PETER BRENT HOME HUBBARD & ORS v KIWIRAIL LIMITED [2017] NZCA 282

PETER BRENT HOME HUBBARD & ORS v KIWIRAIL LIMITED [2017] NZCA 282 [4 July 2017]IN THE COURT OF APPEAL OF NEW ZEALANDCA272/2016[2017] NZCA 282BETWEEN PETER BRENT HOME HUBBARDAND HARLEY HAYNESFirst AppellantsOCEANIC PALMS LIMITEDSecond AppellantAND KIWIRAIL LIMITEDRespondentHearing: 3 May 2017 (further submissions received 10 and 17 May2017)Court: Miller, Gilbert and Katz JJCounsel: First Appellants in personM L Campbell and L M McGlone for RespondentJudgment: 4 July 2017 at 2.15 pmJUDGMENT OF THE COURTA The appeal is dismissed.B The first appellants must pay the respondent costs for a standard appeal on a band A basis and usual disbursements.____________________________________________________________________REASONS OF THE COURT(Given by Gilbert J)Introduction[1] This is an appeal against a judgment of Fogarty J given in the High Court on 20 May 2016 declining an application for relief against forfeiture of a lease for non- payment of substantially increased rent following a rent review.1 The appellants claim that the proposed rent increase is disproportionate and excessive having regard to the characteristics of the leased land and the terms of the lease, including thelessor's right to terminate on 24 months' notice. They claim that the proposed rent isinequitable and amounts to a frustration of the lease. They also claim that thelessor's decision to increase the rent to such an extent was made in bad faith and wasunreasonable. They claim that the decision is judicially reviewable under the Judicature Amendment Act 1972 because the lessor is a state enterprise.Facts[2] Oceanic Palms Ltd has been engaged in palm landscaping since 1989. Its core business is growing and transplanting mature palm trees. Peter Hubbard and Harley Haynes are its directors and shareholders. They state that their aim is to make a significant contribution to the Auckland urban environment. They have been involved in several major projects for Auckland Council, including transplantingmature nīkau palms in Karangahape Road, Queen Street and at Vector Arena.[3] Oceanic Palms' nursery and horticulture business is based in Onehunga, Auckland on land it leases from KiwiRail Ltd under a deed of lease dated 28 June 2010. The leased land is held by the Crown on behalf of New Zealand Railways Corporation for railway purposes and is administered by KiwiRail. The land may not be disposed of without the consent of the Minister of State Owned Enterprises who must have due regard to the future development of the railways.2[4] The lease was negotiated over a nine-month period from about September 2009. At that time, the land had been vacant for a number of years, it was in a bare state and parts of it were prone to flooding. KiwiRail allowed Oceanic Palms to occupy the land rent-free for three months from December 2009 to1 Hubbard v KiwiRail Ltd [2016] NZHC 1061 [High Court judgment].2 New Zealand Railways Corporation Act 1981, s 24(a).the commencement date under the lease of 1 March 2010. During this period, Oceanic Palms improved the condition of the land by removing old tyres and other rubbish that had been dumped there, introducing fill and compacting it to level the land, addressing the flooding problems, laying gravel, removing a perimeter rock wall, cutting down trees and erecting fences. KiwiRail paid Oceanic Palms $20,399 for this work which included 194.5 hours charged at $30 per hour for Messrs Hubbard and Haynes' labour.[5] Oceanic Palms has since planted over a hundred palms, trees and shrubs and many others are displayed in containers. It has also relocated three buildings onto the site and constructed shade houses. It would be a major undertaking for the appellants to relocate their business to new premises.[6] The agreed rent for the initial term of the lease, a period of five years commencing on 1 March 2010, was $34,300 per annum.3 KiwiRail advised Oceanic Palms on 29 October 2009 that the rental "is not the current market rent andis a concession granted to Oceanic Palms". KiwiRail declined Oceanic Palms'request to limit any rent increase after five years to movements in the consumer price index and advised it on 14 December 2009 that if the right of renewal was exercised, the rent would be reviewed to the current market rent.[7] The lease was varied from 1 December 2013 by increasing the leased area from 4,496 square metres to 4,985 square metres and the rent to $37,502 per annum. This was recorded in an agreement dated 8 December 2014.[8] The lease provides for a single right of renewal for a further five years from 1 March 2015. Oceanic Palms has exercised this right of renewal.