PROPERTY JOURNAL

Why preconditions are critical to lease breaks

When tenants want to break a lease, landlords often have recourse to the way it is drafted and the preconditions in particular – but should in turn be aware of legislation protecting tenants

Author:

  • Sam Draper
  • Michael Smart
  • Colette Brimble

25 August 2023

Photo of the façade of a modern building

In an uncertain economy there is usually a spike in the exercise of break clauses, with tenants seeking to negotiate more favourable lease terms or even extricate themselves fully from properties with untenable rents or surplus space. 

This spike inevitably leads to an increase in litigation, with cases most commonly arising from defects in or service of break notices and issues relating to compliance with preconditions.

While the flexibility of break options seems to benefit tenants alone, landlords are inclined to agree to their inclusion in a new lease to attract and secure good-quality tenants. 

The risk can then be mitigated by ensuring that the right to exercise the break option is personal to the original tenant rather than extending to also protect any future assignee tenants. 

However, a landlord could also seek to include within the lease its own break right – if, for example, it has plans for redevelopment and therefore requires flexibility with the property.

Lease wording crucial in common preconditions

In a recession, a tenant vacating a property could mean the difference between a landlord staying afloat or going out of business. Faced with the difficulties of reletting and liability for empty business rates, landlords are likely to be poring over the small print of leases and the break notice itself looking for areas to challenge in the event that the tenant exercises their option. 

Case law has established that any conditions attached to a break clause must be strictly observed unless these are waived by the landlord. Therefore, non-compliance is a common pitfall for tenants and a heavily litigated area. The most common conditions are as follows.

  • Payment of all rents: This could apply to pure rental payments or be a more widely defined term; the rental obligations in the lease itself will need to be reviewed to determine the extent. The most onerous is 'all rents and other payments reserved by the lease', because this may include payment of all VAT, all outgoings – such as utility payments, business rates, and interest on any late payments throughout the term of the lease. Some break notices specify a termination date that is between the annual rent payment dates defined by the lease. Case law indicates that to comply with this precondition, a tenant must pay the full amount – for example the full quarter as and when due – and not apportion the sum by paying up to the break date only. They will only be entitled to a refund of that overpayment after the break date has occurred if there is an express apportionment provision, but all well-drafted modern leases cater for this.
  • Compliance with all tenant covenants: As an absolute precondition this is virtually impossible for any tenant to fulfil, as it means the property must be given back in 'perfect' condition in compliance with all lease repairing covenants. However it can be qualified with 'materially', 'substantially' or 'reasonably'; the latter being the least onerous, albeit still a difficult hurdle for a tenant. In an ideal world, a tenant would not agree to this precondition forming part of the break right wording in the lease. However, if it is included, the best way to try to comply would be for the tenant to instruct a surveyor and solicitor to carry out a lease compliance audit against the property as early on as possible after the break notice has been served in order to determine where there are breaches and how to remedy them.
  • Payment of break penalty financial sum: This is a fairly common provision and represents a commercial bargain between the parties to reflect the loss to the landlord if the tenant chooses to end the lease early. The precondition should be carefully reviewed to ensure the penalty is being paid in the right way – such as bank transfer or cheque – to the right person – usually the landlord or agent – and by the right deadline, i.e. whether being made on service of the notice itself or simply prior to the break date. The tenant also needs to ensure that the monies have fully cleared by the right time. Recent case law has also established that VAT is payable by a tenant on a break penalty sum – where a landlord has elected its property for VAT – so it is important to include this because failure to do so will invalidate the break. 
  • Vacant possession: This is a heavily litigated precondition and, as such, tenants should resist signing up to this when agreeing lease terms. Instead, a 'give up occupation' condition, preferred by the Code for leasing business premises, England and Wales, is a much less onerous test. The tests for vacant possession can be summarised in three considerations. First, the premises must be free from people, legal interests and chattels; second, on the break date the landlord must be able to enjoy use and occupation of the property without any obstruction or obstacle; and third, the tenant must do nothing to suggest that they are substantially interfering with that. In practical terms, this means a tenant must return the keys, ensuring that all their chattels and fixtures are removed where the lease requires and that no people remain in occupation, including security staff, subtenants or unlawful occupiers. The removal of fixtures is the trickiest of these and there is considerable case law that determines what such fixtures comprise and whether they should be removed. The extent to which any particular fixture is annexed to the property is also relevant, and if it can be argued that the fixture has become part of the land then leaving it in situ will not impede vacant possession. 

Related article

How will UK commercial property fare in 2023?

Read more

Landlords exercising breaks must beware legislation

In the current landscape, landlords are also looking to maximise opportunities with their property investments, and they will also exercise breaks in order to do so. However, the inclusion of a break in a lease made under the Landlord and Tenant Act 1954 does not allow a landlord to circumnavigate a tenant's statutory protection. 

The lease is still subject to the termination provisions of the Act, so any break notice served by a landlord will only end the contractual term of the lease – and not the statutory protection afforded by the Act. A landlord wishing to terminate the tenant's continuation of tenancy under the Act will still need to serve a section 25 notice opposing the grant of a new tenancy

Though it will depend on the drafting of the break clause, it is sometimes possible to serve just one notice. However, it is often advisable to break explicitly by serving both a notice under the lease and another – separately – under the 1954 Act.

One of the most common grounds for a landlord to seek to end a tenancy protected under the 1954 Act is redevelopment, which must meet all the elements of ground (f) of section 30 of the Act – demolition, substantial work of construction or reconstruction. 

Often a contractual break will mirror a statutory one on ground (f); however, a key difference will be the timing of when a landlord has to prove its firm and settled intention to redevelop. 

Under the Act this will be at the court hearing, but under a contractual break it may be much sooner. It will ultimately come down to the drafting, but firm evidence of the landlord's intention to redevelop is usually required either on service of the contractual break notice or by the break date itself.

The evidence needed to prove this intention is usually the same for both; that is, all planning permissions and consents are obtained, and any financing necessary for the redevelopment is in place. However, it could be challenging for the landlord to have obtained all documents if this they are required to do so at the date the notice is served.

Agreement and advice can help avoid litigation

Given that this is a notoriously thorny area of property disputes, well-advised tenants will try to agree a surrender with their landlords to avoid any argument about compliance with complicated preconditions. 

This can be neatly tied up with a dilapidation's settlement agreement in which the landlord waives any pre-conditions and agrees the lease will terminate on the break date – or another agreed date if preferable to the parties – in exchange for the tenant agreeing to pay a financial sum to the landlord in full and final release of its dilapidations liability – the breaches of repairing and yield up covenants under the lease.

If you need support to ensure you comply with break preconditions or are seeking to challenge them, though, you should contact an experienced legal team beforehand.

Sam Draper is an associate director at Osborne Clarke

Contact Sam: Email

Michael Smart is a senior associate at Osborne Clarke

Contact Michael: Email

Colette Brimble is a senior knowledge lawyer in the real-estate disputes team at Osborne Clarke

Contact Colette: Email

Related competencies include: Landlord and tenant, Leasing and letting, Legal/regulatory compliance

Sam Draper

Sam Draper

Michael Smart

Michael Smart

Colette Brimble

Colette Brimble

Related Articles

BUILT ENVIRONMENT JOURNAL

go to article Why party wall surveyors must remain impartial

BUILT ENVIRONMENT JOURNAL

go to article Why BSR is extending building control registration date

BUILT ENVIRONMENT JOURNAL

go to article BRE revises guidance on access to daylight and sunlight