CAN A BUSINESS OWNER RENEGOTIATE THEIR RENT?
The rent for cafes, restaurants, hotels, and nightclubs can change during the lease term: every three years – this is called a rent review – or at the end of the nine-year term – this is called a renewal.
The commercial lease regulations were modified by the law of June 18, 2014, known as the Pinel Law, regarding rent, the allocation of charges, and assignment. These provisions apply to leases renewed or signed on or after September 1, 2014.
The main indices used to revise the rent
The rent for a commercial lease (3-6-9) is the result of an agreement between the landlord and the tenant.
• The Commercial Rent Index (ILC):
Unless otherwise stipulated in the lease, the Commercial Rent Index is the reference index for commercial matters, used to adjust rent every 3 years (or more frequently if the lease contains a clause to that effect).
It replaces the Construction Cost Index (ICC), which was based on the value of raw materials and could be unfavorable to businesses because it was disconnected from the real economy and could increase during economic crises.
• Indexation and Revenue Clauses
An indexation clause and a revenue clause allow for rent adjustments on a date agreed upon in the lease:
– An indexation clause allows for rent adjustments when the rent has been increased by more than one-quarter compared to the rent previously stipulated in the lease or by addendum. However, the increase is limited to 10% of the rent paid during the previous year;
– A revenue-based clause: this allows for rent adjustments based on the tenant’s turnover or revenue.
Often, the landlord seeks legal recourse to obtain interest at the legal rate on the difference between the old rent and the renewed rent. The tenant cannot avoid this by arguing that an indexation clause exists to offset this difference, as the issue of interest is independent of the indexation clause, which relates to the variation in the principal rent. Interest should, in principle, accrue from the date of service of the summons in the event of legal proceedings, even if an indexation clause exists (Article 1155 of the French Civil Code – Cass civ 3rd, April 12, 2018, No. 16-26.514).
- The benefits of these two clauses:
These clauses can work against the tenant if revenue increases.
However, for businesses experiencing a decline in turnover due to the health crisis, these clauses are very useful. The current economic climate and the increased burden of expenses and obligations on businesses make these clauses more relevant.
Thus, the tenant can request a rent reduction either because their actual rent has decreased by more than a quarter (indexation clause), or because they have experienced a decrease in turnover or revenue (revenue clause).
Following the health crisis and the significant drop in their revenue, businesses should check their lease for such a clause and invoke it to reduce their rent without resorting to legal action.
Even in the absence of such a clause, businesses experiencing significant losses or a lack of revenue, particularly due to the health crisis, are advised to initiate negotiations with their landlords or take the necessary steps to reduce their rent according to the procedures described below.
If there is no clause in the lease, when and for what reason can a commercial rent be reviewed?
The rent amount can, however, increase or decrease during the lease term:
- every three years: following a request for review or,
If there is no clause in the lease, the tenant can request a rent reduction every 3 years, starting the day after the 3-year period expires (by court bailiff’s notice or registered letter with acknowledgment of receipt).
In principle, this review is indexed to the commercial rent index.
- at its expiry, after 9 years upon renewal.
For example, in one case, a lease was renewed on July 1, 2015. Since the INSEE Construction Cost Index (ICC) was removed from the law as a reference for rent setting and there was no provision for it in the lease, it did not apply. The tenant nevertheless paid the rent for the renewed lease, which was based on variations in the ICC, but contested this amount in writing. The judge ruled that the payment of these sums did not constitute consent by the tenant to be subject to rent payments based on the construction cost index (CA Paris Division 5, Chamber 3, January 15, 2020, No. 18/01935).
For what reasons can you have your rent revised?
If there is no clause in the lease, a legal reason is required to change the rent.
The rent for renewed or revised leases must correspond to the market rental value.
In the absence of an agreement, this value is determined based on:
1. The characteristics of the premises;
2. The intended use of the premises;
3. The respective obligations of the parties;
4. Local market conditions;
5. Prices commonly charged in the neighborhood (Article L-145-33 of the French Commercial Law Code).
Thus, the creation of additional retail space following renovations by the tenant can justify a rent increase.
Similarly, a change in the intended use of the premises.
In a case where the lease stipulated a takeaway, snack bar, tobacconist, newsagent, lottery, and gaming business, the tenants added a new sit-down restaurant service after carrying out renovations during the expired lease. The Court of Cassation ruled that the tenant’s addition of the sit-down restaurant service altered the permitted use of the premises and that local market conditions had, due to the town’s population growth, undergone a significantly positive change. The rent increase requested by the landlord was therefore upheld (Cass, civ 3rd, April 13, 2022 / No. 19-24.068).