[9] The rent may be reviewed by KiwiRail by giving written notice to Oceanic Palms specifying the annual rent to apply from the sole rent review date, being 1 March 2015. This rent is "to be determined by [KiwiRail] to reflect thecurrent market rent of the Leased Land, based on the highest and best use of theLeased Land, as at the Rent Review Date". The leased land is defined as the land3 All amounts referred to in this judgment are exclusive of GST.described in the first schedule to the lease and held by Her Majesty the Queen in right of New Zealand for railway purposes.[10] On 9 December 2014 KiwiRail gave notice that it had determined the market rent for the land as being $123,200 per annum. The lease provides that Oceanic Palms may give written notice within 28 days of receipt of KiwiRail's noticedisputing that the proposed new annual rent reflects the current market rent of the Leased Land. Unless it gives such notice within the 28-day period, Oceanic Palms isdeemed to have accepted the new annual rent specified in KiwiRail's notice.Oceanic Palms did not respond within the 28-day period but KiwiRail has not sought to enforce the deemed acceptance.[11] The lease provides that if the rent cannot be agreed, the rent dispute shall be submitted to a single arbitrator, if one can be agreed upon, or, otherwise, to two arbitrators (one appointed by each party) and an umpire (appointed by the arbitrators). The lease requires Oceanic Palms to pay the rent specified by KiwiRail in its notice until the new rent is determined by agreement or arbitration and then adjusted accordingly.[12] CBRE Ltd, a leading valuation firm, was engaged by KiwiRail to assess the market rental as at 1 March 2015. CBRE carried out this assessment using both the traditional and classical approaches. The traditional approach involves determining a market value for the freehold interest in the land and ascribing a market return taking into account the lease terms. CBRE assessed the unimproved land value at $375 per square metre or $1,869,375. Having regard to the terms of the lease, including thelessor's right to terminate on 24 months' notice, CBRE assessed the market annualreturn as being 6.25 per cent. The derived market rent was therefore $117,000 per annum. The classical approach involves identifying market rentals for other comparable properties and then making appropriate adjustments to reflect differences in the physical characteristics of the land, the terms of the lease and risk (security of return). Using this approach, CBRE assessed the market rental at $22.50 per square metre or $112,000 per annum. Taking into account both of these analyses, CBRE adopted $115,000 as the assessed market rental.[13] Oceanic Palms engaged Knight Frank, another well-known firm offering commercial valuation services, to assess the market rental. It carried out its assessment relying solely on the traditional approach. It valued the unimproved land at $1.5 million. It noted that for many years, industrial land in Auckland suburbs hadachieved "a rack rental rate" of between six and 6.5 per cent. However, in thecurrent low-interest-rate environment, it considered that the market rent for the land would be no more than six per cent per annum. Knight Frank discounted this general market rate to five per cent to reflect the five-year lease term and the right of termination on 24 months' notice. On this basis, Knight Frank assessed the marketrent at $75,000 per annum.[14] The valuers conferred and on 22 June 2015 they made a joint recommendation to the parties that the rental should be fixed at $100,000 per annum for the period commencing 1 March 2015. This is acceptable to KiwiRail and it has invoiced Oceanic Palms on the basis of this figure rather than the higher amount stipulated in its notice. However, Oceanic Palms does not accept the valuers' jointrecommendation and has continued to pay the original rental amount.[15] Oceanic Palms is not prepared to participate in an arbitration to resolve the dispute because it does not consider that this could produce a rent determination low enough to be acceptable to it. Although it seeks relief against forfeiture of the lease, it effectively wants the lease to be set to one side for the purposes of determining the rent.[16] Because no progress towards resolution was being made, KiwiRail gave notice on 17 September 2015 under s 245 of the Property Law Act 2007 advising that unless Oceanic Palms paid the outstanding rent within 10 working days, KiwiRail intended to cancel the lease. This did not produce the desired response.Accordingly, KiwiRail's solicitors served a further such notice on 1 December 2015requiring the outstanding rental to be paid by 16 December 2015 failing which KiwiRail intended to cancel the lease. This notice prompted Oceanic Palms to apply for relief against the proposed cancellation under s 253 of the Property Law Act.High Court judgment[17] Oceanic Palms advanced 16 grounds in support of its application for relief against forfeiture but Fogarty J found that most of these were simply not arguable.4The Judge considered that the fate of the application depended entirely