A break clause gives either or both parties to a lease the right to determine the lease before the contractual expiry date. The importance of a break right to a tenant cannot be underestimated as it gives the tenant much-needed flexibility, particularly in these uncertain times.
Conditional break clauses are often the most contentious as a tenant’s failure to comply with any of the conditions will prevent the valid operation of the break. In the words of Lord Justice Lewison: “The clear moral is: if you want to avoid expensive litigation, and the possible loss of a valuable right to break, you must pay close attention to all the requirements of the clause, including the formal requirements, and follow them precisely.”
Here, we look at some of the key issues that should be addressed in heads of terms to ensure that the tenant can be certain that its break right will be effective.
Break date
The break clause may state that the lease can be terminated at any time, more commonly known as a rolling break. Alternatively, the parties may agree that the lease can be terminated on an agreed fixed date or dates. These dates might be linked to rent review dates so the tenant can choose whether to determine the lease if the rent increases on review.
It is always preferable to specify exact break dates to avoid any possible ambiguity arising where the heads of terms require the break date to be calculated by reference to the term commencement of the lease.
Break notice and notice period
Time is of the essence in respect of any time limits in the break clause. Although this is implied, the break clause may state this expressly. This means if the tenant misses a deadline then the break option will not have been validly exercised.
For example, a lease specifies the break date as 29 August 2022, provided not less than three months’ notice is given. To ensure the landlord receives three months’ clear notice, the first and last day of the notice period are excluded from the calculation. The break notice must be served (or deemed served) no later than 27 May 2022.
Any requirements as to service of the notice will also need to be strictly complied with. It is worth remembering that the service provisions may not be in the break clause itself but elsewhere in the lease.
In Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] 1 EGLR 57, the House of Lords found that minor defects would not necessarily invalidate notices provided the reasonable recipient of the notice would have understood its intention. Although Mannai will often cure a mistake where the notice simply needs to convey certain information (without prescribing the format of that information), it is unlikely to rescue a notice that fails to comply with formal contractual requirements as to the form and content of the notice. In Lord Hoffman’s words: “If the 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 determine the lease.”
Personal break right
The heads of terms should clarify whether the break option is personal to a particular tenant. Once the lease is assigned then the personal break right is lost and cannot be revived by re-assigning the lease back to the tenant who had the benefit of the break right.
Conditions
Any conditions attached to the break right must be strictly performed, which can be difficult, meaning that it is effectively impossible for the tenant to exercise the break thereby defeating the commercial objective of the clause. This is particularly so in the case of a trivial breach of covenant.
If a break clause requires the tenant to make all payments due under the lease by the break date, this could include default interest incurred on late payments, even if the landlord has not issued a demand for payment of such interest. In the case of Avocet Industrial Estates Ltd v Merol Ltd [2011] EWHC 3422 (Ch); [2012] 1 EGLR 65, the High Court ruled the tenant’s failure to pay default interest of £130 meant the break had not been validly exercised.
In PCE Investors Ltd v Cancer Research UK [2012] EWHC 884 (Ch); [2012] PLSCS 84, the tenant paid rent quarterly in advance and the break date fell in between two quarter days. The break clause required the tenant to pay “the rents reserved and demanded by this Lease up to the Termination Date”. The High Court held that the tenant was obliged to pay the full quarter’s rent to validly terminate the lease rather than an apportioned sum up to the break date.
It used to be common to see break clauses which stipulated the tenant must comply with all the tenant’s covenants up to the break date. These days a tenant would not usually agree to such a condition since a trivial breach will frustrate the exercise of the break.
A break clause may include a condition that the tenant must give vacant possession. This is a fertile area for dispute. In Capitol Park Leeds Plc v Global Radio Services Ltd [2021] EWCA Civ 995; [2021] PLSCS 119, the Court of Appeal endorsed the accepted meaning of vacant possession which refers to giving back the premises free of people, chattels and interests, and not to its physical condition. The judgment also indicated that just because the conditions prescribed in a break clause must be strictly complied with, it does not follow that those conditions should be interpreted adversely against the tenant.
The RICS Code for leasing business premises states that the tenant’s right to break should only be conditional on the payment of basic rent and should only require that the tenant gives up occupation and leave no other occupiers. Any disputes about what has been left behind or removed should be settled after the lease has determined.
Tenants should also be aware that the lease will usually include covenants that apply at the expiry or earlier determination of the lease. The lease may oblige the tenant to reinstate alterations and redecorate the property. It will also be important to check any supplemental documents such as a licence for alterations.
Heads of terms should state whether the break option is subject to any conditions and whether the conditions must be satisfied at the date of service of the break notice or at the break date, or both. The tenant’s advisers should carefully review any conditions to check that compliance will not cause any difficulties.
Termination payments and refund of overpayments
In September 2020, HMRC published Revenue & Customs Brief 12 (2020): VAT early termination fees and compensation payments which indicated that where the break clause requires the tenant to make a termination payment in order to exercise the break then such payment would be subject to VAT if the landlord has opted to tax. Previously, such payments were thought to be outside the scope of VAT on the basis that it was a compensatory payment. Subsequently, in January 2021, HMRC announced that it is reviewing and revising the Business Brief, which leaves the current position uncertain. However, the judgment in the recent Scottish case of Ventgrove Ltd v Kuehne + Nagel Ltd [2021] CSOH 129 looked at this point and suggests that VAT may not be chargeable.
Another important issue to cover in the heads of terms is the refund of any rent paid in advance for a period after the break date. If the lease is silent on the refund of overpaid rent, the default position is that rent will not be refunded to the tenant. On that basis, it is essential – from the tenant’s point of view – that the lease expressly provides for the refund of overpayments. The Apportionment Act 1870 does not apply to rents payable in advance, only those paid in arrears. Any rent paid in advance in respect of the period after the break date will not be recoverable by the tenant in the absence of an express provision.
Remember…
The terms of a break option need to be considered carefully at the outset and the heads of terms should cover all the salient issues so that a protracted lease negotiation can be avoided.
Alison Murrin is an expertise counsel at Ashurst LLP
