09 December 2013

Break clauses round-up

Landlords and tenants need to be careful following a spate of cases arising from the exercise of break clauses in leases by tenants. Here's our round up what the cases say, and the practical implications.

It can be crucial to a business to be able get out of a lease of its premises by exercising a break clause in the lease properly. A break clauses typically allows a tenant to exit a lease at certain points during the term of the lease, provided:

  • the clause applies to that tenant;
  • all the conditions in the break clause are complied with – for example that:
    • all rents, interest and associated payments due under the lease have been paid;
    • all covenants in the lease – for example, as to repairs and maintenance, and giving up the premises with vacant possession – have been complied with.
  • the tenant gives proper notice.

That sounds simple enough, but recent legal decisions have highlighted some traps and pitfalls for the uninformed.

The break clause must apply

In one case a break clause said that "if Ashtown.co.uk Ltd shall be desirous of terminating the term hereby granted" then it could do so, provided "Ashtown.co.uk Ltd" had complied with the conditions set out in the lease.

Ashtown.co.uk Ltd assigned the lease but, when the new tenant later tried to exercise the break clause, the landlord said that, because the break clause referred specifically to Ashtown.co.uk Ltd, there was an implied term that only Ashtown.co.uk Ltd could exercise the right to break.

The new tenant argued that the right should only be personal to the original tenant if the clause expressly said so.

The court ruled said that the specific references to Ashtown.co.uk Ltd, including the requirement that it comply with the conditions in the break clause before the right to break was effective, meant the right was personal to the original tenant. If the intention was that successors would also have the right to get out of the lease under the break clause, the word 'assignee' could have been used.

Payment of rents and other sums due

Commonly, a lease will say a break can only be exercised if rent and other sums due under the lease have been paid.

In one case a tenant had sometimes paid rent slightly late. The landlord was entitled to interest on late payment under the lease, but had never asked for it. He was not required to under the lease.

The tenant tried to exercise the break clause in the lease. A condition was that there should be no outstanding monies due to the landlord when it was exercised. The landlord argued that the non-payment of interest on the late rent meant there were outstanding monies due to him and – even though he had never asked for payment of interest - the exercise of the break clause was ineffective.

The court felt it had to agree with the landlord - even though the judge admitted the decision was "harsh".

Landlords must take care too. In another case a lease said a tenant could only exercise its rights under a break clause if it had paid off any arrears, including arrears of insurance rent. Insurance rent was defined in the lease as "such yearly sum … as the Lessor may from time to time expend in insuring and keeping insured the demised premises". The lease also gave the tenant the right to request receipted invoices from the landlord.

The tenant purported to exercise its right under the break clause. The landlord said the tenant had not paid its invoice for insurance rent by the break date and was therefore in arrears within the meaning of the lease. The tenant could not therefore exercise its right to get out of the lease.

One of the tenant's arguments was that the landlord's cheque for the relevant insurance premium was not cashed until after the break date (having initially been mislaid by its insurance broker). The fact the landlord had not actually paid the insurance premium at the break date meant it was not actually in arrears in relation to the insurance rent on that date, so the break was valid.

The landlord countered by saying the wording in the lease meant insurance rent was in arrears if the landlord had incurred a liability to pay the premium, whether it had actually paid it or not.

The Court ruled in favour of the tenant. It said that the wording of the lease meant the landlord had to have actually paid the insurance premium before it could validly demand insurance rent from the tenant. It said the tenant's right to request a receipt was consistent with this interpretation.

Apportionment of payments in advance

One problem area, where the law is not yet certain, is where a tenant has paid rent in advance for a period but the break notice will, if valid, bring the lease to an end before the end of that period. The tenant has therefore paid rent for a time during which it is no longer the tenant. Can it therefore pay only a proportionate part of the rent on exercise of the break clause?

In one case a lease said a tenant had to pay its rent "yearly and proportionately for any part of a year" in equal quarterly payments. The break clause said exercise of the break clause would only be effective if the tenant had paid:

  • rents under the lease up to and including the break date; and
  • a sum equivalent to one month's rent.

The tenant served notice to end the tenancy under the break clause. If the notice was valid the lease would end on 22 August, before the next quarter had finished.

The landlord issued an invoice for the full rent for that quarter, including the period after 22 August. The tenant paid the sum in the invoice in full, and referenced the invoice number. The landlord pointed out that the tenant should also have paid the sum equivalent to the additional one month's rent. As the tenant had not, the landlord said the break had not been validly exercised.

The tenant claimed that the wording in the break clause meant it only had to pay rent up to 22 August. It therefore argued it had complied with the break conditions, because the payment it had made was not for the whole quarter's rent. Part was for rent up to 22 August, and the remainder was the extra sum it had to pay, equivalent to one month's rent.