on whether the rent agreed by the valuers was justified.5 The Judge observed that by employing the traditional method, the valuers may have ignored the disadvantages of the particular lease terms.6 Nevertheless, even accepting that the rent jointly recommended by the valuers might be challenged successfully through arbitration, the Judge concluded that this did not excuse Oceanic Palms from paying the increased rental in the meantime in accordance with the lease requirements.7[18] For these reasons, Fogarty J dismissed the application but allowed Oceanic Palms a further opportunity to avoid cancellation of the lease by taking two steps within one calendar month from the date of delivery of the judgment. The first was to pay KiwiRail the arrears of rent and the second was to formally dispute the rent so that it could be submitted to arbitration. Oceanic Palms has not taken either of these steps and, instead, has appealed against the judgment.Grounds of appeal[19] The appellants' grounds in support of their appeal can be summarised asfollows:(a) They have been the subtenant or tenant of KiwiRail for over 15 years.(b) The rent has been set at a disproportionate and excessive level considering the character of the tenancy established during this period and the character of the land itself.(c) Enforcing the lease will cause undue hardship and result in the appellants losing their livelihood.4 High Court judgment, above n 1, at [22]–[29].5 At [39]–[40].6 At [59].7 At [63]–[64].(d) The High Court put to one side the question of whether the new rent amounts to a frustration of the lease.(e) The valuers failed to comply with the terms of the lease in carrying out the valuation and grossly over-valued the property as a result.(f) Due to a misunderstanding, Fogarty J wrongly thought that the appellants had the ability to pay the assessed rent.(g) KiwiRail, as a government-owned entity, has a duty to act morally, responsibly and considerately but has failed to do so.(h) KiwiRail is obliged under s 4 of the State-Owned Enterprises Act 1986 to assist the community in which it operates when it can.(i) The appellants' business, which is directed to improving the environment for Auckland citizens, is worthy of KiwiRail's support.(j) The Court should take into account social and other factors when considering an application for relief against forfeiture.[20] In their amended notice of appeal, the appellants sought an order that the rent not be increased at all or, failing that, an order that the increase be no more than 30 per cent of the former rent. They also sought a direction requiring KiwiRail to compensate any past or present tenant who can demonstrate that they have been treated harshly, immorally or inconsiderately by KiwiRail since July 2014.[21] The appellants applied on 28 April 2017 to add a further ground of appealseeking judicial review of KiwiRail's decision to charge the increased rent. They contend that KiwiRail's decision was unreasonable and made in bad faith. They also withdrew their alternative request for an order limiting any rent increase to 30 per cent of the former rent, contending that there should be no increase.[22] The appellants argue that KiwiRail's decision was unreasonable because itdisregarded the following asserted facts:(a) If the lease is cancelled, a new tenant will be able to establish a small business utilising improvements and basic amenities provided, and largely paid for, by Oceanic Palms.(b) The use to which the land can be put is limited by Council regulations.(c) Horticulture is not the highest and best use of the land.(d) The land has been tailored to Oceanic Palms' specific usage.(e) No other tenant has ever taken up significant occupancy on the land.(f) Only a dedicated and capable group of people would be prepared to take the steps required to establish a business on the land.(g) Oceanic Palms makes a worthwhile contribution to the community.[23] Oceanic Palms advances the following propositions in support of its contention that KiwiRail acted in bad faith in setting the new rental:8(a) KiwiRail encouraged Oceanic Palms to take up occupation of the land and then made it impossible for it to continue as a tenant.(b) KiwiRail acted in bad faith in demanding a full market rent in the circumstances.(c) KiwiRail used "legal trickery" by making "spurious demands" unders 244 of the Property Law Act to exact payment when other, simpler, means are available to achieve the desired result.(d) KiwiRail failed to take account of Oceanic Palms' financial positionin setting the rent.8 Additional grounds were also listed but these were not relevant to KiwiRail's decision toincrease the rent under the subject lease and we have therefore not referred to these.