Pub Companies - Business, Innovation and Skills Committee Contents


Written evidence submitted by David Morgan

REPORT TO BUSINESS INNOVATION & SKILLS SELECT COMMITTEE PUB RENT REVIEWS—PROGRESS 2008-11

1.0  INTRODUCTION

1.1  I was called to give evidence to the Business and Enterprise Committee on 18 November 2008 in support of my written evidence to the Committee as recorded in the Committee Report, pages EV 243-EV284 dated 13 May 2009.

1.2  In the intervening two and a half years I have continued to have an active and detailed involvement in the processes of rent review throughout the pub industry on a national basis as a result of client referral and instruction. At any one time, I have between 60-70 active cases with the cases being resolved being regularly replaced on a weekly basis. The majority of the referrals are acting for Tenants against Pubcos which include Enterprise Inns, Punch, Wellington, Admiral and S & N.

1.3  Although the initial processes of rent review have been better structured through the Codes of Practice (COP), there is no uniformity of compliance with these initial processes and an alarming number appear not to follow the lead-in time scales. The imbalance in negotiating relationship still remains as before. Only a very small number of Tenants are themselves aware of the "rules of engagement" or are in the position of seeking professional help in their use and implementation. The superficial and paternalistic attitude of the Pubco representative still remains in that the Pubco is portrayed as "knowing best" and is in the guise of being a business partner in the assistance of the promotion and well being of the profitability of the site in question.

1.4  Disputed rent reviews have not changed either in substance or content in the following of the newly formulated COPs in the creation of a level (or policed) playing field. The same inequalities are being followed as two and a half years ago in that:

—  The new objectives of the COP are never properly explained to the Tenant;

—  the RICS regulations (see under) are not adhered to either in principle or in detail, the Tenants having even less awareness;

—  the mantra that the Pubco "knows best" is all-pervading; and

—  Pubco representatives' "opinion evidence" is paramount.

1.5  It is understood there have been a considerable number of complaints as to breaches of the COPs accredited by the Bll (see under). No details have been released of the nature and number of complaints. This lack of transparency gives no reassurance in the intended policing of the implementation of the COPs.

1.6  The Content of this Submission to the Committee concerns the extended world of rent review. The expense of rent and that of staff are the two largest cost items of any public house. Staffing cost to a degree, can be reined in. However, rent, if linked to annual increases in the Retail Prices Index (see under) will inexorably rise and have no relationship to on site profitability. Each example case hereunder is cross referenced to a specific property and lessee, the details of which are contained in Appendix A[29] to this Report. The names and identities of the properties, together with the lessees, are supplied for the confidential information of the Committee and must not be the subject of publication, due to the very real possibility of reprisals against the individuals concerned. (Example 1, South Wales).

2.0  POINT OF NEGOTIATION

2.1  As in 2008, the point of contact between Pubco and Tenant is the Business Relationship Manager (BRM). If matters become difficult or protracted, the next level of management is involved which is either the Area Retail Manager, or Regional Manager. None of these individuals are Chartered Surveyors or have property based qualifications, yet are the only point of contact with the Tenant for a property based negotiation of considerable magnitude, ie the rent.

2.2  The rent review process is now generally instigated well in advance of the rent review date, although there are still a disturbing number that are left very much to the last minute with the inference that there is an obligation to have to urgently settle prior to the rent review date. (Example 2, Surrey). A large number of cases significantly pass the rent review date with little urgency being expressed by the Pubco. In almost every one of these cases, this is where it is in the interests of the Pubco to maintain a high rent for as long as possible if a significant rent reduction is thought likely. (Example 3, South Devon). There is then no incentive to hurry a big rent reduction through the system as a result of its commensurate effect on book value of the subject premises.

2.3  Real open negotiation per se did not and still does not, exist. The BRM will arrive with a given script, commonly known as a Rent Assessment Form, with the understanding that for the BRM, only minimal deviation from that form is tolerated. (Example 4, Midlands). Accounts are always requested whether or not it is a lease stipulation that this information should be divulged. "Bad" accounts results are generally ignored (Examples 5 and 6 Sheffield) and "good" accounts are often adapted into the assessment of fair maintainable trade (FMT) (Example 7, North Devon). With very minor and rare exceptions, goodwill (as a standard lease disregard) is ignored. The new RICS Pub Rent Guidance Notes (see under) are totally ignored by BRMs, either deliberately or through ignorance. The assessment of a living wage, or the impact of annual rent rises through indexation, is almost always ignored.

