Breaking up can be hard to do
Monday, August 23, 2021
When the time has come to move on, those in leased premises need to take extra care that they fulfill the terms of their contract or risk having to pay hefty fees.
As businesses wax and wane, so their need for premises change. For a firm that owns its site, the process of relocating may be expensive, but it’s a relatively simple task. However, those that lease must either wait until the contract expires or seek an early break. And typically, the exercise of a break clause can cause a tenant no end of trouble if they misunderstand the process.
Context and key case law
Nathan Hinks, an associate in the Commercial Real Estate department of Wright Hassall, believes that the pandemic has had a major impact on landlord and tenant relationships. “Often,” he says, “we see tenants looking to exercise a break clause. Where a tenant is struggling to maintain footfall and income due to lockdown measures, these clauses may provide a valuable escape.”
And it should be obvious why break clauses are so valuable at present – they allow the easing of losses where tenants are trapped in leases that were agreed when times were more favourable to landlords.
Interestingly, Hinks thinks break clauses are also an opportunity for landlords and tenants to re-gear their leases. But despite this, he notes that in law, “a tenant does not have a right to break a lease, and break clauses are not regulated by statute”. He continues: “Whilst some principles have been established by case law, break clauses are governed by the contents of the clause within the lease.”
Contractually speaking David Manda, a director in the Real Estate Litigation Team at Walker Morris, has seen what can happen when tenants get it wrong. He says that 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: a tenant may lose the opportunity to break the lease and may therefore remain liable and tied into the property with associated long-term, unwanted commitments.”
He refers to the leading case on the subject, Mannai Investment v Eagle Star in 1997, where Lord Hoffmann 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.”
The point was exaggerated, but Manda says that Hoffman was explaining that “strict compliance, with both contractual break conditions and any particular service provisions, is required for lease breaks to be effective”.
With the rigidity in the need to comply set out, tenants wanting to move on need to carefully examine their lease and the contractual provisions to understand their options.
Hinks’ first point is that generally, “landlords require a tenant to provide three or six months’ prior written notice of the intention to exercise a break. This must then be validly served on the landlord”.
As to how to serve notice, Manda says to check the conditions that must be fulfilled: how notice must be given, and how it must be served, and on whom and by whom.
‘When’ is important to both Hinks and Manda – it is central to the debate.
Break clauses can be fixed or rolling. A fixed break clause is usually exercised on a defined date during the lease term. Rolling break clauses can be exercised at any point during the term, upon sufficient notice.
With either, Hinks warns that timing will always be of the essence in terms of any time limits in the break clause – “it’ll be a condition of the contract and failing to meet it when exercising the break entitles the other party to terminate the contract.” And that brings a whole heap of other trouble.
Regarding timing, Manda says that there are three dates to determine: 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. He says that “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”.
Next is the ‘how’ of servicing notice. Here he notes that “it is essential to check whether the break clause contains a specific process for serving notice or whether the lease contains general ‘service of notices’ provisions elsewhere”.
Lastly, there’s the matter of who needs to serve notice. On this Manda says that “determining the correct party/ies is often more difficult than first imagined”.
He says: “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.” Again, mistakes can lead to the break clause failing.
And when it comes to the actual service, Hinks advises tenants to keep “evidence of the method of posting or delivery of the notice; and if there are no deemed service provisions in the lease, ask the landlord to acknowledge receipt”.
Another threat to counter is the conditional break which, says Manda, “should be approached with real caution”. Referring to the Hoffman ruling, he says that “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”.
He offers an example: the payment of all lease sums with just one penny remaining outstanding at the break date or other prescribed time – that one penny would make the whole break invalid. Here Hinks adds a solid tip: that tenants “pay any outstanding sums due, even if these are in dispute”.
Payment can be made on a ‘without prejudice’ basis and the matter disputed later.
Hinks also adds other potential traps to watch out for – that the tenant must have performed all its covenants; the tenant must not be in material breach of its repairing covenants; and the tenant must give vacant possession or hand the property back free of occupation.
“This last requirement – vacant possession,” says Hinks, “is considered an onerous obligation, and is often refused by tenants. It is much more commonplace now to see reference to a property being returned ‘free of a tenant’s occupation or continuing sub-leases’.” Even so, it’s worth remembering that vacant possession means a landlord having ‘immediate and exclusive possession, occupation and control’ and that a tenant having anyone onsite, such as a contractor and/or tradesman, or anything left in or on the building, can also void vacant possession, even when the landlord has been informed.
To offset the potential of procedural failure, Hinks suggests “asking the landlord for confirmation of the steps the tenant needs to take in order to comply with any conditions. This could mean a request that the landlord prepare a schedule of dilapidations in relation to any repair works”.
We’ve already heard how just a single penny can cause a break clause to fail. In fact, the most common condition applied by landlords is the payment of all rent due as at the break date. On the face of it, that seems straightforward and fair enough. However, as Manda points out, rent will be defined within the lease, and it may or may not include service charge and/or insurance rent. He asks, understandably, “Can these be properly calculated or established? Does rent (and other sums) need to have fallen due under the lease, or do they have to have been demanded? And if demands have been made, were they demanded in time for the tenant to make payment?”
Beyond rent another common condition is a tenant’s repairing obligations, known as ‘dilapidations’ – putting the property back in the state it was when the lease started. On this Manda warns that “a landlord is generally 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”.
It’s notable that the end of the lease term often acts as a trigger to review dilapidations and once a break notice is served, it is likely that the landlord will begin preparing a schedule of dilapidations.
That said, Hinks says: “Even if there are no conditions on the right to break, a landlord can still pursue a dilapidation claim... landlords may find it easier to claim for dilapidations upon the termination of a lease because there are fewer statutory restrictions. And where a break clause is conditional on the tenant having complied with its covenants, dilapidations may mean that the tenant is unable to comply.” This is why Hinks says to “ask the landlord to accept the break notice upon payment of an agreed amount in relation to any outstanding breaches of covenant”. Alternatively, he would seek to ensure that any waiver of a condition is not made ‘without prejudice’ and it is clear which condition the waiver applies to.
One last thing to consider before pulling the trigger: that once a break notice has been exercised, it cannot be withdrawn unilaterally. Hinks does say that the parties to the lease “may, very unusually, mutually agree to the break notice being withdrawn but this is deemed, as a matter of law, to constitute the creation of a new lease with effect from the expiry of the break notice”. And this can have wide ranging and unforeseen circumstances. In other words, the importance of obtaining expert advice in respect of a break clause or the conditions cannot be stressed enough, and a tenant would be strongly advised to talk to a solicitor if they are looking to exercise a break.
There is much risk involved in trying to break a lease. But with the backdrop of the pandemic causing some firms real hardship, it’s never been more important for tenants to carefully consider their break options and, in particular, the time and strategy needed to exercise them.
Skimping on good advice when breaking a lease could turn out to be a costly mistake.