Several recent cases emphasise the need for the utmost care when exercising a lease break option.
It is difficult for a landlord in the current climate to achieve the onerous conditions he used to be able to achieve - such as compliance with lease covenants – in lease break clauses. Tenants have a good bargaining power in break clause negotiation, under current market conditions. A tenant signing up to, say, a six year lease with a break option after three years no doubt expects to have the right to walk away after the third year, if serving notice, without having to surmount obstacles before doing so. It is common to see new leases in the 2010s with no break conditions at all, except for service of the tenant's notice, or with very limited conditions – such as giving up vacant possession, and paying the basic rent (but no other lease sums) up to the break date.
Yet every year there seems to be much property litigation about lease break clauses and notices. One of the reasons is that tenants are looking to exercise breaks, in these recessionary times, in leases that were agreed pre-recession and are thus having to fight to get out of premises in the face of an onerous conditional break clause agreed in a lease which was negotiated in a market where the landlord had much more bargaining power.
The recent decisions of the parties in the cases of both Avocet Industrial Estates LLP v Merol & Anor [2011] and PCE Investors Ltd v Cancer Research UK [2012] to settle their litigation prior to the appeal hearings of the first instance decisions leaves case law in a worrying position for tenants.
Avocet Industrial Estates LLP v Merol & Anor
The Avocet case has caused a particular stir. The break clause stipulated that a break notice served by the tenant would be of no effect if "at the Break Date any payment under this lease due to have been paid on or before that date has not been paid." The lease required the tenant to pay interest on late sums due under it, as is usual. The tenant had delayed in paying lease sums due to the landlord, as a result of which interest charges had accrued under the lease.
At the break date, the tenant had paid off the arrears of which it was aware, but not interest, totalling a mere £130, which had accrued on the late payments. The landlord had not formally demanded the interest. Nevertheless, the court held that the landlord was not obliged to do so. The tenant had not complied with the break condition to discharge any payment due under the lease, and was therefore liable for some further £300,000 worth of rent, for missing a trifling payment not even requested of it.
The hope that the appeal decision would overturn this ruling or at least introduce some de minimis rule so tenants were not penalised for missing trivial payments has been scuppered. Tenants with impending breaks, who are required under the break clause to settle sums due to retain the right to break, must audit their lease payment history with a fine tooth comb to ensure they are not caught. In new leases, tenants and their advisers should resist any break condition requiring payment of any lease sums over and above the basic rent. If this is not agreed, they should ensure that the break will only fail if the tenant does not pay the landlord sums expressly required to be paid which are notified to the tenant before a specified window of time – 21 days would be recommended as an absolute minimum – prior to the break date.
PCE Investors Ltd v Cancer Research UK
The PCE Investors case was less controversial, but also contained salutary lessons for the tenant. Break dates normally fall in the middle of a quarter or other rental period in which instalments of rent are payable. Breaks are very frequently conditional upon the tenant having paid the basic rent at the break date, as mentioned above. Does this entitle a tenant, for the rent period in which the break date falls, only to have to pay the rent pro rata to the break date, as opposed to the rent for the whole period, to retain the right to break?
The break option here was conditional upon the tenant having "paid the rents reserved and demanded by this Lease up to the Termination Date". The break date was 11 October 2010. The rent was payable on the usual quarter days. Prior to the September quarter day, the tenant made an apportioned payment of the September quarter's demand, for the period up to the 11 October break date only, and asked the landlord to confirm that that was the correct basis for calculating the final tranche of rent. The landlord did not respond.
After the break date, the landlord argued successfully that the break had been ineffective because the tenant had not paid the full amount of rent required to exercise the break. The court agreed, and also held the landlord’s silence did not estop the landlord from correctly asserting that position.
Unless the lease expressly entitles the tenant to make an apportioned payment for the last quarter, it has to make the full payment. Rent has to be paid in full when it accrues, which is a legal requirement which goes back to the Apportionment Act 1870. When a lease simply says that payment is required "up to the Termination Date", as was the case here and as is common, that does not exonerate the tenant. What is required when the lease uses those words is payment of the whole of the amount which has fallen due prior to the termination date. That means the rent for the whole of the relevant rent period.
A tenant who only makes a pro rata payment for the last quarter will therefore usually lose the right to break if termination is conditional upon the relevant payment having been made. Tenants should seek landlord’s obligations in break clauses to ensure that, following a successful exercise of a break, the landlord will pay back to the tenant the overpaid rent for the period from the break date until the next rent payment date.
Canonical UK Limited v TST Millbank LLC [2012]
This confirmed the PCE Investors rationale. The tenant was required to pay a break penalty equivalent to one month’s rent to retain the right to break, as well as rent and other sums due under the lease "up to and including" the break date. The break date was 22 August 2012, which fell within the June quarter. The tenant settled an invoice for the full June quarter's rent and service charge, but later tried to assert that the full payment represented apportioned rent and service charge for the period up to the break date, and that the excess should be regarded as the break penalty payment. The court held that the break obliged the tenant to pay the full quarter’s rent and service charge, not an apportioned sum, and thus the break penalty was unpaid. The tenant had therefore lost its right to break.
NYK Logistics (UK) Limited v Ibrend Estates BV [2011]
The yielding up of premises with vacant possession on the break date is frequently seen in leases as a break condition, as indicated earlier. Landlords have a legitimate claim to negotiate that requirement in new leases to ensure that their premises are handed back in a lettable state following exercise of a break. The tenant needs to ensure strict compliance with such a condition, as evidenced in the Court of Appeal decision in the NYK Logistics case.
Here, a warehouse tenant was required to deliver vacant possession on the break date, Friday 3 April 2009. Prior to that date, the tenant set about remedying dilapidations, although there was no break condition requiring it to give up the premises in repair. The two parties’ surveyors met two days before the break date and agreed that some outstanding repairs could be completed after that date. The tenant retained a security guard in the premises over the weekend after the break date and its contractors continued to complete the repairs over the following week.
The landlord asserted that the break notice was invalid as the condition requiring delivery of vacant possession was not complied with on the termination date. The court agreed, and expressed itself to have little sympathy with the tenant. The court adjudged that the tenant ought to have known (or should have taken legal advice to clarify the position) that the only safe course was to move everyone out of the warehouse on or before the break date and deliver the keys to the agent. By retaining a presence in the warehouse after the termination date, it failed to deliver up vacant possession, and not satisfied the break condition.
The Court of Appeal ruled that vacant possession means that the property must be empty of people, and empty of chattels (although the court thought that this obligation was only likely to be breached if any chattels left in the property substantially prevented or interfered with the landlord’s enjoyment of the right to possession of a substantial part of the property). The court also ruled that the landlord must be able to assume immediate and exclusive possession, occupation and control of the property for vacant possession to occur.
Conclusion
The courts have shown little willingness to bend to commerciality when considering break clause conditions. The whole break process must be treated by the tenant with the utmost seriousness, from service of the break notice (about which there is a separate spate of case law), to compliance with the break conditions. The consequences of failure to comply with the minutiae of such conditions can be inordinately severe, as the Avocet case, in particular, showed. The taking of legal advice well in advance of the intended service of the break notice cannot be recommended strongly enough.