3.0  UPWARDS ONLY RENT REVIEWS

3.1  The COPs of the various Pubcos have been accredited by the British Institute of lnnkeeping (BII). Enterprise Inns' COP does not apply to those leases in its estate that are free of tie and Wellington Pub Co. have not sought BIIBAC approval for any form of COP as they operate a free of tie estate. All new Pubco leases and an alarming number of brewery leases, now contain annual increases in accordance with the Retail Prices Index. Save for one month in 2009 when the Index fell by 0.5%, all monthly movement in the Index is upwards only. Currently the RPI is at a level of a monthly increase of 5.5% which, compounded over five years (the normal standard rent review cycle), equates to a fixed uplift of c.30%. This is plainly an upwards only annual rent increase, albeit to a "look again" after five years.

3.2  It would appear that the damage being inflicted by annual rent rises linked to RPI had been recognised by some of the Pubcos such as Punch (for some of its new lease agreements) by suggesting a link to the Consumer Price Index. This has seen a slightly lower rate of annual rise than the Retail Prices Index and thus a "softer blow". However, as at the date of this Submission (May 2011) the CPI has increased to 4.5% in April 2011 from 4.0% in March 2011. The impact on rent is virtually the same as RPI.

3.3  It has to be considered that the COP obligation of the setting aside of upwards only rent reviews, has been compromised by the insistence of rent increases in accordance with RPI or CPI.

3.4  In cases of lease renewal where a previous lease did not contain the provision of such annual indexation, Pubcos are routinely attempting to infuse such indexation into the new lease terms on the pretext of harmonising the documents within their leasehold estate (Example 8, Hertfordshire). Conversely, Wellington Pub Co. are insisting on upwards only rent reviews remaining in leases that are the subject of renewal. (Example 9, Bath).

4.0  BASIS OF RENT REVIEW

4.1  The nationally accepted method is that of the profits test which if implemented correctly, produces a balance of income and resultant gross profit, less expenses, to produce a divisible balance (DB) from which rent and Tenant's remuneration is derived. The DB in 2008 used to be automatically split 50/50 between Landlord and Tenant until clarification was obtained in September 2009 in the case of Brooker -v- Unique Pub Properties Ltd, Claim No. 7BS11690, 7 September 2009. That case involved a fully supply tied, non assignable, five year lease which as such is not often replicated within standard Pubco leases. However, the Judge found that the DB should only attract a Tenant's bid of 35%. The underlying principles have subsequently been confirmed in RICS Guidance Note 67/2010, paragraph 6.13 which affirmed that the Tenant's bid could range between 35% and 65%, RICS GN 67/2010, paragraph 6.9. Pubco Rent Assessment Forms almost always still show a 50% DB with the Brooker case and RICS Guidance Notes recommendations being completely ignored.

4.2  Excessive reliance is placed on comparable properties (Example 10, South London) and information to that effect is shared between Pubcos to produce a cherry picked schedule of properties within a given area to produce a desired "tone" of rent settlements. Such rent reductions that may exist in a given area, are hidden or not acknowledged and are never offered in the rent negotiation process (Example 7).

5.0  COMPARABLE EVIDENCE

5.1  The main disadvantages exist as in 2008 in that the Pubco has all the detail of the comparable evidence and the Tenant has access to none. The COPs make great play about transparency which is not observed in the issue of comparability. The profits test has at its heart the assessment of FMT. As is regularly the case, the assumed FMT for rent review purposes is over-estimated by up to 30%. No direct comparables are offered. (Example 4). Accountancy information related to comparable properties is either compromised by the Data Protection Act or only available in rare instances through agents' particulars of sale. Indeed previous RICS Guidance Notes stated in GN.7.2.13 (August 2002):

5.2  A secondary basis of comparison may be on physical factors. However, when resorting to such a method it is essential that any comparable is very closely relevant, as regards style, location and trading circumstances. The accounting information on which other transactions were based is likely to have been strictly confidential and, unless all the factors are known, any comparison of physical aspects alone can be misleading and unreliable. (Emphasis added)

5.3  Stiff resistance is constantly noted in an application for a blanket revelation of comparables within a given and restricted radius of the subject premises, on the basis that the applicant is on a "fishing trip". Transparency is not observed.

5.4  Usually the only information supplied is the level of rent settlement and occasionally the associated barrelage. This then builds up a picture of cherry picked rent settlements in the justification of the assumed rental on the Rent Assessment Form. Again, full transparency is not observed.

6.0  RICS REGULATIONS

6.1  By invitation I sat on the RICS Committee known as the RICS Pub Forum, between April and September 2010 in the formulation of the RICS Guidance Note 67/2010 that was issued in mid December 2010. Although at Committee stage I pressed for fuller and more plain English explanations of the content of the Guidance Note, it was deemed that the document was for use by specialist Chartered Surveyors involved in licensed / leisure property, rather than a general text book for non RICS members.

6.2  The new Guidance Notes have a wide ranging effect in the clarification of rent review assumptions and procedures and have produced, through extensive negotiation at Committee stage including Pubco representatives, a reasonably level playing field which is certainly a significant advance on those RIGS regulations that existed in 2008.

