The Supreme Court of Japan, in three recent decisions (issued on October 21 and 23, 2003), held that a master lessee has the right to claim decreases in rent under master lease contracts in accordance with Article 32 of the Land and House Lease Law ("Article 32").

Article 32 provides that a party to a lease has the right to claim an increase or decrease in rent where the contracted rental amount becomes inappropriate given changes in (i) the tax rate imposed on the land or building, (ii) the value of the land or building as a result of economic fluctuations in the market, or (iii) the comparative market rents of neighboring properties. The issue in the three cases was whether the right to claim an increase or a decrease in rent under Article 32, particularly a decrease in rent, is applicable to master leases. In ruling that Article 32 does apply to master leases, the Supreme Court of Japan resolved a conflict between several lower courts which had taken opposing positions on this issue.

Please note that while these decisions should not effect transactions where the master lease is a pass through - the master lessee would have no basis to claim a decrease since it would never owe more in master lease rent than it receives in sub-lease rent - in situations where a third party master lessee is in place, the new ruling will provide such master lessee a mechanism to claim a reduction in their rent and thus potentially protect their economic benefit (or perhaps minimize their losses) in the master lease structure.

Importantly, these decisions also remind us that Article 32 does provide substantive rights to tenants of all types of properties to claim rent decreases; moreover, the apparently large number of court cases involving such claims (both for master lessees and property level tenants) indicates that this is a legal remedy tenants are becoming increasingly willing to exercise.

The process for claiming a rent reduction is typically divided into the three stages: First, a tenant would make a claim to the landlord. Second, if negotiations with the landlord are not successful, the matter would typically go to a court supervised mediation process. Third, if the mediation fails, then litigation would be the final resort for the parties.

In determining the appropriate amount of a rent reduction (once a threshold determination has been made that a reduction should be made), the courts would consider, among other things, the following eight factors:

1. A decrease in tax or other burden imposed on the building;
2. A decrease in rent for the land on which the building stands;
3. A comparison with the rent of neighboring properties;
4. The insurance premiums on the building;
5. Renovation and maintenance costs on the building;
6. Period of depreciation;
7. Life remaining on the building;
8. Special relation between the lessor and lessee.

A tenant under a standard lease cannot waive its rights to claim a rent reduction; however, a fixed-term lease can be structured so that such a waiver by the tenant is valid and enforceable. Specifically, under a fixed-term lease agreement, a tenant’s waiver of its right to claim a reduction will be enforceable if the following criteria are met: (i) the lease must be for a fixed term with no automatic renewal rights, (ii) the lease must specifically provide that both parties are waiving their rights to claim increases or decreases in rent under Article 32, and (iii) the landlord must explain in a separate writing to the tenant that the lease provides for (i) and (ii) above. Please note that while it is theoretically possible under the law for a tenant to unilaterally waive its right to claim a reduction while the landlord retains its right to claim an increase, such a unilateral provision may be held invalid by a court based upon general principles of fairness under the Japanese civil code.