OPINION OF COUNSEL RE: PROHIBITION ON UPWARD ONLY RENT-REVIEW CLAUSES

High Court judge Mr Justice Gerard Hogan author The Origins of the Irish Constitution 1928-1941and Enda Kenny, Sept 13, 2012

RE: PROHIBITION ON UPWARD ONLY
RENT-REVIEW CLAUSES
OPINION OF COUNSEL  Mr. justice Gerard Hogan
Preliminary
1. The present decline in consumer confidence and retail spending is, unfortunately, without parallel in our lifetimes. This has given rise to huge pressures in the retail sector. Many of these rents were fixed at a time of high growth rates when demand for retail outlets was intense and when a downturn of this intensity was not reasonably foreseeable. The downturn has left such retailers saddled with inappropriately high rents in the same way as the Government has been left with inappropriately high public sector pay rates and other costs. Nearly all of these commercial leases provided for upwards only rent review clauses – this was not only the norm at the time, but retailers leasing retail space had little option but to comply with such demands. 

2. The question which now arises is whether the Oireachtas could validly introduce new legislation which provided that such rents would be pro tanto amended to enable an arbitrator to have regard to changing market conditions so as to enable (where appropriate) the rents to be reduced. The Labour Party introduced a Private Member’s Bill to this effect, Land and Conveyancing Law Reform (Review of Rent in Certain Cases)(Amendment) Bill 2010, but this was opposed by the Government parties on the basis that the measure was likely to be unconstitutional. The issue which I am now required to consider is whether legislation of this general kind would be likely to be found to be unconstitutional.

Articles 40.3.2 and Article 43 of the Constitution: Some Basic Principles

3. While there is a vast case-law on property rights (Article 40.3.2 and Article 43 of the Constitution), we can nonetheless start by articulating some basic and unexceptionable propositions.

4. First, a contractual right of this kind is a property right for the purposes of Article 40.3.2 of the Constitution.1 Of course, the fact that a contractual right of this kind comes within the ambit of the protection of property rights does not mean that it is sacrosanct or free from legislative interference, for nearly all legislation interferes with contractual freedom in one shape or another.

5. Second, in order to withstand constitutional scrutiny, any legislative interference with such a property right must be proportionate and capable of objective justification and must meet a pressing social objective. Any legislative interference with these rights must be necessary to meet key social and public policy objectives which are necessary in a democratic society.3  Thus, in Re Article 26 and Part V of the Planning and Development Bill 19994, Keane CJ, giving the judgment of the Supreme Court in determining whether the statutory provisions constituted an “unjust attack” on property rights, stated that Part V of the Planning and Development Bill 1999, contains provisions which:- “…are rationally connected to an objective of sufficient importance to warrant interference with a constitutionally protected right and, given the serious social problems which they are designed to meet, they undoubtedly relate to concerns which, in a free and democratic society, should be regarded as pressing and substantial. At the same time, the court is satisfied that they impair those rights as little as possible and their effects on those rights are proportionate to the objectives sought to be attained.” In that case it was held that the Bill which proposed that landowners wishing to develop land were obliged to cede 20% of the land (or the equivalent value thereof) to the local authority did not constitute a disproportionate interference with the land owner’s property rights.

6. Third, the State’s duty to protect property rights is not absolute, as the wording of Article 40.3.2 itself makes clear. This point was classically made by O’Higgins CJ in Moynihan v. Greensmyth6: “It is noted that the guarantee of protection given by Article 40, s. 3, sub-s. 2, of the Constitution is qualified by the words ‘as best it may’. This implies circumstances in which the State may have to balance its protection of the right as against other obligations arising from regard for the common good.”

7. It follows that the State is entitled to balance the protection of property rights against other considerations. Thus, for example, even fully retrospective interference with the right to sell the family home might be justified by reference to the State’s obligation to protect the family (Article 41 of the Constitution): see the comments of Henchy J. in Hamilton v. Hamilton8. Likewise, even where the State destroys perfectly healthy animals in order to contain the spread of lethal animal disease, this does not mean that it is obliged to compensate farmers for all losses as a result.

8. It is, moreover, clear that the State is entitled to have regard to present economic conditions which assessing the extent of its duty to protect property rights. This very point was made by McMahon J. in JJ Haire & Co. Ltd. v. Minister for Health and Children10:“[T]he word “unjust” in “unjust attack” [in Article 40.3.2], must be read in the light of the unusual economic crisis that necessitated the introduction of the 2009 Act. All the evidence before the court was to the effect that the State is facing an unprecedented economic crisis, whereby the State is forced to introduce drastic economies and cuts across the board. These economic realities must inform the interpretation of the constitutional phrases in assessing what the State can do and what distributive measures it must take to ensure not only the stability of the economy, but the stability of the State itself.”

