Introduction
This is a brief overview of the law relating to contractual rights in leases of commercial premises that allow the landlord and/or the tenant to terminate the lease before the end of the full contractual term. These rights are commonly known as “break rights”. The law applies to England and Wales.
To keep this overview as succinct as possible it has been necessary to deal briefly with some points that are in reality quite complex. Specific legal advice should always be obtained as to how the principles set out below apply in any given situation.
The purpose of break rights
Investment landlords are generally keen for commercial leases to have initial terms of 10 years or more to provide certainty of income and enhance their investment value. However many tenants (in particular retail tenants) are keen to preserve flexibility and are therefore reluctant to take such long leases, especially if the lease is in any event going to enjoy the benefit of the security of tenure provided by the Landlord and Tenant Act 1954 (“the Act”), which gives business tenants a right to renew their lease at the end of the initial term. It is therefore common for the parties to compromise by agreeing a term of, say, 10 years but to include a right for the tenant to break the lease after the first five years of the term (a “tenant break right”).
On the other hand, if the landlord anticipates that it might want to redevelop the premises at some point during the term of the lease it may also wish to include a right for it to break the lease early (a “landlord break right”).
Why this is important
A right to break the lease early may be critical to a landlord’s ability to obtain vacant possession to redevelop a building, or to a tenant’s relocation plans. The existence of break rights in a lease may also have significant valuation implications in respect of the landlord’s interest in a building and the certainty of rental income in the future. It may also impact on the level of rent payable by the tenant.
Accordingly both landlords and tenants need to understand the nature and effect of any break rights in the lease and the complications and lack of certainty that can arise when seeking to exercise any such rights.
Commercial considerations
The inclusion of a tenant break right may increase the level of rent payable because the landlord will have less certainty of future income. Similarly the inclusion of a landlord break right might depress the level of rent payable by the tenant as it will not be certain that it can remain in the premises for the full term and may have to incur the inconvenience and costs of relocation. Both landlords and tenants need to bear this in mind when seeking to negotiate the terms of the lease.
Service of the break notice
Break rights can only be exercised on reasonable prior written notice and usually a minimum of 6 months’ notice is required.
The Courts require that to be valid, a break notice must be served strictly in accordance with the terms of the lease. For example, leases generally include specific provisions setting out how notices should be served on the parties, sometimes by reference to statutory provisions such as s.196 Law of Property Act 1925. It is essential that the notice should be addressed to the correct legal owner and sent to the appropriate address by the method specified in the lease and that proof of service is obtained. As Lord Hoffmann made clear in the leading case Mannai Investment Co Ltd v EagleStar Life Assurance Co Ltd [1997] AC 749, “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 terminate the lease”.
It is therefore prudent for a landlord or tenant to ask its professional advisors to serve a break notice on its behalf and to review the validity of any such notice served by the other party.
The need for strict compliance with conditions
Usually the only condition to the exercise of a landlord break right is the service on the tenant of the requisite break notice, so that the mere service of the notice will end the lease on the date specified (unless the lease is within the Act – see below).
Historically however a tenant break right has included fairly onerous conditions to its exercise, such as full compliance with all the tenant’s lease obligations, including the payment of all rents and full compliance with its repairing obligations. As the Courts have required strict compliance with such conditions for the break to be valid, this has caused real difficulty for tenants. They cannot be sure that they have effectively terminated their lease until after the intended break date because the landlord may challenge the validity of the break on the basis of some minor technical breach of the lease, such as minor disrepair or failure to pay a small amount of service charge. In the light of this a tenant should always scrutinise carefully the conditions proposed by the landlord in relation to the exercise of a break clause and seek to limit them if they are too onerous.
Break rights and rent
Most leases require the rent to be paid in equal quarterly payments in advance on the usual quarter days (March 25, June 24, September 29 and December 25). This means that the full quarter’s rent falls due on each quarter day and it is not automatically apportioned if a break date falls part way through the quarter. To ensure that its break notice is effective, a tenant must therefore pay the whole quarter’s rent even when the break date occurs during that quarter.
If the tenant wants to avoid having to pay for a period when it will not have the benefit of the premises it should ensure that the break right provides expressly for the apportionment of the rent, or for the landlord to repay the balance of the rent for the period after the break date.
Break rights and security of tenure under the Act
Business tenants of commercial leases within the Act enjoy additional security of tenure, in particular the right to renew their lease at the end of the contractual term. Such leases can only be terminated in accordance with the provisions of the Act. As a result, whilst a tenant break notice will be effective to terminate the lease whether or not it is within the Act, a landlord break notice will only be effective to end the contractual term of a lease within the Act: the tenant will still have a right to a new lease under the provisions of the Act unless the landlord can also establish one of the statutory grounds of opposition and potentially pays compensation.
If it is essential to a landlord that it can terminate the lease early and obtain vacant possession for redevelopment, the lease should be “contracted out” of the scope of the Act. We have prepared a separate Overview on the contracting out procedure which is available on request.