A significant modification of the parties’ respective commitments may also be taken into account, for example, an agreement between them during the lease term to raise the rent to the market rental value upon subsequent renewal. The Court of Cassation has consistently ruled that if, by an addendum dated March 7, 2014, following a rent review procedure initiated by the landlord on January 17, 2012, the parties agree on an increased rent from January 1, 2012, to March 31, 2013 (€23,000 excluding taxes and charges), the landlord can subsequently use this to obtain the removal of the rent cap to the market rental value (€24,000) upon renewal starting April 1, 2013 (Court of Cassation, 3rd Civil Chamber, February 15, 2018, No. 17-11.867).
If the tenant has to take charge of the property tax, this clause constitutes a factor in reducing the rental value (article R145-8 of the commercial code; Cass. 3e civ., 23 May 2019, no 18-14.917).
Finally, changes in local business conditions can also be taken into account.
The current trend, especially following the health crisis, is a decline in local business conditions.
If local business conditions deteriorate, the tenant is entitled to request a rent reduction: for example, a substantial decrease in the number of residents or offices around the premises, the closure of a well-known business, an administrative service, a large company nearby where many of the business’s employees were customers, or the elimination of public transport lines.
This decline must lead to a decrease in foot traffic to the establishment and have a direct impact on the tenant’s business for them to be able to lower their rent.
Therefore, it is possible to request a rent reduction. There is no legal limit on the amount of rent that can be reduced.
In a case where the lease only included a clause for rent review every three years based on the variation of the INSEE construction cost index, the tenant requested a lease renewal at its expiry date, asking for a rent reduction which he considered excessive. The Court reiterated that the expert appraisal carried out by the tenant on his own initiative, which concluded that the rent should be significantly lower, had no legal value and that the rent should be maintained, pending the outcome of the court-ordered expert appraisal, at the amount applicable on the date of the tenant’s renewal request, and not on the date of the notice to quit given by the landlord (CA Aix-en-Provence – Division 01, Chamber 07, September 30, 2021 / No. 19/06743).
Conversely, rent increases resulting from improvements in local market conditions are capped and cannot exceed 10% of the rent paid in the previous year.
However, this smoothing mechanism provided for by the Pinel Law is not mandatory (French Court of Cassation, 3rd Civil Chamber, Opinion No. 15004 of March 9, 2018, No. 17-70.040). It is not within the judge’s purview to set a schedule for rent payments due during the period in which this rent increase is spread out.
To determine the rent for a renewed lease, the judge must consider the rent initially agreed upon by the parties when the original lease was signed, and not the rent revised three years prior by court order (during the term of the previous lease). This rent, revised during the previous lease and set by the judge, does not justify removing the rent cap to the market rental value (Cass. 3rd Civ., April 11, 2019, No. 18-14,252).
Prices commonly charged in the neighborhood may also be taken into account.
However, a commercial tenant cannot obtain a rent reduction from the judge solely because neighboring businesses have renegotiated their rents downwards with the same landlord (Cass. 3rd Civ., October 25, 2018, No. 17-22129). Another factor, such as those mentioned above in Article L-145-33 of the French Commercial Code, will be required to justify the tenant’s claim.
If there is a clause in the lease, when and for what reason can the rent for your business be revised?
A clause initially included in the lease can also increase or decrease the rent annually or on another agreed date.
This mainly concerns increases or decreases in the ILC index, the application of indexation clauses, or revenue-based clauses in the event of a decline in the business’s activity.
Note: a lease indexation clause cannot prohibit a downward revision of the rent if the index becomes negative (Casss, 3rd Civil Chamber, January 14, 2016, No. 14-24.681, cited by the CA Paris, February 7, 2018, No. 16-07.034); otherwise, it would be void (French Court of Cassation, September 10, 2020, and March 11, 2021). This case law is consistent.
In this case, a clause in a lease stipulated that rent adjustments at the beginning of each year would be made only upwards, proportionally to the variation of an index. This clause, stipulated as essential and determining to the agreement, “excludes reciprocity of the variation” and is invalid because it “distorts the normal operation of indexation” (CA Dijon, 2nd Civil Chamber, September 12, 2019, No. 17/01476).
This case law was confirmed even more recently by the Court of Cassation (Cass. January 12, 2022, 3rd Civil Chamber, appeal No. 21-11.169): a commercial lease contains an annual rent indexation clause stipulating that it will only apply if the commercial rent index is positive but not negative. This clause was established by the contract as an essential and determining condition of the landlord’s consent, meaning that its non-application could entitle the landlord to terminate the lease. The tenant is demanding reimbursement of the indexation payments made, amounting to €315,530 (with interest at the applicable legal rate retroactively), because he considers this clause null and void. The landlord refuses. This clause was annulled by the Court, because neutralizing the years of decline in the reference index mathematically alters the time frame for reaching the 25% variation threshold, which determines the tenant’s right to have their rent revised (Cass. 12 January 2022, 3rd Civ., appeal no. 21-11.169).
