In times of economic decline or uncertainty, many businesses look to divest themselves of surplus property to reduce rental commitment. With Brexit looming and the state of the high street the focus of some concern, Walker Morris’ specialist Real Estate Litigation Partner Martin McKeague reviews recent case law and provides practical advice for businesses considering their lease break options.
Context and key case law
Whilst the cost savings involved in a rationalisation exercise can be significant, so too can the risks. 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.
Top tips and traps for the unwary
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 conditions which must be complied with; and 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).
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’). 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.
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!
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.
What? Conditional Break Options
Conditional break options should 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.
The most common condition is the payment of all rent due as at the Break Date. 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? If sums need to have been demanded, can the tenant guarantee that the landlord will have demanded sums in time for the tenant to make payment?
Another common condition is for a tenant to comply with its repairing obligations. 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.
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.
Faced with a conditional break and uncertainty as to exactly how to ensure compliance, the tenant in the recent case of Goldman Sachs v Procession House [2] opted for another option – it proactively applied to the court ahead of the break date, seeking a declaration as to exactly what was required.
The lease contained an option for the tenant to break five years prior to expiry of the contract term. At a rent of over £4 million per annum, service of an effective break notice would save the tenant over £20 million (and, conversely, service of an ineffective break would effectively cost it that amount). It was common ground between the parties that the break clause was conditional upon there being no arrears of the rent and the tenant delivering up vacant possession, but there was a dispute as to whether or not the successful exercise of the break was also conditional upon the tenant’s compliance with certain yielding-up/reinstatement obligations. The relevant provisions were:
Clause 23 Break Clause – The lease was terminable by the tenant “…subject to the tenant being able to yield up the premises with vacant possession as provided in clause 23.2”
Clause 23.2 – “On the expiration of [the break notice] the term shall cease and determine (and the tenant shall yield up the premises in accordance with clause 11 and with full vacant possession)…”
Clause 11 Yielding Up – “Unless not required by the landlord, the tenant shall at the end of the term remove any alterations or additions made to the premises (and make good any damage caused by that removal to the reasonable satisfaction of the landlord) and shall reinstate the premises to their original layout…”
In a tenant-friendly decision, taking into account both considerations of commercial common sense and the particular factual matrix surrounding alteration works carried out to the premises by the tenant, the court concluded that the conditionality of the break did not apply to the yielding-up provisions.
The court held that, being so open to interpretation (and therefore leaving the tenant effectively unable to ensure compliance), the requirements of clause 11 were not compatible with being a pre-condition to a break. The court considered that if the parties had intended compliance with clause 11 to be a pre-condition, then that should have been more clearly stated in the drafting.
WM Comment
There is a considerable amount of risk and time involved in serving a break notice and complying with the relevant conditions. The best advice for any retail tenant considering its options is to contact a specialist Real Estate Litigator, time, who will be able to advise on the break and overall exit strategy (including, where appropriate, any dilapidations/reinstatement issues).
For any further information or advice, please do not hesitate to contact Martin McKeague.
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[1] Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749
[2] Goldman Sachs International v Procession House Trustee Ltd (1) and Procession House Trustee 2 Ltd (2) (2018, unreported)
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