Tenants’ Break Clauses : Conditionality 0 Comments

Tenants’ Break Clauses : Conditionality

Proposition: (1)  The right of a tenant to break a lease of business premises before the end of the contractual term should not be subject to any precondition other than that the tenant is up to date with the principal rent, gives up occupation and leaves behind no continuing subleases.

(2)  Where a tenant’s right to break is conditional upon due payment of the rent, and the rent is payable in advance, and a break date falls between two rent payment dates, the tenant must pay the whole of the sum due on the rent payment date preceding the break date, even though some of that rent will be attributable to a period after the ending of the tenancy under the break clause.

(3)  However, it now appears (subject to any successful appeal by the landlord in the case of Marks and Spencer Plc v BNP Paribas Securities Services Trust Company Limited [2013 EWHC 1279(Ch)]) that a tenant in the situation postulated in (2) above will be entitled to a refund from the landlord in respect of the rent attributable to any period after the break date.

The first proposition above reflects the recommendation in The Code of Practice for Commercial Leases in England and Wales 2007.  I quote in full (Occupier’s Guide paragraph 5):-

The Code for Leasing Business Premises in England and Wales 2007A right to break should allow you to walk away from the lease at a given time after informing the Landlord in writing.  This should be conditional only upon having paid the rent due under the lease and giving up occupation of the property, leaving behind no continuing sub-leases.  You may have other liabilities to fulfil, but these should not be used to invalidate the right to break.”.

The advice given by the Code reflects significant changes in the market over a number of years.  In the days (long gone) of the unbreakable 25 year “institutional lease” with 5 yearly “upwards only” rent review causes, a landlord would resist the inclusion in a lease of a tenant’s break clause due to the adverse effect the right to break has on the security of the landlord’s income stream and, consequently, on the value of his reversionary interest for the purposes of security or sale.  In recent years, however, due to changes in market conditions, leases of some kinds of business premises (not all – for example, hotels and industrial premises, where the tenant will be spending a great deal of money on fitting out and will not mind a long term) have tended to become a lot shorter and, for example, a typical office lease these days is likely to be for a maximum of 15 years with breaks for the tenant at 5 years and 10 years (in fact 10 years with a break at 5 is probably the current norm).

In the past, where landlords have reluctantly accepted tenant’s break clauses, they have often successfully imposed varying degrees of conditionality.  Up to date payment of rent was standard, but in addition landlords sought to impose (often successfully) conditions requiring that the tenant has at the date of service of the notice, or at the break date, performed and observed, or reasonably performed and observed, all of the tenant’s obligations under the lease.  These conditions were extremely dangerous to tenants and although they are now rare (in particular following the publication of the Code) there are still many leases in existence which contain conditional break clauses and it is worth dealing briefly with the consequences of such clauses for the tenant.
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An absolute condition that a tenant must have performed all of its obligations under the lease is extremely onerous, and puts the tenant in a virtually impossible position; unless specific provision is made in the lease the landlord is under no obligation before the break date to confirm its agreement that there has been full compliance; as a result the tenant will not (if the landlord remains silent) know on the break date whether he has succeeded in determining the lease or not.  Such an absolute condition will prevent the tenant from exercising the break clause if there is at the relevant time (which could the date of service of the notice or the break date) a subsisting breach of covenant or condition, no matter how trivial the breach; Friar v Grey [1850] 5 Ex 584.

In Bairstow Eves (Securities) Limited v Ripley [1992] 2 2 EGLR 47, the lease required the property to be painted in the last year.  The property had in fact been painted just before the beginning of the last year, but the court held that the condition requiring compliance with covenants had not been satisfied.  This was despite the fact that there was no practical difference between what had been done, and ought to have been done, and the additional fact that there would only have been nominal damages for breach of covenant.  There are many other reported examples to which reference could be made but the general principle is clear.

A compromise often adopted was to modify the pre-condition so that it required “substantial compliance” or “reasonable performance” with the tenant’s covenants, or a condition requiring the tenant not to be “materially in breach of covenant”.  This kind of compromise does not do much improve the position of the tenant who (unless the landlord decides to be cooperative rather than simply remain silent) will still not know at the break date whether he has successfully determined the tenancy or not.  “Substantiality”, “reasonability” and “materiality” are subjective terms and carry a great deal of potential for uncertainty, dispute and litigation.  Again, there is a number of reported cases: I will refer to three.

