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16th August 2019

Give tenants a break: tenant’s break rights in commercial property leases

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I want to start by posing a question: “For which lease would you except a higher rent to be payable, a lease for 10 years or a lease for 10 years with a right for the tenant to break it and walk away after 5 years?” The vast majority of those who understand anything about the market for commercial real estate will choose the lease with the tenant’s break right. This is because the tenant is buying a safety valve or an insurance policy against it having over committed itself. If a tenant’s business’ future turns out worse than expected or hoped for, the right to exercise break rights in leases and shed space that they don’t need, or simply can’t afford, could well be crucial to a business’ very survival. Obviously, the landlord pays for the break clause in terms of the uncertainty as to a future rental income stream, but the landlord’s upside is a higher annual rent.

In simple terms, I am trying to illustrate that the inclusion of a break clause in heads of terms and, subsequently, into the terms of the lease itself is a crucial commercial element in the deal reached between the owner and the occupier equally as significant as the rent level, length of the term and the balance of the tenant’s repairing obligations. Yet all too often we see the inclusion of the break right, in both the heads of terms and the actual lease, subject to onerous conditions shrouded and disguised in opaque technical legal language or surveying terms which, whether by design or accident, have the affect of duping too many occupiers into accepting conditions to break clauses. Conditions which down the line will disable them from validly exercising the break rights that they have ‘paid’ for in terms of paying an elevated annual rent. This situation of landlords having their cake and eating it is not right.

What sort of maleficent conditions imposed on break rights are we talking about? For one I mean conditions such as, ‘that the tenant must comply with all tenant’s obligations in the lease’. At face value this condition sounds fairly reasonable, but that is because people’s minds tend to initially focus on the tenant’s obligation to pay the basic annual rent – which all good tenants do their best to do year in year out before each and every quarter day. Think further though. If the condition requires compliance with ‘all’ tenant’s covenants, then that means every last one of them in a lease that can easily run to more than 30 pages of dense legal drafting that two diligent solicitors may have spent way too many weeks drafting and haggling over. In a standard lease we have clauses about EPCs, permitted alterations, prohibited uses and statutory compliance etc, etc, but the ones to really focus the tenant’s mind in this context should be the decorating and repairing obligations. It is a very long established and sensible practice that the owner and occupier settle their differences regarding breaches of these covenants, colloquially the ‘dilapidations’, after the lease’s term and the tenant’s occupation have ended – either reasonably amicably or through dispute resolution solicitors following the relevant judicial procedural protocol – so at least there are rules to the game. I don’t think occupiers automatically consider dilapidations settlements in the context of breaches of the terms of the lease, but they certainly should when accepting a condition to their break right that require there not to be any breaches of their lease for their break right to be operable and effective. To illustrate the situation in pounds and pence imagine a landlord making a dilaps claim of say £100,000 – after each party’s surveyors have negotiated over the schedule of dilapidations, perhaps assisted by lawyers, the tenant could conceivably reduce this cost to £50,000 settlement. However, under the pressure of trying to satisfy a break condition stipulating that there be no breaches of the tenant’s covenant at the break date the tenant’s choice is really threefold, either: (i) it tries to faultlessly carry out all conceivably required repairs and decoration during the last days of the lease and perhaps whilst trying to run a business from the premises, often to the exacting standard of ‘good and substantial repair and condition’ to the point that even the most brazen of landlords could not in good conscience find fault; (ii) to simply pay the landlord’s inflated first suggested settlement figure (even if double a reasonably negotiated figure); or (iii) simply ignore the literal/strict interpretation of the break condition and hope for a beneficent landlord!

None of the three choices are appealing to, nor fair on, the tenant. To re-iterate the point, the tenant has ‘paid’ for the break right, so it should actually be able to exercise it in practice. A modest improvement on this condition is to limit the level of compliance required using terms such as ‘substantial compliance’ with ‘material covenants’ or, as I often do for my clients, limit the obligations to be complied with under the condition so as to specifically exclude compliance with the tenant’s repairing, decorating and yielding up obligations from the equation.

Similar concerns arise with break conditions requiring: ‘payment of all rents and other sums due’ or ‘vacant possession’. Cautionary examples from case law of tenants’ failures to satisfy break conditions requiring ‘payment of all rents’ and to give ‘vacant possession’ and being unable to end their leases are, respectively, that a tenant failed to reimburse its landlord in respect of some obscure historic loading on a building’s insurance premium and that of a tenant leaving some flimsy internal partitioning in situ at a property.

In brief, if forced to accept the principles of these conditions, a tenant’s lawyer should work hard to reach compromises, such that the Tenant need only have paid all of the basic annual rent and that the Tenant need only hand back the premises free from any actual occupiers or underleases.

To be clear, I am not suggesting that tenants get let off from complying with any of their obligations in a lease (the terms of the lease are a matter for commercial negotiation in the context of the market – the parties make their bed and should lie in it). However, the landlord always has the option to enforce the tenant’s obligations under the lease, if necessary through the courts. The point being made is just that the tenant’s break rights, or more specifically the negation of the break right, should not be used as a barrel to get the tenant bent over, perhaps to force it to pay a dilaps payment that is inflated to the point of being unconscionable. To use the monetary example again, the uncomfortable reality of the tenant’s situation might be that the tenant feels forced to pay £50,000 over the odds to settle a dilaps claim in order to avoid paying rent of maybe £250,000 and other occupational costs for a further 5 years for premises that it does need and which may even be a financial threat to the survival of its business.

Not surprisingly therefore, the RICS Code for Leasing Business Premises suggests that conditions to tenant’s break clauses should be limited as follows: “the only pre-conditions to tenants exercising any break clauses should be that they are up to date with the main rent, give up occupation and leave behind no continuing subleases”. When you stop to consider it, this seems only blindingly reasonable and my hope is that we as property professionals respect the balance of the commercial deal reached between the parties to a lease and give tenants a break!
David Wells
David Wells

Partner and Joint Head of Milton Keynes Office

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