Does an indexation clause protect against unilateral rent increases by commercial landlords? | In Principle

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Does an indexation clause protect against unilateral rent increases by commercial landlords?

The rent, terms of payment and rent abatement period are all important factors for parties entering into commercial leases. Given the ongoing growth of the real estate market, the negotiated rent may fall well below market value within a couple of years. This is why long fixed-term lease agreements (which can be terminated only in situations specified in the lease agreement or when provided by law) should ensure that the rent amount remains acceptable to both parties for the duration of the lease. An indexation clause is one way to do this.

Unless the parties agree otherwise, the law allows a commercial landlord to unilaterally increase the rent with at least a month’s notice effective at the end of a calendar month (Civil Code Art. 6851).

Court rulings leave no doubt as to the optional nature of Civil Code Art. 6851. Thus, in their agreement, the parties may decide to apply Art. 685 in its entirety, subject to specific modifications, or not at all. In many lease agreements, the parties include provisions directly excluding the applicability of Art. 6851.

However, our experience has shown that during negotiations parties frequently focus on establishing highly intricate provisions and terms for adjusting rents during the lease period (indexation clauses), while making no reference to the applicability of Civil Code Art. 6851.

This raises the question: Does the landlord retain the right to unilaterally increase the rent with a month’s notice if the lease agreement makes no mention of the applicability of Civil Code Art. 6851?

Indexation clause = clear rules for rent increases

When used in lease agreements, indexation clauses regulate the terms and conditions for adjusting the rent during the term of the lease. In most cases, indexation clauses provide for an annual update of the rent with reference to a specified price index. Depending on the currency in which the rent is stated, this is often Eurostat’s HICP (Harmonised Index of Consumer Prices) or the mid-year price index of consumer goods and services published by the president of Statistics Poland in Monitor Polski.

In addition to selecting the price index, the parties usually also establish the date when the rent will start to be updated and whether they allow for negative adjustments if the price index falls. Some contracts also require the landlord to give the tenant notice of the index value used in rent increase calculations by a certain date, with failure to do so voiding the right to a rent increase during the relevant period.

Thus, in principle, indexation clauses provide a clear and precise basis for determining the circumstances and amounts of rent increases. By using such objective criteria, both parties enjoy a much higher degree of predictability in their dealings than provided by the landlord’s ability to unilaterally increase the rent under Civil Code Art. 6851.

While the tenant has the right to challenge the landlord’s unilateral rent increase via a declaratory action (on a theory of abuse of right or violation of social policy, see G. Kozieł, commentary on Art. 6851 in Kodeks cywilny. Komentarz (Civil Code: Commentary), vol. 3, Lex 2014), in many instances tenants treat a unilateral rent increase as a material change to the contract. As a result, the landlord treats the tenant’s refusal to accept the increased rent as refusal to accept a material term of the rental agreement, resulting in termination. (The legal literature and case law offer varying interpretations of the effects of a unilateral rent increase and when the tenant can refuse to accept it. Some authorities hold that a tenant’s refusal to accept a change to a material term of the contract causes the contract to become void as of the end of the termination notice period.) In any case, a unilateral rent increase represents a potential source of conflict between the parties which can result in a loss of rental income for the landlord and a loss of occupancy rights by the tenant.

Thus it is apparent that inclusion of an unambiguous indexation clause in the lease agreement will frequently be beneficial to both parties.

Courts: indexation clause limits other rent increase options

The question whether a landlord can issue a unilateral rent increase despite the presence of an indexation clause in the lease agreement can only be answered in light of relevant court decisions.

For example, in a 21 August 2014 judgment, the Warsaw Court of Appeal (Case I ACa 654/14) held, “Through the addition of an indexation clause to the lease agreement, the landlord indirectly agrees to limit its general right to issue a unilateral rent increase provided for by Art. 6851 of the Civil Code, to the extent specified by the indexation agreement. Otherwise, if the landlord were to retain the full extent of its Art. 6851 rights, the indexation clause would be redundant. We reject the argument that the landlord’s right to a unilateral rent increase provides for the ability to increase the rent beyond the terms provided for in the indexation clause because the sole purpose of the indexation clause is to ensure that the value of the landlord’s rental income is maintained at the level established at the inception of the lease agreement while a unilateral rent increase may be motivated by entirely different reasons. Such an interpretation of Art. 6851 would be contrary to the fundamental principle of the Polish legal system of the enforceability of contracts, which is only limited by institutional provisions allowing modification … or termination of an obligation … in circumstances that are not only exceptional but also extraordinary.”

A 18 May 2016 judgment of the Łódź District Court (Case XIII GC 1079/15) followed the Warsaw Court of Appeal’s holding in Case I ACa 654/14, adding: “It can only be speculated whether such an interpretation would be supported in a situation where the application of the indexation clause would result in a decrease of the rent. For example, the use of a carelessly phrased indexation clause linked to the inflation index published by the president of Statistics Poland may result in a decrease of the rent following a short-term period of deflation. … It has been left to the parties’ professional discretion to decide which market or consumer goods index should determine the rental amount. Most often, the parties decide to use an index related to their particular industry.”

Indirect support for this thesis can be found in the judgment of the Katowice Court of Appeal of 29 May 2013 (Case V ACa 163/13), where the parties agreed that “the established rent will be subject to annual revision based on the increase of the price index for goods and services for the previous calendar year published by the president of Statistics Poland in Monitor Polski, but application of the indexation clause does not deprive the landlord of its rights under Civil Code Art. 6851.” The court held that the defendants had correctly asserted that the agreement provided two potential opportunities for a rent increase: under the indexation clause and under Civil Code Art. 6851.

Either indexation clause or Art. 6851 rent increase (unless the parties agree otherwise)

It appears that an indexation clause represents a mutual concession by both parties. On one hand the landlord effectively gives up its right to a unilateral rent increase; on the other, the tenant agrees to a potential rent increase during the term of the lease agreement. Both sides agree that any rent increase will be based on an objective, external mechanism. This is why an indexation clause should be viewed as a modification of a statutory right, and the clause’s inclusion as expression of the intent to disallow the applicability of Civil Code Art. 6851—unless the parties expressly provide otherwise in their agreement. The key consideration in analysing contracts is the parties’ joint intent and the contract’s purpose, not the literal wording of the agreement (Civil Code Art. 65 §2).

Dr Jakub Baranowski, Real Estate Development practice, Wardyński & Partners