In Commercial Union Life Assurance Company Limited v Label Ink Limited [2001] L&TR 29 the break clause was exercisable if there was no ‘material’ breach.  There was an issue regarding the rent, but the landlord also pleaded alleged breaches of the repairing covenant which were held not to be material, because the cost of remedying them was not great (£12,000), and the tenant had genuinely sought to comply with the covenant.

In Fitzroy House Epworth Limited v The Financial Times Limited [2006] EWCA Civ 239 the tenant had materially complied with its repairing obligation where he had spent almost £1m on repairs.  However, an additional £20,000 of work was required and again this was held to be “trivial”.  The Court of Appeal decided that materiality had to be assessed by reference to the landlord’s ability to re-let or sell the property without delay or additional expenditure and it could not be assumed that the parties had intended the word ‘material’ to permit only trivial or trifling breaches.  The Court found that on an objective test the tenant had materially complied with its obligations and that, in adopting the principle of fairness and reasonableness in Commercial Union Life Assurance, the High Court had applied the wrong test and taken into account irrelevant considerations such as the conduct and motives of the parties.  The Court ruled that the words ‘substantial’ and ‘material’ were interchangeable, but if the word ‘reasonable’ was used a different test would apply.  Since landlords do not need to act ‘reasonably’ where the requirement is of ‘material’ compliance, it has been suggested that a landlord would be ill-advised to cooperate with his tenant and should leave the tenant to take advice from his surveyor as to any possible breaches of covenants and then ensure that this advice is followed (but, as pointed out above, there is still no guarantee and the tenant will be left with uncertainty).

In Reed Personnel Services Plc v American Express Limited [1997] 1 EGLR 229, the break clauses was condition on “reasonable” performance.  There was a cost to rectify the tenant’s breaches (essentially decorative) of £21,000 in the context of an annual rent of £120,000.  The Court held that any precondition, trivial or otherwise, must be complied with.  Reasonable steps should have been taken by the tenant, although it was not necessary for the tenant to have performed its obligations to the letter; one coat of paint might have been enough to show a reasonable degree of compliance with an obligation to provide “two coats”.  Again the Court referred to the possibility that the tenant taking advice from a surveyor as to what work needs to be done by him but again there is no guarantee.

The second proposition above can again be illustrated by recent caselaw.  In PCE Investors Limited v Cancer Research UK [2012] All ER (D) 111 (which concerned an underlease) the rent reserved by the underlease was £190,000 p.a. payable by equal quarterly payments in advance on the usual quarter days in every year.  The underlease contained a break option clause providing that the claimant might terminate the underlease by (inter alia) paying all rents reserved and demanded up to the termination date.  On 25th September 2009, the claimant served notice to determine the underlease on 11th October 2010 (break date).  The landlord demanded the full quarter’s rent due on the 29th September 2009 but the claimant chose to make a payment of only the rent for the period between 29th September 2010 and 12th October 2010.  The landlord remained silent and the claimant’s application for a declaration that the underlease had been effectively determined was dismissed.  In dismissing the claimant’s application the Court said:-

It is an established principle that the court is required to determine what the parties meant by the language used and that involved ascertaining what a reasonable person would have understood the parties to have meant.  The Court had to have regard to all relevant surrounding circumstances.  If there were two possible constructions, the court was entitled to prefer the construction which was consistent with business commonsense and to reject the other.

In the circumstances, a full quarter’s rent had fallen due on the September quarter date.  That had been payable in advance and on that day it could not have been certain that the lease would terminate on the termination date.  There had been a commercial and sensible certainty in requiring all obligations to operate until the very date of determination but not being retrospectively changed if an early termination had occurred.  The claimant had failed to comply with the obligations in respect of payment of all rent due up to the date of the termination date and its notice had been accordingly invalid.”

TBound manhe next question which arises is whether, if the tenant does pay a full quarter which relates in part to a period after the break date, the tenant is entitled to claim the post-break portion back from the landlord.  Until the Marks and Spencer case, the answer appears to have been a categorical “no”.

The principal authority is Capital & City Holdings Limited v Dean Warburg Limited [1989] 1 EGLR 90.  This was a case concerning forfeiture (as were the two previous cases referred to in Morgan J’s judgement in Marks and Spencer).  There was argument as to whether the lease was forfeited on the 8th January 1988 or the 7th March 1988.  The Court of Appeal held that the tenant was liable for the full quarter’s rent due on 25th December irrespective of the precise date of forfeiture.  The tenant (or rather the tenant’s guarantors) pointed to the fact (an argument used in other cases – see below) that the lease reserved a yearly rent using the words “yearly (and proportionately for any part of a year)” and argued that when the lease was forfeited in the middle of the quarter the liability to pay a full quarter’s rent was “reduced”.  Ralph Gibson LJ said:-

The presence of those words [which I have quoted] does not, in my judgement, modify in any way the obligation imposed by the lease on the tenant to pay a full quarter’s rent on December 25th 1987”.

