Break clauses in commercial property

Break clauses are a common part of the commercial landscape during negotiations for the grant of a lease of commercial property.  For the tenant they offer flexibility allowing tenants to consider the business needs whether they are downsizing or upsizing, seeking to embrace flexible working patterns or simply relocating if the premises have become over-rented and market conditions allow attractive deals to be struck elsewhere.

The cost of the break is ordinarily priced into the deal reached with the landlord.  The break means the landlord is receiving a shorter term of secured income.

The cost of any such relocation including fit-out, IT infrastructure, Stamp Duty Land Tax (SDLT) and professional costs, means that a tenant wants certainty it can determine its interest. A landlord may, in a weak market, look to hold the tenant to the letter of the lease provisions agreed if there is any ambiguity.  Traditionally, compliance with any conditions attached to a break clause have been rigidly interpreted by the Courts.  Therefore the tenant should ensure that they can comply with such conditions on a strict basis.  It is these conditions that unfortunately form the “battle lines” in any subsequent litigation on the construction of such break.

Break clauses come in all shapes and sizes. Invariably they have conditions attached.  At its simplest, this is by service of a break clause on the landlord on say six months’ notice.  At the other end of the spectrum, the clause may require payment of ‘all sums due’ and compliance with all other covenants in the lease e.g. repairing and decorating covenants.

The 2007 Lease Code recommends that:

“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 sub-leases.  Disputes about the state of the premises or what has been left behind or removed, should be settled later (like with normal lease expiry)."

New Leases

Parties are free to agree their own commercial terms.  It is therefore key when you agree heads of terms that any pre-conditions on a break clause are set out at this stage – in the long run it saves time.  We would suggest that a two pronged approach be taken.  Firstly, you should instruct your agents to agree an unconditional break and secondly, you should discuss the draft heads of terms with your solicitors before you sign off the terms so that any issues are identified and dealt with at the outset. Clear advice at this stage will help when it comes to documenting the agreement and exercising any break rights in the future.

Ideally the lease should include a provision for the landlord to repay any overpayments of rent or service charge on determination.

Existing Leases

Where the lease has already been completed and you are considering your options the following checklist will assist:

• Review the lease and notice provisions. Assess options.
• Take advice early, particularly if there are any conditions attached to the break right.  There may be a long lead in time (e.g. tendering and completing significant works) to ensure compliance with any conditions attached.
• Ensure that the right party receives the notice. It’s not unheard of for former landlords to be served notice in error. Checking the last rent demand is one quick method – but it is not fool proof.  Keep evidence of how service of the notice is effected.  In the absence of a deemed service provision, a tenant could ask the landlord to acknowledge receipt.
• Ensure that payments are made in cleared funds in good time prior to the break.
• Pay all disputed sums.  You can dispute liability after the break if there is any merit and/or make payments on a without prejudice basis.  It may go against the grain but consider the cost/risk analysis to the business of the lease being held by the courts to continue.
• Check payment history to assess whether any interest has accrued on late payments and also beware last minute claims for service charge that may need to be settled if the lease requires payment of ‘all sums’ demanded. Ensure someone is on hand to settle any last minute demands.
• Make provision early to deal with any undertenants or other occupiers so that you can ensure you are able to yield up in accordance with the provisions of the break clause.
• Discuss with the landlord whether any works need to be undertaken prior to termination (disrepair, decorating or reinstating alterations etc).  Whilst it may add to the cost, asking the landlord to produce a schedule of dilapidations will help provide some certainty.  The landlord is not obliged to enter into dialogue but it may assist in any subsequent litigation.

Agreeing a full and final settlement early by formal deed of surrender (to include any dilapidations claim) reduces “wriggle room” and the prospect of a claim (however valid) that needs to be defended.

Next week we will provide a brief summary of some of the current cases on the exercise of breaks. For more information on break clauses or to assist with a review of your occupational requirements please contact a member of the Kingsley Napley Real Estate team.