Tuesday, December 1, 2009

Upward-only Rent Clause Ban: More evidence of the nanny state?

The Minister for Justice has reportedly signed a ban order on "upward-only" rent clauses in business leases. Even if he is correct in his claim that "the practice of including upward only review clauses in business leases is a deeply entrenched one...[and the] time has come to end this practice" by putting into place "more equitable business arrangements ... which take account of the reality facing many business owners and retailers," is a ban order the answer? The Minister's (admittedly well-meaning) action will only trigger costly externalities and undermine contractual freedom.

State intrusion into consensual private agreements might be tolerable if narrowly designed and limited to consumer contracts. Even in this limited domain, legislation must not undermine party autonomy. However, intrusion through fiat is perplexing when the parties are commercially sophisticated and are able to bargain freely. The proffered justification in this particular instance - "Upward only rent reviews have imposed enormous damage during this deep recession. It meant that the dramatic fall in property prices was not being reflected in lower rents for many businesses. Coupled with plummeting turnover and high business costs, upward only rent reviews have caused the loss of hundreds of jobs and businesses" - is not a sufficient condition for state intervention. Those leases were not signed under duress or coercion. Sensible landlords would accept the prevailing market-rent rather than leave their premises vacant. If this is not transpiring here, one explanation could be that they are betting on rents going up before the leases expire and are trading off short-term losses (by refusing to lower rent and triggering defaults) against future gain. There might also be a failure of bargaining. The resentment felt by tenants is understandable - being locked into paying a high rent in a bad market seems unfair.

In any event, the leases as drafted reflect a consensual allocation of risk. They may be one-sided and favour landlords over tenants. If shopowners can't afford the rents they are free to lease elsewhere. If enough business owners do this, rents will inevitably come down. If the landlords are indeed in a superior bargaining position, banning "upward-only" rent clauses will not make any difference. Their lawyers will find a way to capture the benefits of rents going up in a different form. State intervention rarely (if ever) eliminates disparities in bargaining power.

If the state gets into the business of re-writing private agreements, it won't have time to do much else.