There have been many conflicting predictions about the possible effects of the Brexit referendum, one of them being that inflation will rise if the value of the pound sterling falls and the currency exchange rates make imports more expensive. This may or may not happen and may or may not be to the advantage of the UK economy generally; however, it would seem timely to think about how movements in the government's figures concerning inflation may affect rents and other payments due under leases.

What is an index linked review clause?

It is a provision to the effect that a rent or other regular payment reserved in a lease will be adjusted at specified intervals in line with the movements in a published index. An index that is frequently used for the purposes of reviews in leases is the RPI 'all items' index published by the Office of National Statistics. In most leases only an increase in the level of the specified index will be considered with no reduction to be applied if the level of the index falls.

Which payments can be caught?

Rents can be subject to index linking, but so can other regular payments. If a lease relates to a property that forms a part of a building or an estate, there will probably be a service charge. If the service charge is capped, the cap may be expressed to increase in line with increases in a specified index.

Who would use an indexation clause?

They are used throughout the property industry with reference to residential and commercial properties alike. Major house builders use them when they sell long leases of new houses and flats. Developers of retail parks and industrial estates can also use them as can owners of office blocks.

What is the appeal?

Index linked rent review clauses can appeal to landlords and tenants alike because they are seen as simple. The traditional open market rent review clause with its reliance on hypothetical assumptions and disregards can appear complex and both landlord and tenant are likely to need professional advice from a specialist rent review surveyor should there be a dispute regarding the open market rental value of a property. The process of referring disputes to an independent expert or arbitrator for determination can appear daunting and can be perceived to carry the risk of expense and delay.

Is it appropriate to use an index linked review clause?

A surveyor is generally best placed to advise on this question. Some commentators have argued that it is never appropriate to use an index linked rent review clause which refers to an index such as RPI because RPI does not reflect the property market nor does it reflect the fundamental purpose of a rent review as set out in decisions of the courts. In addition there is the potential problem that the calculation basis of the index itself may be adjusted to reflect political situations. Since the Brexit referendum and the subsequent uncertainties surveyors will no doubt be giving this question even more thought.

How are they calculated?

Although some lawyers prefer verbal descriptions of the index linked review process, many consider that the simplest way to document the arrangement is to include an algebraic formula in the lease. By way of an example, the following could be used:-

CIV x R = NR

BIV

This provides that first a Rent (R) is multiplied by the Current Index Value (CIV), then the result is divided by the Base Index Value (BIV) and that produces the New Rent (NR). The attachment of a worked example to the lease can assist.

Can they be constrained?

They tend to be upward only, so decreases in the index level will be ignored on review. Some will include a 'cap and collar'. This would operate alongside the formula and say that no matter what the amount of the increase in the index may be, the rent at the review date will increase by a specified minimum percentage (the collar) but the increase will not be greater than a specified maximum percentage (the cap).

What if the Index changes?

Any well drafted index linked rent review clause will make provision for the possible replacement of the index or its recalculation. This is likely to involve the use of a dispute resolution procedure if the parties are unable to agree. The inclusion of an alternative open market rent review clause can be a good fall-back position should the index change.

What can go wrong?

There are a number of excellent precedent forms of index linked review clause but many lawyers and surveyors will have seen examples of poor drafting. Basic errors could include defining the rent and/or the base index value badly so that the use of the formula produces an unfortunate result. In some clauses the problems can become apparent only at the second and subsequent reviews. If, for example, the rent payable following the first review is divided by the level of the index that applied at the start of the term and is then multiplied by the current level of the index, the result will be that the rent increases by more than the increase in inflation. This type of error is easy to make and the consequences can be expensive. It may not be possible to put right errors of this type. Although applications can be made to the court by parties seeking to rectify defective clauses, these applications will often fail.

Conclusion

Post-Brexit it is perhaps more important than ever to check that index linked review clauses say what the parties mean to say. It requires careful thought to ensure that an apparently simple idea will be put into effect.