(e) KiwiRail seeks to take advantage of the fact that most tenants would rather pay an artificially inflated rent than meet the costs of relocating.AnalysisAvailability of judicial review[24] KiwiRail is a subsidiary of KiwiRail Holdings Ltd, a state enterprise.Although we have grave doubts that KiwiRail's decision to increase the rent has therequisite public character to be amenable to judicial review, we will assume, without deciding, that it does.Bad faith[25] For the reasons that follow, we are satisfied that there is no basis for theappellants' contention that KiwiRail acted in bad faith in deciding to review the rentto a market rent in accordance with the lease. Rather, the evidence shows that KiwiRail has accommodated Oceanic Palms in many ways throughout their tenancy, including in connection with the rent review process. KiwiRail has not sought totake advantage of Oceanic Palms' failure to dispute the proposed new rent within 28days, as required under the lease to avoid deemed acceptance of the new rent. KiwiRail has also not attempted to enforce its right to payment of the rent set by its trigger notice, only the reduced amount jointly recommended by the valuers. KiwiRail demonstrated considerable patience in allowing Oceanic Palms to continue in occupation for many months despite non-payment of any increased rental from 1 March 2015. It remained willing throughout to resolve the dispute through the arbitral process provided under the lease and only took the step of giving notice of its intention to cancel the lease when it became clear that Oceanic Palms would neither pay the increase nor engage in arbitration.[26] KiwiRail advised Oceanic Palms that the rent agreed for the initial five-year term of the lease was a concessionary rent. KiwiRail also made it clear, as is recorded in the lease, that the rent would be reviewed to a market rental at the expiration of the initial lease term in the event that Oceanic Palms exercised its right to renew the lease for a further five years. Oceanic Palms took occupation of theland on this basis and exercised its right of renewal with full knowledge that KiwiRail had the right to insist on a full market rental from the rent review date. It is simply not arguable that KiwiRail acted in bad faith in exercising its right to review the rent to a market rent in accordance with the lease. That is exactly what it said it would do prior to the lease being signed.[27] The suggestion that the service of notices in accordance with the mandatory requirements of the Property Law Act is "spurious" and constitutes "legal trickery" is untenable. KiwiRail was not obliged to take into account Oceanic Palms' financialposition in setting the market rent. There is no basis for the contention that the rent jointly recommended by the valuers was "artificially inflated" or a cynical demandintended to take advantage of the costs Oceanic Palms would incur if it relocated its business elsewhere. KiwiRail gave notice of the intended rent increase in December 2014 leaving Oceanic Palms plenty of time to consider whether it wished to exercise its rights of renewal in the face of the proposed rent increase.Unreasonableness[28] The principal objective of every state enterprise is to operate a successful business and to be as profitable and efficient as comparable businesses that are not owned by the Crown.9 KiwiRail is not obliged to subsidise Oceanic Palms' business, whether or not it makes a worthwhile contribution to the community. KiwiRail'sdecision to seek a market rent for the premises in accordance with the lease cannot be challenged as unreasonable. The particular rent sought by KiwiRail was jointly recommended by the independent expert valuers respectively retained by the parties. It cannot be said that KiwiRail acted unreasonably in relying on their advice. That a new tenant will be able to utilise the improvements made to the land by Oceanic Palms or that the land has been tailored to Oceanic Palms' specific usage is besidethe point. Similarly irrelevant is that horticulture may not be the highest and best use of the land. The parties agreed, and the lease directs, that the market rent is to be assessed based on the highest and best use of the land at the rent review date. Such use must inevitably take into account any restrictions imposed by Council.9 State-Owned Enterprises Act, s 4(1)(a).[29] For these reasons, we consider that Oceanic Palms' belated attempt tobroaden the scope of the appeal by adding judicial review as a ground does not assist its case.