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Do Not Block Exit

Joanne Wright, a solicitor, says tenants should beware of the traps that can invalidate a break clause.

The Negotiator

EXIT imageThere are significant implications in value to both the landlord and tenant where a party has a right to end the lease at an early date through the operation of a break clause. Landlords may want the ability to end so they can redevelop and tenants may want the ability to end the lease to manage business finances, relocate or protect against future failure. In practice, what ought to be straightforward is often confused by ambiguous drafting, unclear clauses and other traps which could mean that the break clause is not validly operated. In recent years landlords have, more than ever, wanted to avoid premises being handed back to them. For this reason they have been more keen to seek legal advice when a tenant has served notice to end a lease to see if there is any way they can safeguard their asset by maintaining the break clause has not been validly exercised.

RECENT CASES

Recent cases highlight the need for both parties to consider and take legal advice early at every stage. From agreeing heads of terms through to lease negotiation as well as on the service of the break notice and the satisfaction of any pre-conditions to validly operate the break clause and end the lease. The financial consequences of getting it wrong can be very high. As the cases show, the Courts adopt a strict interpretation of the lease which has recently led to what many would deem to be “harsh and unjust decisions”.

The Courts adopt a strict interpretation of the lease which has led to what many would deem harsh and unjust decisions.’

Joanne Wright solicitor image

Joanne Wright

In Avocet Industrial Estate LLP v Merol and another (2011) EWHC 3422 (Ch) the High Court considered whether the tenant had validly exercised its break. The lease had a break clause which was subject to several conditions including one requiring the tenant to pay a sum equal to 6 months rent on or before the break date and also a clause which stated that “the break notice shall be of no effect if at the break date any payment under the lease due to have been paid on or before that date has not been paid”.

The tenant served a break notice in the appropriate form on the landlord which the landlord did not give any substantive response to; between the date of service and the date the Lease was due to end, the tenant paid its rent or insurance rent late on three occasions. The landlord did not issue any demand for default interest.

On the break date the tenant sent the landlord a cheque for six months’ rent (one of the conditions of the lease) with the keys and written confirmation that they had vacated the premises; reiterating the tenant was not aware of any outstanding sums due.

The landlord issued proceedings against the tenant for non-compliance with the terms of the break clause.

The Court strictly construed the terms of the lease in connection with payment of default interest. Default interest was due from the date on which payment should have been made until the date that payment was actually made. There was nothing in the wording of the clause to suggest that there was a precondition that the landlord must first serve on the tenant a demand for such default interest. As the annual rent and other sums due under the lease were not paid by the due date, the tenant owed the landlord default interest which was calculated in accordance with the lease terms.

It is important to note that the landlord had not made any positive statement, express or implied about its entitlement to default interest in relation to late payments. In some circumstances, silence or inaction can constitute a representation that you are accepting the position. If another party relies on that representation to their detriment you can be prevented from taking any alternative action (known as estoppel). In this case: the tenant believed that he had paid all sums due and the landlord knew of the belief because the tenant had told the landlord.

The tenant had not done anything to demonstrate that it was giving up possession as it didn’t return the keys, but only offered to do so.’

If the landlord had told the tenant that the tenant owed default interest it is more than likely that the tenant would have paid it to avoid an argument about its ability to end the lease. However on the evidence, the landlord did not know that the tenant’s belief was wrong before the end of the break date and did not take advantage of the tenant’s mistake. The landlord had not considered payments of default interest by the end of the break date and only took the point as a result of legal advice received after the break date. The tenant could not therefore claim estoppel.

The Court admitted that the result in this case was a harsh one as the amount of default interest owed was very small and recognised that the conditions attached to the break clause represented “something of a trap for a tenant”.

Wording relating to the payment of default interest is commonly seen in leases and this decision will have implications to many landlords and tenants. Provided that they have not misled the tenant in any way, landlords may be able to rely on such a provision to defeat the tenant exercising its break clause.

OTHER FACTORS

Another key factor which a tenant should bear in mind is whether the requirement for vacant possession has been met. In NYK logistics (UK) Limited v Ibrend Estates BV (2011) EWCA Civ 683, a tenant took a lease of a warehouse which contained break rights at the end of 12 and 18 months of the term. The break clause was subject to the tenant complying with several pre-conditions, one of which was to give vacant possession to the landlord on the break date.

Notice was served in accordance with the lease and the landlord drew up a schedule of dilapidations in response. A week before the break date, the landlord and tenant finally agreed the works which the tenant needed to undertake to the property. The tenant realised that the works it was undertaking (which were not a pre-condition to the break) would not be completed by the break date.

legal document imageThe tenant moved out of the property and made a proposal to the landlord that it would carry out the outstanding works in the week following the break date but offered to hand back the keys and it would continue to pay for security guards at the property. The landlord did no respond to the tenant’s suggestion.

On the break date, the tenant left messages with the landlord asking where the key should be delivered but no response was forthcoming. The tenant had given up occupation of the premises and it was only maintaining a presence for security purposes (effectively for the landlord’s benefit) and to carry out work which was agreed with the landlord.

Shortly afterwards, the tenant received a letter from the landlord’s lawyers stating that the lease had not been effectively ended because the tenant had not given vacant possession on the break date.

The Court of Appeal held that the failure to hand over the keys, the retention of control of the premises via the security personnel and the presence of workmen beyond the break date were all inconsistent with providing vacant possession. Furthermore, the tenant had not done anything to demonstrate that it was actually giving up possession as it did not return the keys but only offered to do so. The break right was lost.

The tenant should have returned the keys and remove all personnel and chattels from the property. The following day, it should have agreed with the landlord to have permission to return to the property to carry out the works as licensee.

The failure to comply with preconditions in a break clause can lead to significant ongoing liabilities. The cases also raise the question whether, as a tenant, it is always appropriate to agree to vacant possession and payment of all sums under the lease as an obligation in a break clause.

The Code for Leasing Business Premises in England and Wales 2007 (“the Code”) recommends that the only preconditions to a tenant exercising a break clause should be:

  • The main rent is paid up to date;
  • The tenant is to give up occupation; and
  • no sub-leases remain in force.

Disputes about the state of the premises, what has been left behind and/or removed should be settled at a later date, as is the case on normal lease expiry. These decisions have influenced the approach in practice to agreeing heads of terms and lease negotiations.

What is clear is that there are questions being raised in the real estate industry as to whether it is now time for a review of the Code to require higher standards and better business relations between landlord and tenant which is surely required, particularly in the current market to avoid such scenarios being replicated?

Joanne Wright is a Senior Associate at Thomson Snell & Passmore.

April 18, 2012

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