by Gavin Le Chat
Leases of business premises often contain a clause giving the landlord, the tenant or both parties the right to determine the lease on a specified date or dates before the expiration of the lease term or on the happening of some event. The purpose of this article is to consider such clauses and to point out some of the pitfalls to be avoided.
The notice
The option to determine or “break clause” will usually stipulate that the party wishing to exercise the option must serve notice in writing to that effect on the other party by or on a particular date. In such cases it will be crucial that the party serving the notice complies with the time-limits for serving the notice, as time will be of the essence: United Scientific Holdings v Burnley Borough Council [8] AC 904; (1977) 243 EG 43.
It will also be crucial that the party serving the notice does not overlook the provisions of the Landlord and Tenant Act 1954 (“the Act”). Notwithstanding the terms of the break clause, a landlord should therefore consider very carefully whether he wishes to impose an absolute prohibition against underlettings. suppose the break clause entitles the landlord to determine the lease on December 25 2000 by giving to the tenant not less than three months’ notice in writing.
In order to comply with section 25(2) of the Act the notice should be served not less than six months and not more than 12 months before December 25 2000. But, suppose the landlord fails to serve the notice until three months before December 25 2000; will the notice bring the tenancy to an end and, if not, will the landlord have lost his right to determine the lease? The short answer to both questions is: “No”.
However, in order to bring the tenancy to an end the landlord will also have to serve the tenant with a section 25 notice to quit specifying as the date of termination of the tenancy a date not earlier than six months and not later than 12 months from the date of service of the notice. In the words of Lord Diplock in Scholl Mfg Ltd v Clifton (Slim-Line) Ltd [6] 3 All ER 16 at p 20:
A tenancy with a break clause is a tenancy for a term of years certain within the meaning of the Act of 1954; but until the latest date at which notice may be given subject to the break clause it is also one which, apart from the Act of 1954, could be brought to an end by a notice to quit given by the landlord. By serving a notice in accordance with the provisions of the break clause, but not in the prescribed form, the landlord converts it into a tenancy for a term of years certain expiring on the earlier date specified in the break clause, but the Act of 1954 itself prevents such a notice from bringing the tenancy to an end. It will continue thereafter by virtue of the Act of 1954 until brought to an end by notice in the prescribed form appropriate to a tenancy for a term of years certain expiring at that earlier date.
It should be noted that where a landlord wishes to exercise an option to determine it will not be necessary for the landlord to serve a common-law notice in accordance with the terms of the lease in addition to a section 25 notice to quit. The Scholl case makes it clear that a section 25 notice may be employed in substitution for a common-law notice.
A tenant wishing to determine a lease pursuant to a break clause will also have to comply with the provisions of the Act. For example, suppose the break clause entitles the tenant to determine the lease on December 25 2000 by giving to the landlord not less than one month’s notice in writing. In order to comply with section 27 of the Act the tenant should serve the notice not later than three months before December 25 2000.
Contracting out of the Act
As all commercial property lawyers will know, if a landlord serves a section 25 notice to quit on a tenant in occupation of business premises, the tenant will be entitled to a new tenancy (subject to the landlord proving a ground of opposition under the Act) if, within two months of the landlord’s notice, he serves a counternotice stating that he is unwilling to give up possession, and if he applies to the court for a new tenancy not less than two, nor more than four, months after the date of the landlord’s notice.
Accordingly, if a landlord served a notice to determine on a tenant pursuant to a break clause and the tenant applied to the courts for a new lease two months after the date of service of the landlord’s notice the landlord would be able to regain possession of the demised premises only by establishing a ground for possession under section 30(1) of the Act(*).
In order to ensure that a landlord’s option to determine is effective, therefore, the landlord should seek to include in the lease an agreement to exclude the security of tenure provisions under the Act. This will involve both parties making a joint application to court for an order authorising the agreement to exclude sections 24-28 of the Act. Without such an order the agreement would be invalid: see section 5 of the Law of Property Act 1969.
Conditions of option
Sometimes a break clause in favour of a tenant will be framed very strictly so that it will be a condition precedent to the exercise of the option to determine that there are no arrears of rent and that all the covenants on the part of the tenant have been performed and observed. The consequence of this is that all arrears of rent will have to be paid and any other breaches remedied before the notice to determine expires for the exercise of the option to be effective.