6.3  It is a noted feature of all COPs registered with the BII, that full adherence to the new RICS Guidance Notes is openly expressed. In addition, the British Beer & Pub Association (BBPA), has confirmed that all of their members should adhere to the new RIGS regulations. A minor number of Pubcos are not members of the BBPA.

6.4  In reality, the first line of negotiation (see above) which is the Pubco BRMs, still totally ignore the detail and content of the RIGS Guidance Notes. This is particularly noticeable in the lack of acknowledgement of the status of the Reasonably Efficient Operator, (Example 11, South London), the calculation offsets in the profits test of the obligation of the assumption of vacant possession (Example 12, Midlands) and the disregard of structural works undertaken by the Tenant at the Tenant's expense (Example 13, South London).

6.5  Reasonably Efficient Operator

—  6.5.1  My understanding of this definition is:

—     The keyword is "reasonable". Referring to the Collins Concise Dictionary 21st Century, the word "reasonable" is defined as: "having modest or moderate expectations". The Concise Oxford Dictionary defines the word as "fair and sensible as much is appropriate, moderate".

—  6.5.2  The Pubcos are in denial that this definition exists and are not quantifying how the existing lessee either equals or exceeds the above definition. (Example 4). As earlier mentioned, Tenantable goodwill is almost always completely forgotten.

6.6  Vacant Possession

—  6.6.1  Every lease makes the assumption of vacant possession on rent review or lease renewal. This requires that the hypothetical Tenant has to acquire the inventory at in situ value, all wet and dry stock and consumables and have available working capital. The assessment of the three input factors is rarely if ever satisfactorily calculated, as is the finance associated with the provision of the capital monies concerned. (Example 14, South Wales).

6.7  Structural Works

—  6.7.1  A large number of leases require that structural works undertaken by the Tenant at the Tenant's expense, have to have formal Landlord's authorisation and approval. In a similarly large number of situations, the finality of formal approval is often overlooked when the works are undertaken and in almost every case, the Pubco does not remind the Tenant that such a document is required. (Examples 13 and 15, Central London).

—  6.7.2  This leads into the regular occurrence that extensive structural works are then rentalised to the detriment of the Tenant. This situation is covered in RICS Guidance Note 67/2010, paragraphs 6.20-6.25. The opportunity does exist for an application for retrospective consent which is almost always granted. For example, a multi award winning lessee in South London (Example 13) lavished some £300,000 on his Pubco owned premises, whose current rent is £32,000 p.a. The Pubco is now seeking a rental of £70,000 upon rent review, on the basis that formal consent for structural works was never ratified, notwithstanding that all of the company representatives knew that the work was being undertaken, the relevant consents and permissions had been given and that the entire cost was financed by the Tenant. That particular case is currently being resolved by arbitration.

7.0  MACHINE INCOME

7.1  Notwithstanding the recommendations of the Parliamentary Hearings in 2004, new lease agreements are constantly being entered into that require a 50/50 share of net proceeds of machines being split between Pubco and Tenant. There is thus little incentive for promoting machine income save for pool tables which have a higher net return than AWP machines. Machine income is regularly over-estimated by Pubcos in the assessment of total sales in the profits test calculation.

8.0  THIRD PARTY REFERRAL

8.1  All leases contain the opportunity for disputed rentals to be settled by third party. Almost always this process is of arbitration. There has, however, been an innovative move being made by the Bll in the creation of the PIRRS system of dispute resolution. The administration of the PIRRS system through the Bll is wholly funded by the BBPA by mandatory annual levy on its members. A full factual critique of the differences between PIRRS and Arbitration was prepared by agreement with the leading licensed trade publication The Morning Advertiser last November (which has yet to be published) and is enclosed in Appendix B.

9.0  CONCLUSION

9.1  The general imbalance that existed in 2008 between Landlord and Tenant, still continues in 2011. The root cause is the disparity between the financial strengths of the parties and the lack of common ground in information sharing as to the processes that should be reasonably followed in the negotiation of a rental upon either review or lease renewal. The following factors continue to exist:

—  Deliberate over stating of FMT and gross profit margins and the under stating of expenses on the Rent Assessment Form;

—  disregard of RICS Guidance Note 67/2010 published in December 2010;

—  denial of the implications of the Brooker case and associated RICS GN 67/2010 paragraphs 6.9 and 6.13;

—  requirement of annual rent increases in accordance with the RPI or CPI;

—  inclusion of structural works undertaken at the Tenant's expense with Landlord's verbal but not formal authorisation in the assessment of FMT;

—  absence of any form of property based qualifications in the first or second line of Pubco / Tenant negotiations;

—  lack of recognition of the ability of the Tenant to obtain a "living wage" or of the continued impact of the reduction in leisure spend (with the exception of Central and parts of suburban London); and

—  new leases continuing to require that machine income be shared between Landlord and Tenant.