Capital & City Holdings was applied in several cases concerning break clauses.  One example will suffice:  Quirkco Investments Limited v Aspray Transport Limited [2012] L&TR 282.  Again the lease reserved a specified yearly rent “and so in proportion for any period less than a year”, payable by equal quarterly instalments in advance on the usual quarter days.  The lessee operated a break clause in the lease to determine the lease on the 18th December 2010.  The lessee had paid a quarter’s rent for the quarter beginning on the 29th September 2010 and one of the issues which came before the Court was whether the tenant was entitled to recover part of the quarterly instalment for the period 18th to 24th December 2010.  The tenant argued that it was so entitled either pursuant to the expressed terms of the lease or on the grounds of unjust enrichment.  The judge rejected the claim, referring to the fact that the Apportionment Act 1870 did not apply.  He held that the rent due on 29th September 2010 had accrued due on that date before the termination of the lease and the law of unjust enrichment did not circumvent the scheme of rights and obligations contained in the lease. The judge followed the approach Capital & City Holdings and held that that the words quoted did not affect the general rule that the full quarter’s rent was payable in advance on a quarter day: the lease made no provision for pro-rata recovery of any monies attributable to the period after 18th December 2010.

Marks & Spencer, Marble ArchIn the Marks and Spencer case, the facts were relatively complicated but the judge dealt separately with the point under consideration here.  In order to allow recovery by the tenant, there would have to be implied into the lease a term entitling the tenant to recover from the landlord at some point the appropriate part of the quarter’s rent paid in advance.  The judge referred at length to decision on the implication of terms of The Privy Council in A.G. of Belize v Belize Telecom Limited [2009] 1 WLR 1988.  Space does not permit a full extract from the Belize case but the key paragraphs of Lord Hoffman’s speech were in these terms:-

The question of implication arises when the instrument does not expressly provide for what is to happen when some event occurs.  The most usual inference in such a case is that nothing is to happen.  If the parties had intended something to happen, the instrument would have said so.  Otherwise, the express provisions of the instrument are to continue to operate undisturbed.  If the event has caused loss to one or other of the parties, the loss lies where it falls”. 

The defendant landlords adopted this approach, submitting that the lease did not contain any express words conferring on the tenant a right to recover the relevant part of the rent.  The claimant however referred to the immediately following paragraph of Lord Hoffman’s speech:-

In some cases, however, the reasonable addressee would understand the instrument to mean something else.  He would consider that the only meaning consistent with the other provisions of the instrument, read against the relevant background, is that something is to happen.  The event in question is to affect the rights of the parties.  The instrument may not have expressly said so, but this is what it must mean.  In such a case, it is said that the court implies a term as to what will happen if the event in question occurs.  But the implication of the term is not an addition to the instrument.  It only spells out what the instrument means”.

The judge (in Marks and Spencer) preferred the claimant’s approach:-

My conclusion is that there is to be implied into the lease a term requiring the lessor to repay to the lessee, on and after 24th January 2012, an apportioned part of the quarter’s rent paid on 25th December 2011 in relation to the period after 24th January 2012”.

It remains to be seen whether the Court of Appeal (and it is believed there is an appeal pending) will come to a different conclusion but at the present time the propositions at the beginning of this post are correct.

One other point needs to be referred to; a condition that “rent” has been paid up to date can be dangerous for tenants as most leases reserve other sums as rent e.g. insurance charges, service charges, contributions to common parts etc.

The lessons for practitioners are I think as follows:-

Lease

(1)  a tenant should under no circumstances accept any degree of conditionality on the exercise of a break clause which does not comply with the Leasehold Code;

(2)  in accepting a condition that rent should be paid up to date, a tenant should ensure that the lease is so drafted that the condition applies only to the principal rent and not to secondary rents; and

(3)  notwithstanding the decision in Marks and Spencer it is better to rely on express terms than implications, and a tenant should argue for the inclusion in a lease (in appropriate circumstances i.e. where the break date falls between advance rent payment dates) of either:-

(a)  a specific provision entitling the tenant on the quarter day preceding the break date to pay only the appropriate portion of the rent or

(b)  a specific obligation on the part of the landlord to repay any part of rent paid by the tenant which relates to a period after the break date.

 

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