Real World - Spring 2013: Break clauses - tenants should err on the side of caution

by Dechert LLP

With the outlook for the UK economy still rather patchy at best, it is not surprising that tenants have in recent times been looking closely at their lease terms and, in particular, any break rights that they may have, with a view to off-loading property that may have become surplus to requirements. It is no surprise too that landlords have been looking for ways to frustrate the operation of break clauses by tenants, so as to preserve rental income for as long as possible. The clash of these competing interests has led to a number of recent court cases highlighting the importance of strict compliance with break clause conditions. 

Undemanded interest

The first case of note was Avocet Industrial Estates LLP v Merol Limited in 2011. In that case the tenant had the benefit of a break right which was subject to a provision that the break would be ineffective if there were any outstanding payments due at the break date. In order to ensure compliance with the provision, the tenant duly paid all arrears of rent that it was aware of. However, the tenant overlooked the fact that the rental arrears had accrued interest totaling £130 and this sum had not been paid. The court held that the tenant's failure to pay the accrued interest, despite the landlord not demanding it and despite the landlord not responding to a request from the tenant for confirmation that all outstanding sums had been paid, was sufficient for the tenant not to have complied with the conditions attached to the break right and so the break was held to be ineffective.

Rent for the remainder of the quarter

In the case of PCE Investors Limited v Cancer Research UK in 2012 it was held that a condition that the tenant pay “the rents reserved and demanded” up to the break date required the tenant to pay rent for the whole quarter during which the break date fell, so the tenant would be paying rent for a period after the lease had ended. The fact that the tenant had only paid rent for the period up to the break date meant that the tenant had not complied with the conditions and so the break was not effective.

No reimbursement

The case of Quirkco Investments Limited v Aspray Transport Limited in 2011 further compounded problems for tenants in that it held that, without express provisions to the contrary, a tenant is not entitled to reimbursement of any overpayment of rent in respect of the period after the lease has ended. As there is no common law entitlement to reimbursement of overpaid rent and the Apportionment Act 1870 only applies to rent paid in arrears (rarely the case), the obligation to refund must be expressly set out in the lease.

“Yearly and proportionately for any part of a year”

This year has seen the case of Canonical UK Limited v TST Millbank LLC which has confirmed the principles set out in PCE Investors. In this case, the exercise of the break was conditional upon the tenant complying with the lease terms, the payment of rent up to the break date and the payment of a month’s rent as a premium for the exercise of the break. The tenant duly paid a full quarter’s rent in compliance with the lease terms, even though the break date fell part way through the quarter. However, the tenant did not make a separate payment to cover the additional one month’s rent premium. Instead the tenant argued that the balance of the quarter’s rent, in respect of the period after the break date, ought to have been applied in settlement of the premium. The tenant’s argument was based on the fact that the lease provided, as most do, that the rent is to be paid “yearly and proportionately for any part of a year”. Applying this wording to the break clause, the tenant said that it was only liable to pay rent up to the break date. The court rejected this argument and said that this wording was only intended to deal with the situation where the commencement and expiry dates of the lease fall part way through a quarter. Its application did not extend to break clauses, particularly as there was no certainty at the time of payment that the other conditions would be satisfied and the lease would therefore determine on the break date.

Even if the tenant had succeeded on that point, the court rejected the argument that the balance of the quarter’s rent ought to have been treated as payment of the premium. The payment had clearly been made in settlement of the rent demand for the quarter and there had been no suggestion by the tenant prior to the break date that part of the payment should have been applied in that manner.

Advice for tenants

Given the court’s strict interpretation of break conditions, it is important for tenants of new leases to endeavour, where possible, to negotiate unconditional break clauses. Failing that, the tenant should ensure the lease specifies that rent may be apportioned up to the break date, any overpayment is refunded after the break is exercised, and failure to pay interest that has not been demanded will not prevent the exercise of the break.

Where a tenant is seeking to exercise a conditional break clause in an existing lease, careful consideration needs to be given to the terms of the break and where there is any scope for argument that the tenant has not properly complied with the terms, the tenant would be well advised to err on the side of caution rather than risk a subsequent challenge by the landlord and the possibility of being tied in for many years to a lease of premises it no longer needs or can afford.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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