In the current climate, a tenant break option in a lease is likely to be more significant than ever for both landlord and tenant. Landlords will be keen to retain their existing tenants at a time when new tenants are thin on the ground, and avoid potential empty rates liability, while tenants may wish to downsize their business, reduce their expenditure and escape from rents negotiated at the height of the market. In light of three English cases this year, which may indicate that the courts are reinforcing the principle of strict interpretation of these provisions, we highlight some issues which landlords and tenants should consider on the negotiation and exercise of break clauses.
Conditions for the break
A break option in favour of the tenant will often provide that the tenant must pay the rents reserved by the lease, comply with its obligations and deliver vacant possession on the break date in order for the break notice to be effective. Whether negotiating a break clause in a new lease or seeking to exercise an existing break option, some points to be considered include:
- Does the lease provide for rent relating to the period after the break date to be refunded to the tenant? If there is no express provision, the tenant will not be entitled to any refund of rent. Depending on the timing of the rent payment dates and the break date, this may be a significant amount.
- Tenants should seek to limit the sums which need to have been paid to the principal rent only. The definition of "rents" in the lease is likely to include service charge, insurance and other payments due. If all of these have to be settled before the break can be effective, the tenant's break notice may be frustrated by, for example, a disputed service charge payment. If there is any doubt as to what is required, the tenant should give serious consideration to paying any disputed sums to ensure that the break is validly exercised, and pursuing its claim separately once the lease has come to an end.
- On receipt of a break notice, landlords should check whether there are any outstanding arrears or other breaches which would prevent the break notice from being valid. The landlord may wish to refrain from bringing any such matters to the tenant's attention, in the hope that they are not remedied by the break date and the break is therefore ineffective. A tenant should seek confirmation from the landlord as to what is required of it well in advance of the break date, so that any repair issues or other breaches of the lease can be resolved.
- The requirement to give vacant possession is more than simply an obligation to give up occupation of the property. Items left at the property or the presence of third parties such as licensees, sub-tenants or squatters will mean that the vacant possession criterion is not met. Landlords should inspect the property at the break date to ensure that vacant possession has been given. If there is any doubt as to which items are tenant's fixtures and need to be removed, the tenant should seek early advice from the landlord as to what is required, to avoid any argument either that vacant possession has not been given, or that the tenant has unlawfully removed items which belong to the landlord.
- Are the obligations on the tenant pre-conditions for exercise of the break? This is an important distinction, because if not, the tenant will still have liability for these matters, but will not be tied into the lease for the remainder of the term.
Effect of the Lease Code
The Code for Leasing Business Premises in England and Wales 2007 seeks to lower some of these hurdles for tenants, and suggests that the only pre-conditions for exercise of a break option should be that the tenant is up to date with payment of the principal rent, gives up occupation and does not leave behind any continuing subleases. The Code takes the view that disputes as to repair, removal of tenant's fixtures and reinstatement of alterations should be dealt with after the break has been exercised, as if the lease had simply expired. However whatever the Code provides, the reality is that tenants will still have to contend with the stricter requirements of many existing leases.
Personal break clauses
Another condition sometimes seen in break clauses is that the option to terminate the lease is personal to the original tenant. In Norwich Union Life and Pensions v Linpac Mouldings Limited (decided in May 2009, but only recently reported), the court clarified that a tenant's personal break option will be extinguished by an assignment of the lease. It cannot be exercised by the original tenant once the assignment has been completed, even if the lease is an "old tenancy" so that the original tenant remains liable for performance of the tenant covenants after assignment. It can only be exercised for so long as the original tenant remains in possession of the lease. Furthermore, a personal break option will not be revived if the lease is subsequently re-assigned back to the original tenant (unless there is specific express wording to that effect). The judge rejected any continuing right for the original tenant to exercise the break clause once it has assigned the lease in question as inevitably leading to uncertainty for the landlord and any purchaser of its interest.
