Back to the Future for some Telecom Leases following Vodafone v Hanover Capital

This big budget case (over £300,000 in legal fees for Vodafone) has given answers to the question of how certain terms of the lease (including what rent should be awarded) will be dealt with pursuant to the Landlord and Tenant Act 1954 (“LTA 1954”) following the introduction of the new electronic communications code (“New Code”).

Martin Rodgers, the Deputy President of the Upper Tribunal (Lands Chamber) (“UT”), took conduct of this case.  The UT is where New Code cases are heard but on this occasion, Martin Rodgers heard the case in his capacity as a judge of the County Court as the UT has no jurisdiction to hear LTA 1954 cases. The case concerned the renewal of a lease that was granted in 2008 for a term of 5 years at a peppercorn rent.  The property was part of a car park.  Vodafone explained that they had paid a one off premium of £10,000 when they took the lease.  The freehold owners had served notice on Vodafone pursuant to section 25 of the LTA 1954 on 6 December 2016.  The notice confirmed that the freehold owners would not oppose the grant of a new lease.  In August 2017, Vodafone issued proceedings claiming a new tenancy of the property.  Hanover Capital Limited (“Hanover”) was substituted as defendant during the course of the proceedings when they purchased the property. The case is important, as there are a large number of leases that will still need to be renewed pursuant to the LTA 1954 rather than the New Code.  This is because when introducing the New Code, the Digital Economy Act 2017 introduced transitional provisions governing the renewal of leases that were subsisting prior to that Act.  The transitional provisions excluded the renewal process set out in the New Code in circumstances where the existing lease was protected by the LTA 1954.  Whilst the process for renewal will be undertaken pursuant to the LTA 1954 the lease that comes out of that process will confer New Code rights and will no longer be protected by the LTA 1954.The parties had managed to agree all of the terms except for the length of term, the rent, and the details of the tenant's break clause.  The parties had agreed the level of the interim rent to be £6,750 per annum paid from 6 June 2017 .

The Length of the Term

The length of the term has become an important issue for telecommunication operators and landowners.  Operators are keen to have as short a term as possible and/or an early break in order to be able to move onto a New Code agreement as soon as possible.  In this case, Vodafone sought a 3 year term with a rolling break clause excisable at any time on 6 months' notice.  Vodafone argued that it needed the short time period as there was a risk that the rents granted pursuant to a renewal under the LTA 1954 would be higher than could be achieved under the New Code.  They also argued that they could have better rights once they moved onto the New Code although the remainder of the rights were agreed and there did not appear to be any evidence as to what extra rights Vodafone required.Landowners prefer to have a longer term as they like to maintain the status quo so far as possible.  In particular, they want to restrict the burden of having an Operator on the land and receive a market rent that is unaffected or at least less impacted by the valuation principles in the New Code.   Further, they do not want to have to go through an expensive renewal process too soon after concluding one pursuant to the LTA 1954.  In this case, Vodafone managed to incur costs in excess of £300,000 on the proceedings.  Vodafone justified the enormous cost on the basis that they regarded this as a test case as they were concerned about its potential impact on their Estate.The duration of a tenancy is dealt with by section 33 of the LTA 1954 and is to be such length of time as the Court considers reasonable in the circumstances. The duration of the existing tenancy is a relevant consideration (in this case 5 years) but there is no presumption in favour of repeating it.  In the end the Court decided that it would grant a 10 year term with a break clause excisable on the fifth or subsequent anniversary of the term.  The Court considered the following when making its decision:

• The length of term granted in the open market is of limited assistance.
• Balancing the interests of the tenant's business and the need to ensure that the decision is not unfair or oppressive to the landlord.
• The burden of the proceedings on both parties in terms of costs and commitment.
• Balancing the tenant's wish for flexibility against the landlord's desire for certainty.

The Court gave little weight to the following:

• The forthcoming appeals of the cases of CTIL v Compton Beauchamp Estates Ltd [2019] EWCA Civ 1755 or Cornerstone Telecommunications Infrastructure Ltd v Ashloch Ltd [2019] UKUT 388 (LC).
• The desire by Vodafone to avoid the limitations on upgrading set out in paragraph 17 of the New Code. Paragraph 17 allows an operator to share or upgrade so long as there is no more than a minimal adverse impact, on its appearance and it imposes no additional burden on the other party to the agreement.

The Break Clause

Hanover had offered a break after 5 years on 12 months' notice conditional on the operator giving vacant possession, having paid the rent and complying with its obligations in the lease.  Vodafone wanted an unconditional break exercisable at any time on 6 months' notice. The Court awarded a break clause exercisable on 6 months' notice expiring on the fifth or subsequent anniversary of the term. The break clause to be conditional on the tenant paying all outstanding rent and there being no material breach of covenant.  The consideration of the break clause was very much a part of the Court's consideration as to the length of term and the reasoning set out above applied to both. With regards to the conditionality of the break clause, the Court considered that the payment of rent and compliance with covenants were standard and reasonable conditions to include.  However, the Court felt that the requirement to provide vacant possession would make the break clause much less useful to Vodafone.  A vacant possession condition would have prevented Vodafone from using the break to start a renewal of the Lease pursuant to the New Code. Although the Court gave little weight to the restrictions on upgrading in paragraph 17 of the New Code when deciding the length of term it did still factor this in when considering the break clause.   The Court recognised that a 5G upgrade might not be possible within the constraints of paragraph 17 of the New Code and that a break at 5 years would provide an opportunity to improve the site and the terms of the agreement. The fact that it might be difficult to upgrade to 5G where an agreement is restricted by paragraph 17 will be of particular concern to Operators.  For landowners, this might be an area where they could consider voluntarily agreeing wider rights that go beyond the paragraph 17 restrictions in order to improve the consideration or in this case remove the break clause.