19 May 2011

APPENDIX B

PIRRS AND ARBITRATION

Who Controls the Two Systems?

The President of the RICS and the RICS Dispute Resolution Service (DRS) control the appointment of either arbitrators or experts.

Under PIRRS, the Tenant begins the proceedings by completing the PIRRS application form and selecting their preferred independent valuer from the regional list of recommended experts. Although the Tenant's selection of valuer is final, the opportunity exists for the brewer / Pubco to object to any particular appointment.

Who Pays for the Appointments?

The applicant (this could be either the Landlord or the Tenant) for an RICS appointed arbitrator or expert, currently pays £361 (inclusive of VAT) application fee for the appointment. The applicant has no control over the President of the RICS or the DRS. The opportunity does exist for challenge. The RICS Dispute Resolution Service is funded by the general membership of the RICS through individual RICS members' annual subscriptions.

There is no application fee for a PIRRS appointment. The PIRRS system is funded by the British Beer & Pub Association (BBPA) through a mandatory levy of £2.50 per unit of pub ownership for every BBPA member.

Who are the Experts and who appoints them?

The RICS has a nationwide pool of arbitrators which also includes some of those experts registered in PIRRS. Re-examination of the RICS panel members occurs on a regular basis.

PIRRS experts are appointed by the PIRRS board on the understanding that each of the individuals has to hold a qualification (not specified) and professional indemnity insurance and have to have at least five years experience of conducting and being involved in pub rent reviews. PIRRS currently has 14 experts appointed by the PIRRS board, representing nine different surveying practices. The experts are split into ten different regions with a number of the experts serving in a large number of different regions.

Can the Tenant represent himself?

Yes. Both the RICS and PIRRS allow for the Tenant to represent themselves.

Costs

On the understanding of Tenant self representation, the RICS appointed arbitrator will initially confirm an hourly rate fee charge, but will not be specific in respect of ultimate fee costs for the whole arbitration. Associated fees can vary between regions with Central London based arbitrators being the most expensive with some hourly rates exceeding £350 plus VAT. Regional arbitrators' fees generally start at £175 an hour plus VAT. The ultimate fee charge, which can vary between £3,000-£8,000 plus VAT as a rough guide, is initially split evenly between parties.

The PIRRS system has a fixed fee charge for the services of the independent expert which fall into two categories—those with rents under £25,000 and those with rents over £25,000 p.a. Under £25,000 the Landlord pays a fixed fee between £2,000-£2,500 and the Tenant pays a fixed fee between £1,000-£1,500. Over £25,000 p.a. rent, the Landlord and the Tenant pay fixed fees between £1,500 and £2,000.

Can the Tenant recover costs and fees?

Under the Arbitration Act 1996, the opportunity exists for the recovery of all costs and fees after the issuance of a successful Calderbank offer (easily Googled for further and more detailed explanation).

PIRRS has no system for the recovering of costs and each party bears all of their own costs including the initial fixed expert's fees.

Do I need a Deed of Variation?

Not required at Arbitration. Existing Tenancies / Leases identify the binding nature of any dispute resolution system. No threat of lease forfeiture is implied in the system of arbitration referral.

PIRRS requires a Deed of Variation for the PIRRS appointed expert's determination to be binding on both parties. The Tenant will need legal advice in the preparation of the Deed of Variation which is an extra cost which will have to be borne by the Tenant. Any subsequent deviation from the agreed Deed of Variation carries the threat of Lease forfeiture.

Reasons

An arbitration award has to be fully reasoned and must include the detail of the arbitrator's calculations.

The PIRRS expert gives no reasoning, calculations or explanations.

Can I Appeal the ultimate Judgement?

Under the Arbitration Act 1996, there are strictly governed opportunities for appealing the arbitration award.

The final PIRRS independent valuation cannot be appealed under any circumstance.

Extent of Evidence

An arbitration has no restrictions or constraints on the type or length of evidence that can be submitted.

The PIRRS scheme limits the Statements of Case.

Points of Law

Under the Arbitration Act either party to an arbitration can raise points of law and have them determined either by the arbitrator, or an independent legal assessor that is appointed by the arbitrator with the agreement of the parties.

PIRRS does not allow any dispute of interpretation in law to be resolved by the PIRRS independent expert.

Time Scales

Similar. PIRRS on average takes six months.

Confidentiality

Arbitration awards as to rent calculations, valuation methodology etc are widely used in the assistance of setting other rentals and can be of interest in establishing comparable properties as evidence. The prior approval of the parties to the arbitration should be obtained.

In the Terms & Conditions, PIRRS requires that all details of any PIRRS case and the independent expert's workings on any particular case, are strictly confidential.



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Prepared 6 October 2011