9. This leads us to directly to the question of whether such an interference would be capable of objective justification. While this argument is set out in more detail later in this opinion11, the key consideration here is that upward-only review clauses were negotiated in a different economic era where, inter alia, the spectre of deflation was not foreseen. More to the point, the existence of such clauses might be thought to be inflicting widespread damage to the retail sector, because they are artificially blocking the  achievement of an “internal” devaluation in that sector, i.e., a situation where rents, income and wages would reflect true economic conditions, instead of the artificiality created by bubble conditions at the end of the Celtic Tiger period. This is not only critical to the recovery in that sector, but is a vital feature of national economic well-being, given that consumer spending represents some 50% of Irish GDP.

10. In these circumstances, such legislation would seem in principle to be more than capable of objective justification.

11. Third, the fact that the legislation affects existing contracts is certainly a factor to which very considerable regard must be had in assessing the constitutionality of the measure. There is no doubt at all but that, so far as the landlord is concerned, an upward-only rent review clause was a key element of the contractual bargain. 12. Yet, if one surveys the case-law to examine the cases where the legislation affecting property rights was found to be unconstitutional, nearly all of the cases share a common theme, namely, that the legislation in question was inherently arbitrary, disproportionate or unfair. Two of the classic authorities may serve to make this point. In Blake v. Attorney General12 the Supreme Court held that Part II of the Rent Restrictions Acts was unconstitutional, precisely because it was found to operate in an “unfair and arbitrary” manner. The legislation applied in a selective manner; the legislation froze rents at a very low level and yet failed to take account of rampant inflation or the respective means of the landlord and tenant. Likewise, in Brennan v. Attorney General13 Barrington J. and the Supreme Court held that the farmers’ rates legislation was unconstitutional because it was based on the Griffith  Valuation which was conducted in the immediate aftermath of the Famine. That Valuation was hopelessly outdated and was riddled with anomalies and it was on that basis that the Court concluded that the legislation was unconstitutional.

13. Subject to the question of retrospection – to which I will presently return – no question of unfairness or arbitrariness arises in the present case. The legislation will apply generally to all commercial leases and will, in effect, permit property arbitrators to have regard to the impact of deflation in the economy. In effect, therefore, the Oireachtas would be removing an impediment to the market finding its true levels of rent. This would not simply be in the private interests of the retail tenants, because it is vital to the economic health of the nation that the retail sector recovers and removing upward-only clauses may be thought to be essential for this general purpose. For these reasons, subject only to the question of retrospectivity, I am clearly of the view that general legislation of this kind could be justified, certainly having regard to the prevailing economic conditions.

14. Against that background, we can now proceed to examine the reasons offered by the Minister for Justice as to why such legislation would be likely to be found to be unconstitutional.

The reasons advanced by the Minister for Justice to oppose the 2010 Bill

15. In the course of the Dail Debate in March of this year, the Minister for Justice (Mr. D. Ahern TD) gave two reasons as to why the 2010 Bill would be unconstitutional. First, he said that: “If that benefit14 is now to be removed by the State and not the market, we would be depriving individuals and companies of an important contractual right, and would be doing so without compensation and also in an arbitrary and discriminatory way.”

16. This reasoning invites the following comments. It is true that the Oireachtas would be depriving individuals and companies of an important contractual right without compensation, but this is, in fact, a not infrequent consequence of regular and ordinary legislative activity. As Costello J. noted in Cafolla v. Attorney General15: “But laws having such an effect do not necessarily conflict with the Constitution. Laws may, for example, with constitutional propriety prohibit fishermen from fishing at certain times and limit the nature and size of their catches, restrict the hours of trading in licensed premises, fix the price at which goods can be sold or services remunerated, all of which adversely affect the livelihood of those engaged in the activity concerned. Laws may even prohibit an existing business activity, as was shown in Private Motorists Provident Society v. Attorney General16…….”17 14 I.e, the upwards-only rent review clause.

17. As Costello J. pointed out in Cafolla, the real question is whether the restriction on the exercise of property rights is capable of objective justification by reference to the exigencies of the common good (to use the language of Article 43). If it is, then the restriction will be upheld even though some appreciable interference with contractual freedom will be entailed. In Private Motorist Provident Society the Supreme Court upheld the constitutionality of legislation prohibiting (without compensation) an industrial and provident society from operating a banking business at the end of a five year transition period. That legislation doubtless deprived those plaintiffs – to use the Minister’s words – of “an important contractual right without compensation”, but this was not seen by the Supreme Court as constitutionally objectionable, given that the evidence in the High Court was (not surprisingly) to the effect that such regulation and control was desirable in the public interest.