[30] We now turn to the grounds of appeal set out in the memorandum amending the grounds of appeal dated 13 September 2016.Overlapping grounds — grounds (g), (h), (i) and (j)[31] Four of these effectively replicate the same grounds advanced in support of the proposed application for judicial review and fail for the reasons already given. These are: KiwiRail, as a government-owned entity, has a duty to act morally, responsibly and considerately but has failed to do so (ground (g)); KiwiRail is obliged under s 4 of the State-Owned Enterprises Act to assist the community in which it operates when it can (ground (h)); Oceanic Palms' business is directed to improving the environment and is worthy of KiwiRail's support (ground (i)); and theCourt should take into account social and other factors when considering an application for relief against forfeiture (ground (j)).Oceanic Palms' particular circumstances — grounds (a), (c) and (f)[32] Grounds (a), (c) and (f) can usefully be dealt with together because they allrelate to Oceanic Palms' particular circumstances: it has been the tenant or subtenant of KiwiRail for over 15 years (ground (a)); enforcing the lease will cause undue hardship to the appellants (ground (c)); and the Judge wrongly thought that the appellants could afford the assessed rent (ground (f)). These factors, which are peculiar to Oceanic Palms, are not relevant in this case. This is because the lease calls for the assessment of a market rent which is the rent a hypothetical, willing but not over-anxious, informed lessee would agree to pay on the rent review date to occupy the land on the terms and conditions of the lease and what a hypothetical lessor, similarly described, would accept.10 The hypothetical lessor and lessee arenot influenced in this hypothetical negotiation by Oceanic Palms' financial position,the duration of its previous occupancy, or any costs that it may incur by having to10 Granadilla Ltd v Berben (1999) 4 NZ ConvC 192,963 (CA) at [5]–[7].relocate. The hypothetical negotiation occurs on the rent review date and is unencumbered by these factors.Frustration — ground (d)[33] The appellants complain that the Judge did not address the question of whether the new rent amounts to a frustration of the lease. The doctrine of frustration can only apply if an unforeseen event occurs that is so significant as to destroy the whole basis of the contract for lease. It is self-evident that the exercise of an express right conferred under the lease to review the rent to market on renewal is not an unforeseen event destroying the foundation for the lease. This argument is misconceived and the Judge was right to reject it.Assessed rent is excessive and outside the terms of the lease — grounds (b) and (e)[34] We agree with the Judge that the application for relief against forfeiture stands or falls on whether the trigger notice issued by KiwiRail stipulating the new rent was valid. This turns on whether the notice was a valid exercise of KiwiRail'srights under the lease. If the notice was valid, it is clear that Oceanic Palms was obliged under the terms of the lease to pay the stipulated rent, even if it did not accept that it was an appropriate market rent, pending determination of the new rent by agreement or arbitration. Ultimately, as the Judge said, this comes down to whether the rent was assessed in accordance with the terms of the lease.[35] Oceanic Palms' focus on the size of the increase is a distraction. The evidence shows that the initial rental was concessionary and below market. It is not the correct reference point for gauging whether the assessed rental is a market rental as at the rent review date, five years later.[36] Clearly, the trigger notice could not be invalidated merely because the stipulated rental could be shown to be in error and above a market rate. The parties agreed that any dispute about the correct market rental would be resolved by arbitration. They cannot have intended that the agreed arbitral process could be subverted by the lessee contesting the validity of the trigger notice on the basis of mere valuation errors. On the other hand, the trigger notice would not be valid if itwas based on a valuation not authorised by the lease, for example, if it valued land and improvements not land only.[37] The principle was explained by McHugh JA in Legal & General Life of Australia Ltd v A Hudson Pty Ltd:11While mistake or error on the part of the valuer is not by itself sufficient to invalidate the decision or the certificate of valuation, nevertheless, the mistake may be of a kind which shows that the valuation is not in accordance with the contract. A mistake concerning the identity of the premises to be valued could seldom, if ever, comply with the terms of the agreement between the parties. But a valuation which is the result of the mistaken application of the principles of valuation may still be made in accordance with the terms of the agreement. In each case the critical question must always be: Was the valuation made in accordance with the terms of a contract? If it is, it is nothing to the point that the valuation may have proceeded on the basis of error or that it constitutes a gross over or under value. Nor is it relevant that the valuer has taken into consideration matters which he should not have taken into account or has failed to take into account matters which he should have taken into account. The question is not whether there is an error in the discretionary judgment of the valuer. It is whether the valuation complies with the terms of the contract.