Break Clauses in Commercial Leases

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Lease Agreements:

Landlords of
residential properties have become used to the “rules of the game”
being largely governed by statute, that is laws laid down by
Parliament. They govern the relationship between landlord and tenant
much to the exclusion of express custom clauses drawn up by the
landlord and set-out in the tenancy agreement.

Many of the clauses in residential agreements are pretty standard, indeed the government now provides a model tenancy agreement that all landlords can use free of charge. It has clauses that reflect the Housing Acts, even when not expressly included, as some rules are implied. Yes, there is some flexibility whereby landlords can include their own rules by way of custom clauses, but they can only be enforced if a court deems them “reasonable.”

However, with a commercial lease things are somewhat different. Yes, there are some over-riding common law and statutory principles that lease clauses must adhere to, but in the main the agreement is based on contract law whereby the parties make and agree their own rules. It contrasts somewhat with the consumer law influence now attached to a residential tenancy.

This article is based on English law and is not a definitive statement or interpretation of the law; rules change and every case is different – only a court can decide. Other jurisdictions are similar but there are important differences. Always seek expert advice before making or not making decision.

A case that illustrates this point very well involved a dispute between commercial tenant Marks & Spencer and landlord BNP Paribas (Marks and Spencer pic v BNP Paribas Securities Services Trust Company (Jersey) Ltd), a case which in 2015 ended up at the Supreme Court, having previously gone through the Court of Appeal.

M&S had rented
retail space off the landlord on a lease which included a conditional
tenant’s only break clause. The conditions to exercise the break
were that (1) six months’ notice was to be given, (2) a break
premium was to be paid, and (3) there were to be no rent arrears at
the time the break notice was served.

The dispute between
the parties arose because the break itself was out of sync with a
quarter’s rent paid in advance, which meant two months’ rent was
paid for a period after the tenant had gone.

In all the respects
the conditions of the break were met in full, the six month’s
notice served, the break premium of £919,800 + VAT paid, and there
were no rent arrears, indeed the converse was true – rent was
overpaid.

The difficulty for
the tenant was that there was no express clause in the lease either
stating what would happen in the case of a rent overpayment, and
nothing to align the break with the end of a quarter, but the tenant
wanted the overpaid rent to be returned.

The initial court
case involved a claim for the “overpaid” rent on the basis that
the court should imply such a term in the lease; after all, on the
face of it logic would seem to imply that any overpayment should be
refunded.

The Court found in
favour of M&S, and as the tenant requested, implied a repayment
clause even though no express clause existed. BNP Paribas appealed
the decision and it was overturned by the Court of Appeal. M&S
then pursued the matter through to the Supreme Court, the final
arbiter, and lost its case, and its refund.

What are the
lessons for property investors?

The main principle
to remember is that business leases are basically contractual
agreements based on negotiations between the parties and the courts
will enforce them as such. Courts do not like to imply terms in
commercial leases unless there are exceptional circumstances.

In giving judgement,
the Supreme Court stated that “a term will only be implied if it
satisfies the test of business necessity or is so obvious that it
goes without saying.” It was determined by the Supreme Court
that the absence of a repayment clause in the lease was not a
“business necessity” or a “practical absurdity”
and accordingly it ruled that a repayment clause should not be
implied by the Court. These were matters that should have been dealt
with by the parties when negotiating the contract according, to the
judges.

The ruling is an
important one because it lends a good degree of certainty for
commercial landlords regarding the position of the parties regarding
the repayment of rent following a break. The Court was concerned that
if had it found in favour of the tenant in this case, then numerous
further disputes might arise alone similar lines where matters were
not expressly dealt with in the lease.

On the face of it
the decision could be construed as overly “landlord friendly” and
against logic; a harsh decision on the tenant when it had paid for a
period it was unable to use. This was the case even though it had
paid a substantial break premium. But it was stymied simply because
the date of the break did not align with a quarter day and there was
no specific repayment clause.

However, the Court
took into consideration that a tenant-only break clause was
potentially of considerable commercial value to the tenant, and
therefore deemed it fair that the landlord should not be obliged to
repay the two-months’ rent when it was the tenant’s decision to
break the lease.

This Supreme Court decision stands and it is an important principle for property investors and for assignees to bear in mind; that whatever the lease says binds the parties, and usually what it does not say, doesn’t. It’s important to check lease break clauses carefully when purchasing a commercial building with an existing tenant, or taking on an existing lease.

Break Clauses in Residential & Commercial Leases

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