Real Estate rationalisation: Lease break cases hit the headlines

14th September 2016

In times of economic decline or uncertainty, businesses look to divest themselves of surplus property to reduce rental commitment.   As lease breaks hit the legal headlines again, Real Estate Litigation specialist Martin McKeague reviews recent cases and shares his practical advice.

Focussing on the core of a business can be a sensible strategy when it comes to improving efficiency. It is therefore often a strategy that is adopted in times of economic decline or uncertainty.  A recent survey on corporate real estate usage and surplus property in the years 2012 – 2014 concluded that, despite the intentions of many businesses to drive down overheads and to concentrate resources on their core following the 2008 financial crisis, many corporates have not yet made significant changes to their property usage, so as to increase efficiency and reduce rental commitment.

In the wake of the “Brexit” result on 23 June 2016, the economic outlook is uncertain.  That means that businesses may increasingly look to their property portfolios to see whether divesting of any surplus could be a means of saving cash.  In the current climate, and in light of recent case law, Real Estate Litigation specialist Martin McKeague shares some practical advice for businesses considering their lease break options.

Context and recent case law

Whilst the cost savings involved in a rationalisation exercise can be significant, so too can the risks. Apart from the commercial, HR and PR issues that can arise if a tenant’s departure from business premises is not handled sensitively, there are important legal and procedural considerations that need to be followed.  Once the decision has been made to seek to bring a commercial lease to an end, the failure to serve a valid break notice can have drastic consequences.  The business may lose the opportunity to break the lease and therefore remain liable and tied into the property with long-term, unwanted commitments.

In the leading case of Mannai Investment v Eagle Star [1] in 1997, Lord Hoffmann famously said: “if the [termination] 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.”  In doing so he vividly articulated that strict compliance, with both contractual break conditions and any particular service provisions, is required for lease breaks to be effective. Two recent cases have reaffirmed that strict approach.

In Riverside Park v NHS [2], the ten year lease contained a one-off break option for the tenant to terminate the lease after five years, subject to the giving of a valid break notice and on condition that vacant possession was delivered up on the break date. The tenant served a valid notice on the landlord, however it did not remove internal demountable partitioning.  The tenant argued that the partitioning amounted to ‘fixtures’, which had become part of the premises and did not have to be removed in order for vacant possession to be delivered; whereas the landlord argued that the partitions were mere ‘chattels’, which the tenant was obliged to remove.  The High Court agreed with the landlord [3] and concluded that the tenant had not given vacant possession and had not therefore complied with the break condition.  The tenant was found not to have validly exercised the break and it remained tied to the lease for the whole of the remainder of the term (a further five years).

Having acknowledged that notices requirements and break conditions must be strictly complied with, the House of Lords in Mannai did, however, also recognise the need for the law to provide a realistic and workable framework.  It therefore developed the ‘reasonable recipient’ test.

In Vanquish Properties v Brook Street [4], the lease contained another one-off break option – this time for the landlord to terminate the lease on a specified break date.  The landlord originally named on the lease had granted an overriding lease to “Vanquish Properties (UK) Limited Partnership acting by its general partner Vanquish Properties GP Limited”.  With the intention of facilitating redevelopment plans for the premises, Vanquish Properties (UK) Limited Partnership purported to serve a break notice.  The tenant challenged the validity of the notice, arguing that the landlord was, in fact, Vanquish Properties GP Limited [5] and so the landlord had not given notice in accordance with the lease at all.  By this time the deadline for service had passed, and so no further/alternative notice could be served.

The tenant also argued that the incorrect name on the notice was a defect which the Mannai principle could not save because a reasonable recipient would be confused.  The High Court agreed, and again the right to break the lease was lost.

Top tips and traps for the unwary

As these cases demonstrate, very careful consideration must always be given to the exercise of any break. The starting point when serving a break notice must always be to examine the lease and the contractual provisions which set out the option to determine; any conditions which must be complied with; and any particular requirements for service (including when notice must be given, how notice must be served and on whom, and by whom, it must be served).

