Contract Law: implementing a break clause and avoiding a court case

Contract Law: implementing a break clause and avoiding a court case

Article by Roger Watts, Director of Trident Building Consultancy

Your company may be expanding and you’d like to move to larger new premises; or you now need less physical space as a result of technological or other changes. In either case, the focus on the bigger picture could take your eye off the legal ball, and while break clauses can usually be navigated successfully, they can also result in substantial costs if the small print is overlooked. After all, initiating a break clause in a property lease invariably benefits the tenant over the landlord, so unsurprisingly landlords’ leases ensure that their interests are protected.

Essentially, break provisions allow tenants (or landlords) to terminate a lease before the expiry of a fixed term. Break clauses usually take place on a fixed date unless rolling breaks have been agreed previously.

Where they exist, break clauses will include payments of all rents and other costs (service charges, insurance, any interest incurred on previously unpaid rent – calculated and paid in advance to the exact date of departure). They also require the return of the premises in the condition required by the lease (something which can be complicated by an ongoing PPM schedule, or where changes, however beneficial, have been made by the tenant) and full vacant possession (which assumes that all building work is complete and that the construction team has left the building).

Today the demands made on tenants when initiating a break clause are more stringent than previously because the last recession led to many thousands of companies vacating premises and landlords finding themselves with a gap in rental income and an empty property to fill in a challenging market. This increased pressure is illustrated in case law – but case law also provides us with some important lessons in managing break clauses.

Lesson number one: the requirement of ‘vacant possession’ is absolute. In the case of Riverside Park Limited v NHS Property Services Limited 2016, the break clause required vacant possession. During the course of the lease the tenant had installed partitions which remained in place. The Court determined that the demountable partitioning was a tenant fitting and should have been removed. On the basis of this ruling, the NHS, without occupying the property, remained a tenant in name for a further five years, paying rent, rates and service charge accordingly.

Lesson number two: vacant possession is not just a matter of removing chattels: this is extended to removing personnel from the building too. In the case of Ibrend v NYK 2011 the tenant undertook dilapidations works as required by the break contract, and contractors remained on site on the date of the break clause to attend to final matters. The Court held that this prevented the landlord from enjoying the premises such that the break was not effective.

Lesson number three: payment of rents, rates and service charges must be made in full in accordance with the terms of the lease and not on a pro rata basis unless that provision is specifically included. Even if small amounts are outstanding the Courts can act punitively. In Avocet Industrial Estates LLP v Mercol & Another 2011 the tenants had allowed £130 of interest to accrue on late payments. The fact that this interest was overlooked in the final payment despite it being such a small amount was sufficient for the Courts to deem the break ineffective.

Lesson number four: the importance of communicating effectively. In the case of Fitzroy v Financial Times 2005 the tenants embarked on a £1 million scheme of reinstatement, repair and redecoration to satisfy the break clause. Attempts were made to communicate with the landlord over the work schedule but ultimately the landlord did not inspect the building or comment on the acceptability of the changes. On the break date the landlord’s surveyor inspected the building and found small matters outstanding which summated to approximately £20,000. This relatively small amount potentially threatened the break, though in Court it was deemed that the obligations to break had been reasonably satisfied and materially complied with, such that the break was effective.

One final lesson: follow the specific requirements of the break clause to the letter, however unnecessary they may be. Although 21 years old, the judgement in the case of Mannai Investment Co Limited v Eagle Star Life Assurance Co Limited 1997 exemplifies this well. Summing up, the judge stated that:  “If the notice clause had said that the notice had to be on blue paper it would have been no good serving it on pink paper.”

As this case law demonstrates, exercising break clauses comes with significant and potentially unexpected risk. The following advice – although by no means comprehensive – can help you navigate this complex path:

  1. Follow the form required when issuing the notice: some clauses state very specifically how notice should be given, for example to whom it is addressed (the landlord may comprises two or more entities), which provision it relates to and its intention. Failing to comply with this detail can render the notice redundant and as such can be costly. If you are not the original tenant, check that you have the right to terminate the lease. It may be that the right was only granted to a named tenant.
  2. Be realistic about timing, allowing ample time for all conditions to be met. The option to break may arise on one or more specified dates or be permissible after a specific date. Ensure that all parties agree to the break date and that agreement is in writing.
  3. Use guidance: familiarise yourself with the Lease Code 2007.
  4. Comply precisely: it is useful to take advice from lawyers and property advisors to ensure that the conditions have been complied with. Appoint a surveyor to carry out a lease compliance audit.
  5. Aim to avoid compliance of all covenants as a condition of the break, as this can be extremely difficult to comply with.
  6. Consider the possibility of a financial settlement in lieu of pre-conditions.
  7. Agree a schedule of dilapidations: ensure that sufficient time is allowed to ensure that builders can be engaged and works undertaken completely prior to the break date, ideally allowing some leeway for delays.
  8. Calculate outstanding sums accurately. Check payment histories for rent, service charge, insurance rent, VAT, outgoings and interest payments and ensure that all invoices are settled. Ideally seek the landlord’s confirmation that payments are up to date. In the case of any payment disputes, pay upfront on a ‘without prejudice basis’ with a view to settling after the break date.
  9. Clarify ‘vacant possession’. If necessary, instruct a building surveyor to advise on what is necessary to constitute vacant possession. Communicate and negotiate with the landlord, ensuring that decisions are recorded appropriately.
  10. Document everything: written evidence could affect whether a court case succeeds.

Contract Law:  implementing a break clause and avoiding a court case