Is "Fair Market Rent" Really that Fair?
By the Commercial Real Estate Group at Clark Wilson LLP
February 19, 2007
In most commercial leases, "Fair Market
Rent" is the standard for the rent payable during a
renewal period. While most leases provide some general
guidelines for how to determine "Fair Market Rent", they
typically do not set out exactly what is to be included
or excluded in this determination. It goes with out
saying that when the time comes for renewal, the
landlord and tenant may have very different ideas on the
amount of rent payable during a renewal term.
Most leases attempt to resolve this
inherent problem by providing that if the landlord and
tenant cannot reach an agreement, the matter will be
referred to arbitration. While this sounds like a simple
solution, arbitration can be both expensive and
unpredictable, especially if the terms of the lease are
vague and subject to different interpretations. Fire Productions Ltd. v.
Lauro, a recent decision from British
Columbia Court of Appeal, is a good example of the risks
for both the landlord and the tenant when "Fair Market
Rent" is not clearly defined. This case also provides
insight on how arbitrators and British Columbia courts
will interpret the term "Fair Market Rent" in the
The facts in this case are
straightforward. Fire Productions leased a 3,100 square
foot premises to operate a restaurant and cabaret in
Vancouver. The leased premises were in desperate need of
improvement, which the tenant paid for and completed.
The term of the Lease was renewed once with no concern.
It was when the tenant exercised its second option to
renew the term for five years that disagreement arose on
the rent payable during the second renewal term. In
accordance with the provisions of the lease, an
arbitrator was appointed to resolve the dispute. At
issue in these proceedings was the meaning of "Fair
The arbitrator held that "Fair Market
Rent" was based on the value of the premises at the time
of renewal, which included all improvements made to the
premises by the Tenant. This was because the lease
provided that all tenant improvements became the
property of the landlord upon completion. The arbitrator
set the annual rent payable during the second renewal
term at $19.00 per square foot.
The tenant appealed the arbitratorís
decisions to the British Columbia Supreme Court, arguing
that the rent should be based on the value of the leased
premises, excluding the tenant improvements. The Supreme
Court found this argument persuasive and concluded that
annual rent should only be $13.66 per square foot, a
significant reduction. The landlord then appealed to the
British Columbia Court of Appeal.
The British Columbia Court of Appeal
overturned the decision of the British Columbia Supreme
Court and reinstated the decision of the arbitrator. In
coming to this conclusion, the court held that use of
the word "Market" could only mean that the rent to be
paid during the renewal term was the rent that the
premises would attract if exposed to the market at the
time of the renewal. Thus, because the tenantís
improvements became the property of the landlord on
completion, it was proper that they were included in the
calculation of "Fair Market Rent".
In this decision, the Court of Appeal
is essentially saying that unless the lease contains
some sort of qualification, "Fair Market Rent" means
whatever the open market would pay for the leased
premises in question at the time of renewal. It is an
objective determination, that does not necessarily have
to be "Fair" to the tenant or the landlord.
To get around the unpredictability of
what "Fair Market Rent" will be at the time of renewal,
it is paramount that the parties set out exactly what
should be included in the calculation of "Fair Market
Rent", and what should be excluded. For example, if the
Fire Productions Ltd. v.
Lauro provided that "Fair Market Rent"
would be on the basis of the premises being in the
condition before tenant improvements, the arbitrator and
the Court of Appeal likely would have set the rent at
$13.66 per square foot, rather than $19 per square foot.
Clearly, at the time the lease was drafted, the
landlord and tenant could have avoided the considerable
cost of arbitration and appeals by putting their minds
to what should be included in the determination of "Fair
Market Rent" and then having this reflected in the