The court said that the tenant was contractually obliged to pay the full quarter's rent in advance on the quarterly rent day despite the break notice (because there was no certainty at that point that the break would be successfully exercised) unless the break clause specifically allowed it to pay an apportioned rent. The tenant had not therefore paid the extra sum equivalent to one month's rent.

Refunds of rent paid in advance

If a tenant does pay a full quarter's rent, but then successfully exercises the break before the end of the quarter, can it claim a refund? In a leading case a tenant successfully exercised a break clause during a quarter, after paying the full rent for that quarter in advance. It then claimed that the landlord should apportion the rent paid, and repay the amount representing the period after the break.

The Court disagreed. It said that rent payable in advance could not be apportioned and partly repaid on a break unless the lease expressly said it could. In this case, it did not.

However, a later decision has given tenants some hope that they can recover rent paid in advance. In that case a tenant leased part of a large office building. The lease gave the tenant a right to break the lease provided that (1) its rent was not in arrears at the break date and (2) it made a payment equal to one year's rent before the break date.

The tenant purported to exercise the break clause, to end the lease during the December 2011 quarter. The landlord invoiced the tenant for pro rata rent (and other sums) calculated up to the intended break date. However, following the decisions discussed above, the tenant made sure it paid both a full quarter's rent and also the sum equal to one year's rent, before exercising the break. The break was effective and the lease came to an end on the intended date.

The tenant then wrote to the landlord and asked for a repayment of that part of the quarterly rent attributable to the period after the lease had ended.

The landlord refused. It relied on the previous court decisions saying landlords only had to repay rent to a tenant in these circumstances if the lease expressly said the landlord had to. In this case it did not.

However, surprisingly, the court ruled that the landlord should repay part of the rent. It said that the terms of the lease showed that the parties had thought about the consequences of the lease ending during, rather than at the end of, a quarter and that a reasonable person reading those terms would understand that the landlord was to repay rent paid in advance for the period after the lease had in fact ended. The terms leading to this conclusion included:

  • The term specifying the yearly rent payable, which said that, for a period of less than a year, only a proportion was due.
  • The term saying rent was payable in instalments.
  • The term requiring the tenant to pay an amount equal to a year's rent before exercise of the break clause would be effective. The court said this term showed the parties clearly envisaged that the landlord should get compensation if the break right was exercised, and this implied that the parties intended the landlord to have to repay rents paid for the period after the lease had ended.

The court therefore implied a term into the lease that the landlord should repay rent for that period. Such an implied term was "necessary to give business efficacy to the lease" and "obviously what the parties meant".

However, if the provision for the additional payment had not been in the lease it is likely the court would have followed the previous cases. The landlord would not (in the absence of an express requirement to do so in the lease) have had to make a repayment.

Tenants should not, however, rely on this decision just yet. The landlord has been given permission to appeal this decision to a higher court.

Vacant possession

Tenants should also make sure they have vacated premises after exercising a break clause. A tenant in one case exercised its option to end a tenancy early under a break clause in its lease. The right to exercise the break was conditional on the tenant giving vacant possession of the premises at the break date. Some repairs were needed to the property under the termination provisions, and the tenant brought its own contractors in to carry them out so it could control costs.

There were still contractors on site during the week following the break date. The tenant tried to contact the landlord's managing agent to agree an extension, but was unable to do so.

The landlord claimed that the break was not valid because the presence of the contractors meant that the tenant had not given vacant possession at the break date. It said the tenancy therefore continued and it could continue to claim rent. The tenant said that the landlord had waived its rights by failing to collect the keys on the break date.

The Court of Appeal agreed with the landlord, saying that the break was not valid because the tenant had not given up possession of the property on the break date.

Lessons to be learnt

On a purported exercise of a break clause the parties to a lease should ensure:

  • Whether the break rights apply to both current and future tenants, or are personal to one particular tenant.
  • The tenant has made all rent, interest, insurance and other payments payable under the lease - even those that the landlord may not have asked for.
  • Whether any sums due from the tenant must have actually been paid before the tenant is in arrears.
  • They know whether there is an express provision for apportionment of rent, or whether tenants must pay rents due in advance (and any other sums payable on exercise of the break clause) in full, even if part of the payment relates to a period after the lease will end.
  • They know whether a tenant is entitled to a repayment of rents paid in full in advance, where part of the rent relate to a period after the lease has ended.
  • They have removed all people and property from the premises by the break date.

For more information please contact Simon Jackson at Shulmans on 0113 297 7721 or at sjackson@shulmans.co.uk.

Case refs:

Gemini Press Ltd v Parsons [2012] EWHC QB
Avocet Industrial Estates LLP v Merol and another [2011] EWHC 3422
Quirkco Investments Ltd v Aspray Transport Ltd [2011] EWHC Ch 3060
Canonical UK Ltd v TST Millbank LLC [2012] EWHC 3710
Marks and Spencer Plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2013] EWHC 1279 (Ch)
NYK Logistics (UK) Ltd v Ibrend Estates BV [2011] EWCA Civ 683