Accordingly, although a breach of covenant may exist at the time the tenant serves the notice to determine, the notice will be valid if the breach is remedied before the notice expires: Simons v Associated Furnishers Ltd [1] 1 Ch 397. However, the tenant should strongly resist any attempt by the landlord to make it a condition precedent to the exercise of the option that all the tenant’s covenants have been performed, since, even if a minor breach of covenant exists, the notice to determine will be invalid if the breach has not been remedied when the notice expires.
Effect on underlessees
(a) Landlord’s option
What effect will the exercise by a landlord of an option to determine contained in a headlease have on underlessees? In the event of a headlease being forfeited an underlessee will be entitled to apply to the court for relief: section 146(4) of the Law of Property Act 1925. However, where a headlease is terminated by a superior landlord exercising an option to determine the position is different and the exercise of the option will end any underlease granted out of the headlease: Weller v Spiers (1872) 26 LT 866 and Keith Bayley Rogers & Co v Cubes Ltd (1975) 31 P&CR 412. However, as indicated above, the underlessee, being a tenant in occupation of business premises, will have a statutory right to remain in possession of the demised premises and (subject to the superior landlord establishing a ground for possession under the Act) he will be entitled to a new tenancy.
As a condition of granting consent to an underletting a superior landlord, who has the benefit of an option to determine, may require the option to be reflected in the underlease. Alternatively, he may require a provision to be inserted in the underlease to the effect that the underlease will automatically terminate in the event of the headlease being terminated by the superior landlord exercising his option to determine. However, as the termination of a headlease by a superior landlord exercising an option to determine will automatically end any underlease granted out of it, there would seem to be little point in the underlease containing a parallel option to determine or any provision for automatic termination. What will be essential, if the superior landlord wishes to ensure that he will obtain vacant possession of the premises demised by the lease and the underlease, is that the underlease excludes the security of tenure provisions of the Act.
(b) Tenant’s option
Will the exercise by a tenant of an option to determine contained in a lease put an end to any underleases granted out of it? Under section 139(1) of the Law of Property Act 1925 the surrender of a lease does not destroy the rights of underlessees and the interest of the superior landlord is deemed to be the reversion expectant on the underlease. Accordingly, the exercise of a break clause by a tenant will not terminate any underleases granted out of it. This will be the case even if the superior landlord knew nothing of the underletting: Parker v Jones [0] 2 KB 32. Before granting a tenant an option to determine a landlord should therefore consider very carefully whether he wishes to impose an absolute prohibition against underlettings.
The fact that the exercise of the option by the tenant will cause hardship to the undertenant will not prevent its exercise: Barry v Vincent and City of London Real Property Co (1921) 90 LJ CH 302. However, a tenant who sublets for a term of years extending beyond the last date at which he has an option to determine will be precluded from determining his own lease: Phipos v Callegari (1910) 54 Sol Jo 635.
Rent reviews
The presence of a break clause in a lease may have the effect of making time of the essence in relation to the rent review provisions. For example, if a tenant has a right to break the lease by serving notice on the landlord by a specified date, which is later than the last date for the serving by the landlord of a trigger notice to initiate the rent review, then time will be of the essence in relation to the service of the trigger notice: Richards & Son Ltd v Karenita Ltd (1971) 221 EG 25. Even if the last day for exercising the break clause and the last day for serving the landlord’s trigger notice are the same time will be of the essence: Rahman v Kenshire Ltd (1980) 259 EG 1074.
In order to ensure that the presence of a break clause will not make time of the essence the rent review clause should not require any action by the landlord to initiate the rent review and there should be no timetable for agreeing the revised rent or the appointment of an arbitrator or expert: Edwin Woodhouse Trustee Co Ltd v Sheffield Brick Co plc (1983) 270 EG 548.
Where the lease contains a break clause in favour of the landlord he should consider including in the rent review provisions a “disregard” that the break clause will be ignored on rent review to prevent the tenant seeking a discount.
Conclusion
Options to determine in commercial leases need to be carefully considered both by landlords and tenants, not only when the clause containing the option is first drafted but also when the option is exercised. Break clauses cannot be looked at in isolation and need to be considered together with other clauses in the lease, such as the rent review and alienation provisions.
(*) There are seven grounds on which a landlord may oppose an application by a tenant for a new tenancy. The two most common grounds are: (i) that the landlord intends to demolish or reconstruct the premises demised by the lease or to carry out substantial work of construction; and (ii) that the landlord intends to occupy the premises for his own business purposes. The latter ground will not be available if the landlord’s interest was purchased within five years of the date of the end of the current tenancy.