[38] In that case, the parties were bound by the valuer's determination. Here, thelessee has the right to contest the valuation through arbitration. This reinforces our conclusion that mere valuation errors, even if they lead to a gross overvalue, will not invalidate the trigger notice. Something more fundamental is required, such as the wrong land being valued, or improvements being taken into account when the lease requires that they be disregarded, or it can otherwise be shown that the valuation was not in accordance with the lease. We are not persuaded that the rent sought byKiwiRail, which is based on the valuers' joint recommendation, can be dismissed as falling outside the terms of the lease.[39] CBRE noted the physical characteristics of the land, including that under the then-proposed Auckland Unitary Plan it is located in a flood plain and a flood-prone area. It also noted that the land is held for rail purposes and, for this reason, the lease provides an early right of termination. CBRE considered a number of terminating ground leases with two- to seven-yearly review frequencies on comparable land in the same locality. This evidence indicated that the ground rent percentage returns11 Legal & General Life of Australia Ltd v A Hudson Pty Ltd (1985) 1 NSWLR 314 (CA) at 335–336.ranged from 5.75 per cent to 6.5 per cent per annum. Taking into account that the subject lease term was for a period of five years but with an early termination right on 24 months' notice, CBRE adopted a market rate of return of 6.25 per cent. CBREalso considered the evidence of rentals struck in the market for comparable land in the locality. These ranged from $17 per square metre to $27 per square metre. Taking into account the size, location, profile, site improvements and quality of the yard space, CBRE considered that $22.50 per square metre was an appropriate reflection of the market rental for the subject land. The separate assessments based on the traditional and classical approaches provided a cross-check. Because these assessments yielded similar results, this provided a degree of confidence in the accuracy of the outcome.[40] Knight Frank's approach on behalf of Oceanic Palms was arguably lessthorough in that it relied solely on the traditional approach. However, it is clear that it also took into account that the land is retained for railway purposes and this is the reason for the early termination right. Knight Frank expressly stated that it was because of the specific lease terms, including this early termination right, that it discounted the rental rate from six per cent to five per cent in making its assessment of the market rent.[41] It is clear on the face of the valuations that both valuers took into account that the land is held for railway purposes and that the lease could be terminated on 24 months' notice for this reason. In carrying out their assessments, they also tookinto account the condition of the land, relevant Council restrictions including the uses to which the land may be put, and the terms of the lease. Both disregarded the lessee's improvements. In summary, Oceanic Palms has not established that thevaluers overlooked the character of the tenancy or the land (ground (b)) or the terms of the lease (ground (e)).[42] Oceanic Palms may be able to demonstrate in an arbitration that the figure jointly recommended by the valuers is above a market rental, for example, because the wrong comparative data set has been chosen or because the adjustments made to reflect the particular characteristics of the subject land and the lease terms were inappropriate. However, that does not mean that the trigger notice was invalid.Conclusion[43] The appellants have made it clear that they are not prepared to pay any increased rental. They acknowledge that such an outcome can only be achieved by setting the lease to one side and ignoring the rent review provision. That is not a proper basis for the Court to grant relief against forfeiture of a lease. Such relief is generally only appropriate in circumstances where the Court can have reasonable confidence that the lease terms will be complied with if relief is granted. That is not the case here. If relief against forfeiture were to be granted, that would effectively require KiwiRail to accept the initial concessionary rental agreed in 2005 for the entirety of the lease. That would be contrary to the parties' agreement and neitherfair nor equitable.[44] The appellants have not established that the Judge made any appealable error in declining to grant relief against forfeiture. The appeal must therefore be dismissed.Result[45] The appeal is dismissed.[46] The first appellants must pay the respondent costs for a standard appeal on a band A basis and usual disbursements.Solicitors:Russell McVeagh, Wellington for Respondent