We are all aware of the Bank of England’s stark warning that the UK now faces its longest recession since records began, with rising interest rates and inflation running at a 40-year high.
Against this backdrop, and with the cost of occupying commercial premises likely to be a significant overhead for most businesses, tenants may be evaluating their property portfolios and needs to identify if any savings can be made.
A tenant’s break option in a lease offers a tenant one such opportunity – whether to exit the lease early and relocate to cheaper premises or to renegotiate more favourable lease terms. Particularly in recessionary times, and where a lease has upward-only rent reviews, this can be a very valuable tool for a tenant to avoid potential cash flow problems that could jeopardise their business.
However, break options are rarely as straightforward as they may seem. The requirements for the form and service of the notice must be strictly adhered to. Additionally, tenant break options usually contain pre-conditions, some of which can be very difficult to satisfy. If there is a failure to comply with any of these, the break will be ineffective and the lease will continue. Consequently, break options need to be approached with great care.
On the other hand, landlords may be scrutinising the exercise of break options if they are facing high occupancy rates.
Plan ahead
Break options typically require the tenant to give formal notice to the landlord if it wishes to bring an end to the lease. Often the notice period is 6 months but sometimes longer. Therefore, a tenant who wants to break – or simply to use the option as leverage to attempt to negotiate better lease terms with their landlord – should consider the break option well in advance.
It is important to seek legal advice on the exact length of notice required to be given and the break date as the lease wording can be misinterpreted. If a ‘fixed date’ break option is missed, the opportunity to terminate the lease early is lost.
Another reason to look at the option early on is that it could take several months to satisfy the break conditions (more on this below).
Serving the notice
If the lease prescribes a particular form of notice, it must be used. The notice also needs to be served on the correct party at the right address and the lease may also prescribe how that notice is served. What appears a basic issue has in fact led to an abundance of litigation in this area. Accordingly, a party exercising a break option should tread very carefully.
Compliance with break conditions
Quite often a break option can be drafted on a conditional basis. This means certain things have to happen by a certain date for the lease to terminate on the break date. To comply with even a relatively simple condition may take a good deal of care. For example, a break option requiring the tenant to pay the ‘rents’ by the break date requires the tenant to establish precisely which rents and how much of each rent is due (remembering that there will be no apportionment of rent unless the lease expressly provides for it).
Depending on the definition of “rents” in the lease, such a condition may also require the tenant to pay any default interest on late payments (even if the landlord has not demanded such interest). In one case the tenant’s non-payment of default interest invalidated the exercise of the break, even though the amount involved was only about £130.
In such circumstances – short of agreeing with the landlord what, if any, amounts are owing under the lease (which may include a break premium) – a tenant would be well advised to include a sum to cover any potential interest. It is therefore sensible for a tenant to carry out an audit of the lease payments in sufficient time before the break date to arrange any payment. More generally, any sums due should be paid, even if in dispute. Payment can be made on a ‘without prejudice’ basis and the matter contended later.
Where a break clause includes a condition for the tenant to return the premises with “vacant possession” by the break date, the law has historically been far from clear what this means in practical terms, often leading to disputes when items were left behind. Whilst a recent Court of Appeal decision has offered some clarity (determining that vacant possession requires a property to be returned free from people, chattels and legal interests) this remains a challenging condition to satisfy and a substantial amount of work may be needed in the removal of all chattels. A tenant will also need to terminate any existing third party interests, such as sub-leases, and this requires forward planning to ensure that the break options in any underlease(s) dovetail with the main lease or the tenant could fall foul of this condition.
Some break clauses go further and require compliance with ‘all tenant covenants’. In such instances, very careful management of the process will be needed as (depending on the specific lease wording) even trivial breaches can invalidate the exercise of the break. In one case the tenant lost its right to break the lease because it had painted the premises 13 months before the break date instead of within 12 months (despite this making no practical difference)! Thus, if the tenant is to successfully break the lease, a considerable amount of work may be required not only by the tenant itself, but also advice and input from the lawyers, agents and dilapidation surveyors if works need to be undertaken to meet the condition.
Avoid distraction from the landlord
It is almost always sensible for the tenant to speak to the landlord about the break option to see if a deal can be done – for example, in exchange for not exercising or removing future break options, the tenant may be able to negotiate other advantages (depending on the parties’ bargaining positions and prevailing market conditions):
- a rent reduction or an extra rent-free period;
- removal of future rent reviews provisions;
- a reduction in space; or
- less restrictive alienation rights (e.g. enabling the tenant to more freely assign or sub-let).
However, the landlord has no obligation to enter into such negotiations and, unless and until a legally binding agreement is reached, the landlord can end discussions with the tenant at any time. Therefore, the tenant must not allow such discussions to create a (false) sense of security.
So if, for example, a 3 month works programme is required to comply with a break option, the tenant would be well advised to commence the works at least 3 months before the break date to ensure compliance, however close the parties are to doing a deal. If the works do not start, and the tenant is left with insufficient time to comply with the condition, the tenant will face the possibility of non-compliance and, in the absence of agreement waiving the required condition, the lease will continue.
No going back
If a tenant serves a break notice to create leverage for re-gear discussions (if they consider their landlord may prefer to keep them on less advantageous terms rather than suffer a vacant premises), a tenant should start those negotiations without delay as their time for negotiating and documenting the new terms will be lost come the break date if the tenant has no true intention of leaving.
Once a break clause has been exercised by the service of a notice it cannot be withdrawn unilaterally by the tenant. While a tenant could not satisfy a break condition to frustrate the break, the risk remains that the landlord waives that condition and the tenant finds itself without a lease, when that may not have been its intention on serving notice.
Conclusion
The exercise of tenant break options tends to increase during an economic downturn as tenants seek to re-gear their leases or terminate existing arrangements. There are many pitfalls (for both landlords and tenants) when attempting to exercise a break option. Given the stakes, it is important to seek early legal advice.
Key Points
- Break options give tenants the opportunity to end lease arrangements early or to potentially renegotiate terms.
- The conditions of break clauses require strict compliance.
- Tenants should consider their options well in advance.