17. The critical question is, therefore, not so much whether a contractual right will be interfered without compensation, but rather whether the end result is proportionate and objectively justifiable. Most legislative interferences with contractual rights do involve abrogating or significantly altering that right without compensation. While these are important considerations, they are far from being decisive. If that were so, then the constitutionality of the significant reductions in professional fees effected by the FEMPI Act 2009 could never have been upheld by the High Court in the JJ Haire case.

18. Nor can I agree that such legislation prohibiting upward-only rent review clauses would be arbitrary and discriminatory. If the Oireachtas were to focus via such legislation on prohibiting such clauses in the commercial sector, it would be simply because of the damage which was clearly been done to that sector by the existence of such clauses and given the importance of this sector to the generation of consumer confidence, economic transactions and wealth creation. One might well as contend – as indeed the plaintiffs in the Private Motorists Provident Society case did – that the legislation in that case was also arbitrary and discriminatory. The reality, however, is that legislation prohibiting such clauses in the commercial sector would be perfectly general in its operation and it is, frankly, difficult to see how it could be regarded as arbitrary or discriminatory in the sense of cases such as Blake.

19. The second key point which the Minister made was that:
“It has been suggested that intervention in this area is possible on the basis of the justifications recited in the Financial Emergency Provisions in the Public Interest Act 2009. However, the 2009 does not give the Legislature the freedom to interfere in an arbitrary way with property rights in general. The legal issues raising under the 2009 Act are entirely different and the same financial imperatives do not apply.”

20. With great respect, I fundamentally disagree with this analysis, since I see no difference in principle between the position of the State and its suppliers on the one hand and the position of private parties on the other. In each case, the problem is essentially the same.

21. In the case of the State, it agreed to pay (what ultimately transpired to be) inflated prices for a range of professional services at a time when the market was overheated. These were doubtless the prevailing market prices at the time, but that market was at unrealistic levels in the longer term. When the market subsequently crashed, the State nonetheless found itself paying prices for professional services which it could no longer afford, not least given that its revenue base had significantly contracted. This problem was solved at one stroke by the State with the enactment of the Financial Emergency Measures in the Public Interest Act 2009 (“FEMPI”) This enabled the relevant Ministers to make orders which reduced the level of payments in respect of these services.

22. The striking thing about the FEMPI legislation, of course, is that it interfered retrospectively with an existing contract in the sense that it enabled the Minister to override unilaterally the terms of a contract freely entered into between the parties prior to that date and to fix the price at which such services would now be remunerated. Such contracts also provided for guaranteed income streams for the professionals concerned and they, presumably, entered into other contractual commitments (such as, for example, the leasing of premises) on the understanding and belief that this income stream would continue.

23. The situation with regard to private retailers is very similar. The property bubble had the effect of inflating rental demand and rents generally. The retailers concerned entered into such commitments at these (inflated) rental levels, simply because they had no choice but to do so if they wanted to compete in that market at that time. It is true that they freely entered into contractual commitments which bound them to upwards only rent reviews, but then so did the Government when it entered into agreements with its third party service providers.

24. Thus, a critical question here is whether a distinction can be drawn between the State on the one hand and the private parties to a landlord and tenant relationship on the other. I do not think that any such distinction can in principle be made. The very unreality of such a supposed distinction can be illustrated by the following example. Suppose that in 2006 (at the height of the boom) Pharmacist A enters into a community pharmacy contract with the HSE which (more or less) guarantees a fixed income stream at contractually agreed levels. Having signed this contract, Pharmacist A agrees to rent retail premises from B at a particular rate, with an upwards only rent review clause. Of course, it might be said B would not have agreed to lease the premises to A without this clause, but it can equally be said that A would not have agreed to take on this commitment unless he was confident of his own income stream from the HSE. If the State can constitutionally reduce A’s income stream under FEMPI, then why can the Oireachtas equally not act to void a term of a contractual position (upwards only rent review clauses) which would have the (admitted) effect of reducing B’s income stream from A?

25. It is difficult to see how there could be any difference in principle between the two situations. In both cases, the paying party agreed to pay at a level which is greater than is now justified by the present post-crash market and in both cases, these parties are struggling to make these payments due to a recession-induced contraction. The public policy considerations are, moreover, the same: the decline in income of the paying party, coupled with the presence of deflation – a phenomenon which has not been seen in the Irish economy since the early 1930s – which has artificially boosted the real value of the payments for the professional services and rent alike.