Rent

Section 34 of the LTA 1954 deals with how the rent in a new lease should be determined.  This requires the Court to determine the rent which the holding might reasonably be expected to be let in the open market by a willing lessor on the terms of the tenancy.  Crucially for landowners, it does not include “the no network” assumption required by paragraph 24 of the New Code.Some important points to come out of the Court's considerations on rent decided pursuant to section 34 of the LTA 1954 are as follows:

• Both parties are assumed to be willing but neither party is anxious to do a deal, nor under particular pressure to do so.
• The negotiation anticipates the hypothetical tenancy commencing on the date the existing tenancy ends in accordance with the LTA 1954.
• The site being valued was the site before the 2008 lease. In other words, part of a car park, unfenced and unimproved apart from the tarmac surface, and with no mast, cabinet or other apparatus, meaning that all  tenant improvements  need to be ignored (this might not always be the case).
• The hypothetical tenant is a Code operator.
• The parties are prudent and professionally advised.
• The parties are aware that the hypothetical tenant or any other Operator has the right to give notice under paragraphs 20 or 26 of the New Code and that this would mean that an Operator would have sums ascertained, in default of agreement, under paragraphs 24 and 25 of the New Code.
• There is no premium or capital incentive and nor will there be any compensation payable at the start of the tenancy pursuant to paragraphs 25 and 83 to 86 of the New Code
• It may be possible to make an allowance for inducements when looking at comparables. This is because many New Code agreements are only completing where inducements are being provided by Operators (this will be a developing area).
• There may be room for claims to compensation in the future both pursuant to the terms of the lease and in respect of loss or damage sustained but not covered by the contractual provisions as per EE Ltd v Islington [2019] UKUT 53
• Whilst there is a disconnect between the concept of open market and how the process for negotiating mast sites works in practice, the valuation assumes an open market and that the property has been offered to all potential bidders on the terms of the agreed tenancy for a reasonable period.
• Section 34 of the LTA 1954 does not include a “no network” assumption.
• The ability of a tenant to share the site was likely to result in a higher value in the open market.
• Vodafone proposed the use of a six-part test (see below) which could be useful for determining a New Code rent as it looks at the value to the owner rather than the Operator. A rent of between £2,200 and £2,500 was reached on this basis.  However, the test did not take account of the fact that the property was being let on the open market.
• The open market brings with it competition for the site and in this case there was evidence that four operators would be interested. The presence of competition causes the sums that the tenant would be prepared to pay to increase.  This included the fact that the tenant could extract payments from its competitors for allowing them to share.
• The rent would be adjusted upwards by a 5% adjustment as there was going to be no rent review in the lease.

A rent of £5,750 plus VAT was determined in this case, which is close to the rents achieved prior to the New Code.  Whilst this decision is not binding on other Courts, and is likely to be appealed, it is still an interesting starting place when looking at a telecommunications site lease renewal pursuant to the LTA 1954.

New Code valuations and the six-part test

The six-part test proposed by Vodafone could be useful for assessing the rent to be paid in New Code agreements. The third part of the test which deals with the greater adverse effect appears to follow on from Cornerstone Telecommunications Infrastructure Limited v Thomas Steuart Fotheringham where the Judge looked at the burden on the owner when deciding at what level to set the rent.   For Site Providers this could be an area to explore in greater detail as there is often quite a high burden involved with such sites as against other uses.Below is the proposed test:

1. The first step would be to assess the alternative use value of the site, which would be equal to the rental value of the holding for the most valuable non-operator use. This would be a matter of evidence and would depend entirely on the location of the property and land values in that location. Parking spaces next to a sports ground or an airport would have a higher value than on an industrial estate.
2. Secondly, if any additional benefit was to be conferred on the tenant by the letting an allowance would have to be made to reflect it. In one example, the letting of part of a secure car park at the Gillingham Vehicle Testing Centre, internal analysis showed that Arqiva was prepared to pay an additional £1,000 a year for the benefit of a manned security gate.
3. Thirdly, if the letting would have a greater adverse effect on the willing lessor than the alternative use on which the existing use value was based, this should also be reflected by an adjustment.
4. Fourthly, consideration would have to be given to the fees payable by the hypothetical landlord for negotiating the rent with the hypothetical tenant's representatives. The evidence demonstrated that operators routinely make a contribution to these on new Code lettings and renewals.
5. Fifthly, legal fees will be incurred in undertaking the necessary conveyancing following agreement of the rent, and once again the evidence shows that operators usually make a contribution to these.
6. Finally, consideration would need to be given to the possibility that the hypothetical tenant will pay an additional amount by way of an inducement to secure the letting.