Break clauses in commercial leases

Introduction It is not unusual for fixed term commercial leases to contain a clause (a “break clause”) which entitles one or other party unilaterally to bring that lease to an end prematurely. A break clause offers a significant benefit to a tenant to surrender a lease prior to the end of the term of the Lease with or without penalty. The Courts have always considered break clauses to be analogous to options to renew and options to purchase. Break clauses are always construed very strictly, and if (as is usually the case) the break clause is subject to the fulfilment of certain conditions, the Court will usually treat those as conditions precedent which must be strictly complied with for the break clause to be exercised validly. As a matter of contract a court cannot rewrite the terms of a negotiated lease and it is therefore crucial that consideration is given to possible future outcomes when drafting the provisions of a lease. Commonest mistakes in exercising break clauses include:

1. Missing the deadline for service of a break clause.
2. Failure to comply with the notice provision of the lease in relation to the service of the break option notice, e.g. written notice to be received by a certain date.
3. The entity exercising the break clause is not the tenant within the meaning of the lease or the notice is served on the wrong landlord.
4. Failure to pay the full rent due to the end of the quarter.
5. Failure to pay all sums due i.e. service charge, rates, insurance, other liabilities under the lease.
6. Failure to provide vacant possession.
7. Relying on non-binding/without prejudice discussions relating to conditions precedent to the exercise of the break clause.

Typical Break Clause Conditions

• Service of written notice by a given date often up to six to nine months before the break date (this long lead in time is to permit the Landlord to consider his options re letting and also would provide for review of the property to consider dilapidations etc.);
• Payment of a “break premium” or “break penalty” often included instead of compliance with all tenants covenants;
• Vacant possession;
• Compliance with the covenants of the lease both at the time that the notice was given and also on the determination of the lease (the time when the property is vacated);
• Return of original lease documentation to the landlord; and
• Payment of fees, stamp duty and/ or VAT that arises out of the transfer, surrender or termination of the lease.

To ensure that the exercise of a break option is effective particularly in the case of a tenant, it is imperative that the above conditions are correctly exercised to minimise the risk of a challenge by a landlord. It should be noted that if a lease contains a break clause but is silent as to who can exercise that clause (which would be unusual) it is the tenant alone who can exercise it. Difficulties with exercising Break Clauses An unconditional break clause is most unlikely and normally, it can only be exercised if the person seeking to break the lease has complied with all his/its obligations. As outlined above, prior to the valid exercise of a break option all preconditions must be strictly adhered to. Failure to comply with such conditions precedent could prove detrimental to the exercise of the break option. Application of break conditions To understand the application of break conditions it is best to consider this in light of Court decisions. In the recent UK determination of NYK Logistics (UK) Ltd v Ibrend Estates BV [2011] a warehouse was held under a lease which contained a break clause. Exercising the break option was conditional upon the tenant giving up vacant possession by a specified date.  A valid break notice was served i.e. within the stipulated time but the tenant wanted to deal with the dilapidations themselves before giving up possession. The agreement of the dilapidations was only reached a very short time before the property was scheduled to be vacated. As a consequence in the delay in agreeing the dilapidations contractors were still on the premises at the point where the property should have been vacated. It was held by the Court that the presence of possessions (of the tenant) and a security guard of the tenant did not prevent the tenant giving up vacant possession. However, the presence of contractors meant that the lessees were still in possession and accordingly the tenants were liable for rent until the next break option in the lease. This particular case was the subject of an appeal but the landlord’s position was upheld on appeal. One of the grounds of appeal was that the tenant had sought an extension of time to complete the dilapidations work. The request for an extension of time had not been acceded to and therefore this ground failed. An alternative to simply staying in possession would have been to move out of the property and then seek a licence to go back in and carry out the dilapidations work. This illustrates the necessity of strict compliance with the terms of the lease by the tenant. Any departure from the conditions of the lease cannot be unilateral and must be agreed between the parties in writing so that they can be relied on and are deemed to vary the lease. It has also been upheld by the Courts, where there has been a change of name of the tenant (as will often happen within company structures) and there is a formal requirement that a break notice be served by the Tenant that the service for and on behalf of another party will not be a valid notice. Payment of rent In the case of Avocet Industrial Estates Limited –v- Merol Limited (2011 EWHC 3422) a ten year lease of a factory contained elaborate break provisions with a general stipulation that the tenant had to have fully complied with his obligations under the lease. A term of the lease provided that “if any Annual Rent or any other money payable under this Lease has not been paid by the date it is due, whether it has been formally demanded or not, the Tenant shall pay the Landlord interest at the Default Interest Rate (both before and after any judgment) on that amount for the period from the due date to and including the date of payment.” In this Lease the break provisions were very specific and whilst the time for service of notice was short at three months for the Break Date to terminate the Lease on the Break Date there were very detailed provisions and a number of particular requirements were laid down as to the validity of a break notice and to the service of such a notice.  One of the provisions was in the following terms: “At the Break Date any payment under this Lease due to have been paid on or before that date has not been paid; or At the Break Date there is subsisting material breach of any of the tenant covenants of this Lease in relation to the state of repair and condition of the Property; or At the Break Date the tenant has not paid to the Landlord a sum equal to six months annual rent.” The break notice was challenged and the argument on the various points is interesting as it shows the Courts will apply a certain element of “business sense” to deliberations. Grounds for challenging the Break Notice One of the arguments put forward by the landlord was in relation to how payments had been made.  It showed that over a period of time payments had been made by cheque and subsequently by electronic transfer albeit that there was a reference to standing orders in the lease documents. The landlord had made a claim that because payments were not made by standing order that a payment by cheque would defeat the Break Notice.  This ground of challenge failed. Second ground of objection Another argument put forward by the landlord was that the tenant had failed to pay default interest on various late payments of rent, insurance, service charges etc.  There had been a history of missed payments by the Tenant in this instance. Notwithstanding that this had not been claimed by the Landlord and had not been demanded, this argument by the Tenant failed. The Tenant had also put forward a proposition known as estoppel i.e. if you don’t demand something that you are precluded therefore from seeking it into the future. This argument also failed for the Tenant.  The Judge held on the facts of the case as follows:

1. In a course of dealings between the parties the landlord had agreed to accept cheques in payment of sums due under the lease.
2. A demand for default interest was not necessary to show that it was due and owing.
3. There was no positive statement on the part of the landlord which would give rise to estoppel i.e. allowing someone to rely on a representation i.e. that the landlord was going to waive its entitlement to the interest on late payments.
4. The landlord’s failure to tell the tenant that default interest was due and owing did not raise an estoppel by acquiescence.

In the case of PCE Investors Limited –v- Cancer Research UK (2012 case) the lease provided for annual rent of Stg£190,000 per annum payable in equal quarterly payments. The lease went on to provide that it would be yielded up at 12.00 on the termination date but that termination would not affect any claim by either party against the other for breaches of obligations under the lease. When the tenant served the break notice, the tenant, instead of paying a full quarter’s rent, paid rent on a daily basis from 29 September 2010 to 12 October 2010. When the payment was made, the tenants requested the landlord’s agent to “confirm this is the correct basis for calculating the liability for the short period”. The landlord did not respond. In a subsequent letter dated 2 November 2010 the landlord’s solicitors wrote to the tenant demanding payment of the balance of the rent and contended that the break clause had not be validly exercised. The Court held that on a straightforward construction of the lease all obligations continued until its actual termination. That extended to future rent. Therefore there was a strict construction of the obligation to pay the rent of €190,000 “by equal quarterly payments in advance on the usual quarter day.…. Until the next following quarter day.” As of the 29 September 2010 the lease was still in being and there was a positive obligation on the tenant to pay rent up to the next quarter. Whilst this went beyond the actual termination date the mechanism that should have applied was that the tenant would pay the full quarter’s rent and then seek a refund (if entitled) of the overpayment. A particularly interesting case is that of Marks and Spencer PLC –v- BNP Paribas Securities Services Trust Company ltd which deals with the issue of a refund on the quarters rent paid in advance on the exercise of a break option. In this case, the tenant, Marks and Spencer PLC, exercised their break option and subsequently requested a refund in relation to the quarter’s payment of rent in advance, in relation to the part of the quarters rent which was after the break date. The High Court held that the relevant portion of quarters should be refunded and, concluded, that the refund was “obviously what the parties intended”. The Supreme Court overturned this decision and held that no refund was due and the landlord was entitled to retain the full quarters rent particularly in circumstances where no refund provision has been included in the break option. The Supreme Court stressed that the lease had been commercially negotiated by experienced negotiators advised by independent legal advisors and that rent could only be apportioned by express provisions in the lease. The Supreme Court further noted that the courts are not contract makers and will only imply a term to a lease where it is required for commercial necessity. Matters to be considered when negotiating leases for tenants

• Attempt to agree unconditional break clauses in return for break payments, this can be cost effective.
• Ensure a refund provision is included in the break option in relation to advanced payments of for periods after break date.
• Avoid agreeing compliance with all tenants’ covenants under the lease as a condition precedent to the exercise of the break clause since these can often be almost impossible to comply with.
• If the landlord will not agree to remove certain break conditions make sure that compliance is both possible and measurable.

Both Landlords and tenants should look closely at the pre-conditions imposed for valid exercise of break options. Tenants intending to rely on a break option should plan the process carefully and well in advance of the time lines stipulated in the lease. Any departure from the strict terms of the lease should be recorded in writing and acknowledged by both parties. The case law above demonstrates that the courts will not rewrite the contact and will uphold the terms of the lease on the basis that this is what had been negotiated and agreed between the parties.