26. Indeed, if anything, the FEMPI legislation goes further than what is at issue here in that the existing service payments under contract were reduced unilaterally by ministerial order made under FEMPI, so that the Minister determined the amount which he or she was going to pay for such professional services. All that is at stake here with the proposed legislation is that a clause which precludes a property arbitrator from reducing the rent having regard to existing market conditions is rendered void. It would not necessarily follow the rent would be reduced as a result, although one must concede that this would probably happen in many cases. All that would occur is that the property arbitrator would be entitled to have regard to prevailing market realities, including deflation. In effect, insofar as the upward-revision clause gives protection to landlords, it is to protect them against the impact of then severe deflationary pressures presently operating in the retail sector. But why should the public interest, for all the reasons mentioned above?

27. Besides, the Oireachtas has frequently legislated with retrospective effect in a way which fundamentally affects existing contractual rights. Thus, for example, spouses who were the owners of a family home prior to July 1976 found that after the passage of the Family Home Protection Act 1976 they could no longer sell such property without the consent of their spouse. Likewise, many (heretofore) lawful agreements, decisions and concerted practices were rendered void by the passage of the Competition Act 1991.18

28. Another example from the retail arena may be found in section 64(9) of the Pharmacy Act 2007. This provision enables the Minister for Health to make an order, the effect of which, broadly speaking, would be to prohibit pharmacists and general practitioners sharing the same general premises. There were, of course, many such arrangements in existence prior to the commencement of the section in August 2009 and the Minister has now made such an order under section 64. This will presumably significantly disrupt the arrangements presently enjoyed by many pharmacists and general practitioners alike. There are doubtless dozens of instances where pharmacists and general practitioners have entered into contractual commitments of this nature, yet the effect of the making of such an order will be to deprive these parties of a valuable contractual right without compensation. In all of these cases, the Oireachtas interfered retrospectively with existing contracts in the public interest, in the sense that a pre-existing contractual provision was rendered void with prospective effect after a particular date.19

Conclusions

29. In summary, therefore, I am of the view that:
A. Any legislation which rendered void pre-existing contractual commitments providing for upwards-only rent review would deprive the landlords of a valuable contractual right without compensation. This, however, is not a dispositive consideration, since legislative interference with contractual rights along these lines is not uncommon, i.e., the very point which Costello J. made in Cafolla.

B. The critical question is rather whether such legislation would be proportionate and objectively justifiable. For the reasons set out in this opinion, there are far reaching policy reasons why the Oireachtas might think that the prohibition of such clauses is necessary in the public interest. Not the least of those reasons is that the Oireachtas might consider that such clauses artificially maintain unrealistically high rental levels in the retail sector, thus hindering the recovery of the retail sector. Of course, given the high importance of the retail sector to the volume of economic transactions and consumer confidence, the economy as a whole cannot fully recover from an economic crash without the recovery of that sector.

C. In my view, any such proposed legislation is no different in principle from many other forms of legislation which preclude or render void pre- existing business practices provided for by contract. The proposed legislation satisfies the proportionality test in that –
i. It is rationally connected to an objective of sufficient importance (i.e., recovery in the retail sector) to warrant interference with a constitutionally protected right and, given the serious social problems which they are designed to meet, they undoubtedly relate to concerns which, in a free and democratic society, should be regarded as pressing and substantial.
ii. Such legislation would also impair those rights as little as possible and their effects on those rights are proportionate to the  objectives sought to be attained in that it would simply provide a mechanism whereby rents could be assessed by reference to prevailing market conditions and deflation.
iii. Critically, such legislation would not attack the essence of the contractual right, namely, the right to receive a market rent and, unlike cases such as Blake, it would not involve one sector of society (namely, landlords) being expected unfairly to bear the burdens from other sectors of society are exempt.

D. No difference in principle can be drawn between the proposed legislation and the FEMPI Act. Certainly, if the Oireachtas can constitutionally take steps drastically to interfere with existing contractual rights of service providers and public servants without compensation (as the High Court has already held in the JJ Haire case), then the proposed legislation of this kind would equally seem to be constitutionally valid. 

I can advise further if required.

Gerard Hogan SC,
Law Library Building,
149-151 Church St.,
Dublin 7
April 16, 2010

About these ads

One Trackback to “OPINION OF COUNSEL RE: PROHIBITION ON UPWARD ONLY RENT-REVIEW CLAUSES”

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Follow

Get every new post delivered to your Inbox.

%d bloggers like this: