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Break clauses in commercial leases and practical implications of lockdown

office_building Print publication

30/03/2020

In times of economic decline or uncertainty, many businesses look to divest themselves of surplus property to reduce rental commitment.   Break clauses are common in most fixed term commercial leases and can allow a landlord and/or a tenant to bring the lease to an end early on one or more specified dates.  In light of the current situation, this note aims to highlight some of the break clause-related issues of which tenants should be aware, and to provide practical advice for those considering their lease break options.

Commercial context

The enforced closure of a large proportion of commercial premises in the UK and the wider economic impact of the Coronavirus crisis will leave many tenants faced with the prospect of having to pay rent and other lease sums whilst being unable to generate income from their business.  Where a lease contains an immediately available or upcoming break option, this may be an attractive and convenient escape-route for a tenant in this predicament. Alternatively, in some cases a break notice may have been exercised relatively recently, before lockdown measures were imposed. In both of these scenarios tenants must be acutely aware of, and must comply with, any requisite formalities and conditions, so as to ensure that the break option is validly exercised.

Traps for the unwary

Once the decision has been made to bring a commercial lease to an end, the failure to serve a valid break notice can have drastic consequences.  The business may lose the opportunity to break the lease and may therefore remain liable and tied into the property with long-term, unwanted commitments.

In the leading case of Mannai Investment v Eagle Star [1] in 1997, Lord Hoffmann famously said: “if the [termination] clause had said that the notice had to be on blue paper, it would have been no good serving a notice on pink paper, however clear it might have been that the tenant wanted to terminate.”  In doing so he vividly articulated that strict compliance, with both contractual break conditions and any particular service provisions, is required for lease breaks to be effective.

As such, very careful consideration must always be given to the exercise of any break. The starting point when serving a break notice must always be to examine the lease and the contractual provisions which set out the option to determine; any particular requirements for service (including when notice must be given, how notice must be served and on whom, and by whom, it must be served); and any conditions which must be complied with.

  1. When?

The question of when a break notice can be served is very important, especially if the option is a one-off or ‘once and for all’ break (as opposed to a ‘rolling break’). Where break clauses specify time limits, time will be of the essence. This means that where a tenant is unsuccessful in exercising a once and for all break clause, it may not get any other chance to break.

There are then three dates to ascertain: the break date; the date by which notice must be served (that is, when the notice must be received by the other party); and, working back, the date by which the notice must actually be issued.  If any of these are calculated incorrectly then there is a real risk that the break notice will not be validly drafted or served, and the lease will continue.

  1. How?

It is essential to check whether the break clause contains a specific methodology for serving notice or whether the lease contains general ‘service of notices’ provisions elsewhere. Service must be effected in accordance with any contractually specified provision. For example, the lease may specify that service must be by fax or e-mail at a particular address; by first class or registered post; on an agent as well as, or instead of, on the party; or even that notice must be written on pink paper [2]!

  1. Who?

As indicated earlier, it must be ascertained exactly who must give the notice and on whom the notice must be served. However determining the correct party/ies is often more difficult than first imagined. In most cases the landlord and tenant are no longer the original contracting parties; the land or tenancy may be unregistered; the landlord/tenant may not be based in the UK; and/or the lease may specify that the notice must be served on an agent.

  1. What? Conditional Break Options

Some break options will have a number of conditions attached and must be approached with real caution.  If the lease requires absolute compliance with one or more conditions, then failure to do so, no matter how trivial, will render the break ineffective. For example, if a break option was conditional on making payment of all lease sums and just a penny remained outstanding at the break date or other prescribed time, that penny would render the whole break invalid.

If conditions in a break option are not absolute, they are often drafted to say that the tenant must materially, substantially or reasonably comply with certain conditions. This is to try and protect the tenant from rendering the break invalid due to minor and inconsequential breaches. The problem here is that each of these terms can have a slightly different meaning and no guarantees can be given to provide absolute certainty of compliance. In these circumstances a tenant may be well advised to undertake the fullest possible compliance. Apart from the risk of a break being ineffective, a party will always face the risk of a damages claim for breach of covenant either during or after the end of a lease in any event. The fullest possible compliance has the dual-effect of mitigating that risk.

The most common condition is the payment of all rent due. On the face of it, that seems straightforward and fair enough. However, is rent is defined within the lease and does it include service charge and/or insurance rent. If it does, can these be properly calculated or ascertained? Does rent (and potentially other sums) simply need to have fallen due under the lease, or do sums have to have been demanded?

Other common conditions include for a tenant to comply with its repairing obligations [3]; for the tenant to return the premises with vacant possession; and/or for there to be no material breach of the tenant’s covenants and obligations under the lease outstanding as at the break date.

Owing to the lockdown restrictions currently in place, many tenants will find that it is practically impossible to comply with certain break conditions, such as the removal of property and belongings where removals companies are not allowed to work or where contractors are unable to undertake a strip out or any requisite repairs.

Practical steps

In the current climate, it is perhaps even more important than ever for tenants to carefully consider their ability to exercise any break options and, crucially, their ability to comply with break conditions.

Where the time limits of a break option allow, it may be better for tenants to wait for current restrictions to be relaxed.

Where this is not possible, it will be crucial for tenants to plan, prior to service of the break notice, exactly how they will comply with any break conditions.

Where compliance will simply not be possible, tenants may have no option other than to negotiate with landlords to seek to agree an approach.  Any such negotiations should be handled with the assistance of expert advice.  It will be essential, in these circumstances, for tenants to tread a fine line between not openly admitting any failure to comply with covenants, and between agreeing that compliance with break conditions can be waived.

Alternatively, where a break clause remains unexercised, tenants may want to investigate any rent free period that may be tied to a delay of any tenant break, and potentially negotiating an extension. This would not trigger any SDLT liability for tenants as the term of the lease would not be extended.

Should you require any specific advice on the terms of any break clause, any further guidance on the successful execution of a break notice and/or any expert assistance with landlord and tenant negotiations in these unprecedented times, please do not hesitate to contact Martin Mckeague, David Manda or Lewis Couth in the Real Estate Litigation team.

 

[1] Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749

[2] See our recent briefing on serving legal notices amid the Coronavirus crisis

[3] albeit it is important to note that the landlord is under no obligation to confirm exactly what work it expects to be carried out, nor to provide any certainty prior to the break date that any works carried out are satisfactory to discharge the tenant’s obligations

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