It doesn’t pass anyone by: inflation has risen sharply. The Central Bureau of Statistics’ Consumer Price Index (CPI) averaged 11.6% in 2022, down from 2.7% in 2021. Inflation also affects rents. Rents tend to rise along with inflation by indexing. Landlords, given the increased costs, naturally maintain indexation. Tenants therefore face a (steep) rent increase this year. What is actually the basis of the rent increase? Is there any reason to deviate from that now that inflation is so high? And: what steps can be taken to reach a solution that is acceptable to both tenant and landlord? This article provides initial answers to these questions. Needless to say, the specialists at Wille Donker will be happy to help you with appropriate advice.
Annual rent indexation is commonplace within the real estate industry. A lease almost always includes a provision allowing for annual increases in rent based on an index. In principle, parties can choose this index themselves. An index provides an objective basis for rent changes. The rent change is thus simple and predictable.
In most cases and also in the widely used standard terms and conditions of the Real Estate Council (ROZ), the CPI is adhered to. The CPI is objectively determined by CBS based on a fixed basket of goods and services used and consumed by Dutch consumers. With that, the rent increases along with the average price increases over a year. This provides the parties with an objective method of indexation and eliminates the need to negotiate the increase.
Housing rentals are subject to a maximum annual rent increase. It is set by the government. It may be that in a residential lease, the development of the rent is linked to the CPI. However, if the CPI – as in 2022 – exceeds the legally permitted rent increase, the CPI cannot be passed on in full.
Corporate and office space
There is no cap on renting business and office space. The basis for what applies in those cases is what is agreed between the parties. So the contract is leading. If the lease does not cap indexation, no cap applies. If the lease refers to the CPI, the landlord can change the rent based on the CPI.
Thus, the parties are bound by what is included in the agreement regarding the rent increase. This means that in the ROZ model, for example, the allowable rent increase is one-to-one with the CPI, regardless of the outcome. Even if it leads to an extreme increase, such as 11.6% in 2022, this outcome holds. Of course, the landlord is free to implement a lower indexation. For the tenant, it depends on the landlord’s leniency. After all, the basic principle is: a deal is a deal.
Legal possibilities for derogation
Many business owners are facing cost increases. A sharp increase in rent may be objectionable to the tenant. The question, then, is whether – even if the contract is leading – there are options for the tenant to get a different outcome. There are legal entrances to request a lower rent change in court, such as on the grounds of unforeseen circumstances or on the grounds of reasonableness and fairness. Whether those options can help the tenant, however, is questionable.
The court has the ability to modify an agreement at the request of a party. This is possible in very exceptional, unforeseen circumstances that the parties could not have expected in advance. What is important here is that the parties also did not discount it in their agreements: it was not provided for. Courts are not likely to honor a tenant’s invocation of contingencies. Indeed, this requires that the parties have not made a provision in their contract. This is not the case with an indexation clause, which is precisely part of the contract. Circumstances affecting inflation (including exceptional ones such as COVID-19 or the war in Ukraine) have instead been taken into account by including a general index. This index takes into account all possible factors affecting price trends. By agreeing on such an index, the parties anticipated future circumstances. This is thus provided for. For the court to then still intervene, there must be very exceptional circumstances. The bar for that is high. For example, the 2008 economic crisis was not considered an unforeseen circumstance in case law.
Reasonableness and fairness
Another option for the court to modify an agreement is on the grounds of reasonableness and fairness. The issue then is whether it is unacceptable in the circumstances in reasonableness and fairness to hold the parties to the agreements. In (legal) practice, an appeal to reasonableness and fairness is a last resort. The tenant could use this remedy. Yet it is doubtful that the courts will honor a tenant’s appeal on this. The tenant must then argue that given all the specific circumstances, it is unacceptable for the tenant to be held to the agreed-upon indexation. For example, the tenant will have to explain why application of the CPI is unreasonable. That in itself is complex because it would require a review of the CBS system. The CPI is calculated using many different factors, including factors that are subject to frequent change. Consider, for example, energy prices and food prices. It is conceivable that a tenant pays the energy bill himself, while the increase in energy prices is also passed on through indexation. Then the tenant may be double-charged for this cost increase. It can be argued that such double indexation qualifies as unreasonable. On the other hand, however, the parties have just signed an agreement knowing that energy costs are also factored into the CPI. The question then becomes why it is unfair or unreasonable if the outcome of the indexation agreed upon by the parties in one year is sharp. Whether the court will see cause to intervene in the lease in favor of the tenant is therefore questionable. There is no case law showing that in situations such as this, the courts rule that intervention should be made on the grounds of reasonableness and fairness.
How to proceed?
The conclusion is that a landlord may implement the price increase that follows from the agreed index. Even if it leads to a substantial increase. The tenant must accept this increase and is in a difficult position to legally challenge the increase. Of course, consultation between a tenant and a landlord is possible to see if a solution can be reached. For example, it may be agreed that indexation is capped or moderated for the current year, but is combined with agreements on indexation for one or more subsequent years, regardless of the outcome of indexation in that year or those years. Parties could choose to join the so-called core inflation.
If the landlord and tenant cannot reach a joint agreement on the rent increase, then in the case of commercial space, it may be useful to compare the (increased) rent with the rent of comparable commercial space in the neighborhood. In fact, if the rent does not match the comparable business premises on site and the contract has been in place for a long time, the law offers the possibility of claiming a change in the rent in court. The judge then assesses whether and to what extent the rent is reasonable and what the rent to be paid should be. Please note that this legal provision can only be invoked when it comes to the (re)lease of business premises (including retail and hospitality).
Do you want to know what your position is or how you can so deal with the questions in your situation? The specialists in our Real Estate practice group will be happy to advise you.