Defective break notices
Focussing on the technical points of drafting the break notice as well as the substantive issues is crucial. Failing to include the correct identity of the landlord and tenant, details of the lease, and the timing and method of service may result in the notice being defective.
The Mannai case (Mannai Investment Co Limited v Eagle Star Life Assurance Co Limited [1997] UKHL 19) has, over the last decade, provided a lifeline for tenants who have served break notices which were technically defective. Mannai states that a break notice will not necessarily be invalid if the defects are minor and the reasonable recipient of the notice would have understood it. However, a High Court decision in June this year highlights some of the limitations of the Mannai principle, and illustrates that it is no substitute for careful drafting of the notice.
In The Prudential Assurance Company Limited v Exel UK Limited & Another, premises were let to two companies jointly as the tenant. The two companies were in the same group: one was a trading company and the other was dormant. The lease contained a break option in favour of the tenant. The tenant's solicitors served a break notice on the landlord, but referred only to the break option being exercised by the trading company. The court held that the break notice was invalid as the break option could only be exercised by both tenant companies acting together. Mannai did not save it, partly because previous correspondence from the tenant's solicitors had created confusion about which parties they were acting for. A reasonable landlord would not necessarily have understood the intention of the notice.
The Prudential decision is to be contrasted with the 1999 decision in Havant International Holdings Limited v Lionsgate (H) Investment Limited [1999] EWHC 303 (Ch), where it was held that a subsidiary company could validly exercise a break option even though this was personal to the parent company. In that case, the court took the view that the reasonable recipient would have assumed that there had simply been an error in describing the company exercising the break rather than the less likely scenario that the lease had been unlawfully assigned to the subsidiary.
The Prudential case illustrates that the Mannai principle offers the courts considerable discretion as to whether to save a break notice in any individual case, because an assessment of the view of the "reasonable recipient" is necessarily dependent on the particular circumstances. Tenants who have not drafted a break notice correctly are therefore vulnerable to a trend towards stricter interpretation.
Timing of the break
When negotiating a lease, the tenant should consider the timing of the break option and particularly the interaction with any rent review provisions. The amount of any rent increase may be a key factor in allowing the tenant to decide whether or not to exercise the break, and ensuring that this is ascertained before the last date for exercise of the break option can allow the tenant to consider its options from a more informed position.
Timing of service of the break notice itself is also key: almost all break clauses will provide for a minimum period of notice to be given to the landlord. Time is of the essence, meaning that any failure to serve notice timeously will render the break inoperative.
In Orchard Developments (Holdings) plc v Reuters Limited decided in January this year, the tenant sought to exercise a break option which required six months' written notice to the landlord. The tenant could either exercise the break formally by letter to the landlord's registered office, or informally by some other method of communication provided the landlord acknowledged receipt of this. The tenant served notice under both routes, by letter and by fax. However, the letter was delivered to the wrong address and was not received by the landlord, and the fax arrived when the landlord's office was closed. By the time the office opened two days later, the last date for service of the break notice had passed. The landlord later acknowledged that it had received the fax, but argued that the break notice had not been served within the required period and so was invalid. The court agreed, finding that the landlord's subsequent acknowledgement could not retrospectively validate the notice.
Certainty v flexibility
Break clauses continue to provide fertile ground for disputes between landlords and tenants. Case law demonstrates an inherent conflict between the desire to achieve certainty of outcome for landlords (giving rise to a strict construction of the requirements of the lease relating to exercise of the break) and the desire to ensure that tenants do not have their legitimate break entitlements defeated on mere technicalities (giving rise to a more flexible approach). In Linpac, the judge commented that in the commercial and property world, certainty is of prime importance. That case, together with Prudential and Orchard may suggest that, in a turbulent market, the courts are currently resolving the conflict in favour of such certainty for landlords.
To read the full decision in The Prudential Assurance Company Limited v Exel UK Limited & Another click here.
To read the full decision in Orchard Developments (Holdings) plc v Reuters Limited click here.