Furthermore, a clause that stipulates a period of index variation exceeding the time between each revision is null and void.
To avoid rent reduction requests, some landlords require a key money payment when the tenant moves in. Key money represents “the cost price of an intangible fixed asset,” that is, the tenant’s right to renew the lease.
For these landlords, this is essentially an advance payment of rent from the tenant. In this case, the tenant can deduct it from their profits.
In practice, commercial tenants should be vigilant regarding landlords’ attempts to include explicit (lease clauses) or disguised (setting a higher rent at the start of the lease, including a 10% annual increase over nine years) exceptions to circumvent the 10% maximum annual increase rule.
Negotiating a rent reduction or having a revenue-based clause in the lease agreement may allow for the possibility of a rent reduction. Given the economic activity, this clause could allow for a significant rent reduction tailored to the growth of your business.
Commercial tenants should be vigilant and seek expert advice before signing a commercial lease, as well as before any agreement on rent during the lease term, to avoid any unpleasant surprises.
Hotels: A Specificity Due to the Single Use of Premises
The hotel industry has a specific characteristic due to the designated use of hotel premises.
Indeed, hotels are generally considered single-use. In other words, the premises cannot be used for any purpose other than as a hotel without significant and costly renovations to the building.
Upon renewal of a hotel lease, the rent will be calculated based on the hotel’s projected revenue.
This calculation will be performed either using the hotel method (as used by the courts), which combines the hotel’s maximum and actual occupancy rates with gross and net rental values, or using the real estate method, which combines revenue with the tenant’s investment cost.
The Paris Court of Appeal ruling, case no. 20/05346, dated November 23, 2022, clarifies the hotel method to be applied over time.
The landlord served notice on the tenant with an offer to renew the lease at a rent equivalent to the current rent, and summoned the tenant before the court to determine the rent for the renewed lease. The parties disagreed on the rent assessment method to be applied. The landlord argued for the updated hotel method, which he considered more appropriate given evolving practices in the hotel industry, while the tenant claimed the application of the standard hotel method in effect on January 1, 2013, the date of the lease renewal in question, since the updated method was only published in October 2016. The Court ruled in favor of the tenant.
The rent for hotel leases can therefore be subject to significant increases because it is not indexed to the ILC (unless otherwise stipulated in the lease, which is very rare in practice). Tenants with multi-purpose premises (such as a hotel-restaurant) will therefore benefit from demonstrating the multi-purpose nature of their space in order to limit rent increases on the “restaurant” portion and even request a rent reduction.
The multi-purpose nature of the premises will be particularly evident when both activities are substantial and independent. For example, a hotel and a restaurant with separate entrances in the building: the restaurant has its own clientele, and the premises can easily be used for a bar or shop (CA Aix-en-Provence, April 25, 2019, No. 15/18290).
Following the health crisis, hotel occupancy rates, and therefore revenue, have been, and often still are, significantly down. Since revenue growth is a fundamental criterion in the hotel industry, these hotels will be able to request and obtain rent reductions in the future to alleviate their expenses.
What are the risks if the tenant fails to request a lease renewal on time or adds a new activity to the one stipulated in the lease?
The tenant must, in principle, request a lease renewal from the landlord six months before its expiry date, which is eight and a half years after the lease was signed.
However, they can do so later. Business owners who risk a rent increase should avoid letting their lease reach 12 years without renewal, as in such a case, the rent would be uncapped at the market rental value. If this value has increased significantly, then the rent will increase.
Similarly, for leases signed for more than nine years, tacitly renewed, and for leases of more than 12 years, or for leases where the tenant has changed the permitted use with the landlord’s authorization, the law also provides for the possibility of uncapping the rent amount, both upwards and downwards.
Charges
Unlike the previous situation, a property condition report detailing the allocation of charges between the tenant and the landlord is now mandatory. This provision ensures a fairer distribution of expenses.
Can a business owner renegotiate their rent at any time?
There are several legal and contractual options for reducing your rent.
A business owner can first renegotiate the rent with the landlord at any time, and if this fails, seek a reduction through legal action.
Business owners need to reduce their rental charges to maintain or sustain their business, but they should also keep in mind that they will be more likely to sell their business with a renegotiated or reduced rent.
Therefore, it is advisable to consult a specialized lawyer to renegotiate both the rent and the charges, either independently of a sale or before a potential sale.