Break Clauses in Commercial Leases
In today's competitive commercial property market tenants are looking to introduce as much flexibility as possible into their leases in order to protect their future business interests. This will often include a break clause which gives the tenant the right to bring the lease to an end part way through the agreed term. This is a useful option particularly in circumstances where a business changes significantly over a short period resulting in a need for larger or smaller premises.
Whilst having an option to walk away from the lease is of benefit to the tenant, it is not such good news for the landlord who faces the risk of being left with a loss of rental income and vacant premises that may have been left in a worse condition than at the start of the lease. There is a balance to be achieved in allowing tenants sufficient flexibility to address changing business needs whilst at the same time affording landlords adequate protection of their property interests.
It is common for landlords to attach conditions to an option for tenants to bring their lease to an early end. These conditions often include a requirement to comply with all the tenant covenants in the lease including repairs to the property, payment of all rent and other payments up until the date of termination under the break clause.
Where there is a pre-condition to the tenant's right to break, there will often be a further requirement for the tenant to demonstrate an absolute compliance with these obligations. Case law shows that the courts take a strict view when determining whether a tenant has or has not complied.
In the case of Osborne Assets Ltd v Britannia Life Ltd in 1997 the lease required the tenant to demonstrate absolute compliance with the covenants in the lease, which included an obligation to redecorate the premises by painting with three coats of paint before the end of the term The tenant, Britannia Life Ltd, maintained that it had complied with this covenant despite the fact that it only used two coats of paint! The landlord maintained that Britannia Life Ltd had acted in breach of its obligations and was therefore not entitled to exercise the break option. Despite the breach being only trivial, the court held that absolute compliance was required so the tenant's failure to comply fully with its obligations under the lease was sufficient to deprive it of the right to exercise the break It is more common for landlords to adopt, what may appear to be, the more lenient approach of insisting that tenants show material compliance with their lease obligations in order for them to successfully exercise their option to break. However, deciding what is or is not material compliance often creates conflict between the parties and prevents them reaching agreement over what the tenant must do to comply with the lease covenants. In many cases tenants believe that they have abided by all covenants only to be denied the right to exercise a break option by reason of a seemingly minor breach of covenant.
There has been much debate about what constitutes a material breach of tenant covenants and case law has proved useful in determining this issue and also illustrating the type of situation in which a tenant is not entitled to break the lease.
Basic guidelines were laid down in the 2001 case of Commercial Union v Label Ink where the court determined that the following circumstances should be taken into account when considering whether an alleged breach was material:
- the actual breach
- the practicalities of quantifying the damage caused by the breach
- the extent of the tenant's efforts to avoid breaching the relevant covenant
- whether the landlord has a genuine interest in strict compliance rather than an opportunity to take advantage of the tenant's non-compliance to prevent the exercise of the right to break
The more recent case of Fitzroy House Epworth Street v Financial Times Ltd in 2005 illustrates the factors that courts will take into account when deciding whether there has been material compliance with tenant covenants before the break option is exercised.
In this case the lease contained a covenant to put and keep the premises in repair and the tenant, Financial Times, took all reasonable steps to ensure that this was done. The tenant invoked the break option and invited the landlord, at an early stage, to comment on the work that was required to put the premises into the condition required under the lease and to review the detailed specification for repairs that they had prepared. The landlord did not respond to the tenant's invitation nor did it take the opportunity to arrange inspection of the premises as the works were being carried out. Once the works were completed the tenant vacated the premises and returned the keys. It was only at this point that the landlord argued that the tenant was in breach of the repairing obligations and so not entitled to bring the lease to an end. The landlord served a schedule of dilapidations on the tenant together with a claim for all rent and other outgoings from the break date.
The question for the court in this case was whether the tenant had done enough to show material compliance with the covenants in the lease as set out in the conditional break clause. The starting point for the judgment were the guidelines set out in the Label Ink case in determining the extent to which a breach could be described as material in the circumstances. However the judge in the Fitzroy case went on to say that a breach will only be material if it adversely affects the landlord's interest in preserving the value of its reversion and its ability to re-let the property quickly.
The court took the view that the tenant had made all reasonable efforts to engage with the landlord in order to identify the extent of the required works. The tenant had incurred repair costs of approximately £1 million and yet the value of the outstanding defects was estimated at only £20,000. The court considered the outstanding wants of repair as insignificant by comparison and therefore not material. For these reasons the court held that it would be unreasonable to refuse the tenant the right to operate the break clause.
The Fitzroy case illustrates the type of factors that the courts will consider when determining whether the tenant has demonstrated material compliance with lease covenants before the exercise of a break clause and provides some useful point to note for both landlords and tenants on this issue.
Landlords will now need to be aware that their conduct in dealing with tenants could be open to scrutiny by the courts. The Fitzroy case has shown that where a tenant is proactive in their dealings with the landlord, there is an onus on the landlord to cooperate with the tenant in their proposals. The court will also look closely at the extent to which the any non-compliance will seriously affect the ability of the landlord to re-let their premises on acceptable terms.
From a tenant's perspective, whilst it would be ideal to have a lease which contained an unfettered right to bring the lease to an end, there is comfort to be gained from the decision in the Fitzroy case. This shows that the courts are prepared to take a more sympathetic view when the tenant can demonstrate that they have done all that is reasonable to engage with the landlord to identify what is required to ensure material compliance and a successful operation of the break clause.
Mary Cutts
Solicitor
Lemon & Co Solicitors
This article gives a general view and cannot be relied upon in any particular case. The need for specific legal advice must always be considered. For further information, contact Mary Cutts or another member of the commercial property department at Lemon & Co on 01793 496341 or alternatively, please visit our website at www.lemon-co.co.uk for articles on other legal issues.
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<p><strong><a href="http://www.lemon-co.co.uk/article_considerations-for-landlords.php">Break Clauses in Commercial Leases</a></strong><br />
In today's competitive commercial property market tenants are looking to introduce as much flexibility as possible into their leases in order to protect their future business interests...</p>