brierley's] agreement to provide a lease without a ratchet clause did not require provision of a lease with a mandatory review clause. The two were different and were not spoken of as the same."

 

19. The Court of Appeal agreed.  In view of these concurrent opinions as to the meaning of what is in effect a term of art in New Zealand commercial property transactions, their Lordships would be very reluctant to take a different view. Even though Mr. Smith may have been aware of the economic effect which Mr. O'Regan wished to achieve by eliminating a ratchet clause, the latter's letter of offer is expressed in terms of the language of the lease. It says that the "form of lease submitted" is acceptable and that the lease must not contain a "ratchet clause." (Emphasis supplied).  The only conclusion to be drawn is that Mr. O'Regan was content that a lease in this form would achieve the necessary result. The fact that this was not the case does not lead to the conclusion that the parties meant something different.  It demonstrates only that Mr. O'Regan made a mistake.  But there was no claim for rectification of the agreement constituted by the letters of 9th February 1988 or any claim that Mr. Smith had knowingly taken advantage of what he knew to have been a mistake: compare A. Roberts & Co. Ltd. v. Leicestershire County Council [1961] Ch. 555.

 

20. The mistake may have been due to the fact that surprisingly, as the judge found, Mr. O'Regan was willing to allow his client to send the letter of 9th February and to sign Mr. Smith's acceptance letter without having  read  the form of lease attached to the lease agreement.  On the  other hand,  the  judge found  that  he was familiar  with  the BOMA  form, knew that it gave the lessor the option to initiate rent reviews and did not think that such a provision was the same as a ratchet clause. Whatever the explanation, their Lordships think that the meaning of the exchange of correspondence is plain and did not require Brierley to provide a lease which excluded clause 3.5(a).  It follows that the conclusion of McGechan J. that the introduction of a ratchet clause by rectification had caused no loss was correct.  Their Lordships will humbly advise Her Majesty that the appeal should be dismissed. The appellants must pay the respondents' costs before their Lordships' Board.

 

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