• When?

The question of when a break notice can be served is very important, especially if the option is a one-off or ‘once and for all’ break (as opposed to a ‘rolling break’). There are then three dates/ to ascertain: the break date; the date by which notice must be served (that is, when the notice must be received by the other party); and, working back, the date by which the notice must actually be issued.  If any of these are calculated incorrectly then there is a real risk that the break notice will not be validly drafted or served, and the lease will continue.

• How?

It is essential to check whether the break clause contains a specific methodology for serving notice or whether the lease contains general ‘service of notices’ provisions elsewhere. Service must be effected in accordance with any contractually specified provision. For example, the lease may specify that service must be by fax or e-mail at a particular address; by first class or registered post; on an agent as well as, or instead of, on the party; or even that notice must be written on pink paper!

• Who?

As indicated earlier, it must be ascertained exactly who is required to give the notice and on whom the notice is required to be served. However determining the correct party/ies is often more difficult than first imagined. For example, in most cases the landlord and tenant are no longer the original contracting parties; the land or tenancy may be unregistered; the landlord/tenant may not be based in the UK; and/or the lease may specify that the notice must be served on an agent.

In the case of The Hotgroup Plc v The Royal Bank of Scotland Plc [6] the lease required service not only on the landlord but also on the landlord’s managing agents, and both within the specified timescale.  A notice was served on the landlord in time and on the managing agent shortly thereafter and despite the landlord actually receiving notice, the break was held to be invalid and ineffective.

• What? Conditional Break Options

Conditional break options should be approached with real caution. If the lease requires absolute compliance with one or more conditions, then failure to do so, no matter how trivial, will render the break ineffective. For example, that would be the case if a break was conditional on making payment of all lease sums and just a penny remained outstanding at the break date or other prescribed time.

The most common condition is the payment of all rent due as at the Break Date. On the face of it, that seems straightforward and fair enough. However, is rent is defined within the lease and does it include service charge and/or insurance rent. If it does, can these be properly calculated or ascertained? Does rent (and potentially other sums) simply have to have fallen due under the lease, or do sums have to have been demanded? If sums need to have been demanded, can the tenant guarantee that the landlord will have demanded sums in time for the tenant to make payment?

Another common condition is for a tenant to comply with its repairing obligations. The landlord is under no obligation to confirm exactly what work it expects to be carried out, nor to provide any certainty prior to the break date that any works carried out are satisfactory to discharge the tenant’s obligations.

If conditions in a break option are not absolute, they are often drafted to say that the tenant must materially, substantially or reasonably comply with certain conditions. The purpose of this is to try and protect the tenant from rendering the break invalid due to minor and inconsequential breaches. The problem here is that each of these terms can have a slightly different meaning and it is difficult to know with any certainty what the minimum level of required compliance is. In these circumstances we would always advise the fullest possible compliance. Apart from the risk of a break being ineffective, a party will always face the risk of a damages claim for breach of covenant either during or after the end of a lease in any event. The fullest possible compliance has the dual-effect of mitigating that risk.

WM Comment

It is clear that there is a considerable amount of risk and time involved in serving a break notice and complying with the relevant conditions. The best advice for any business considering its options is to seek the advice of a specialist Real Estate Litigator at the earliest possible time.  They will be able to advise on the exit strategy including, where appropriate, any dilapidations issues.

If you have any queries or concerns arising from the issues highlighted in this article, please do not hesitate to contact Martin McKeague or any member of Walker Morris’ Real Estate Litigation team.

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[1] Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749
[2] Riverside Park Ltd v NHS Property Services Ltd [2016] EWHC 1313 (Ch)
[3] in a decision that is equally of interest for its discussion and application of the law on fixtures and chattels.  See also Walker Morris’ earlier briefings on that subject.
[4] Vanquish Properties (UK) Limited Partnership v Brook Street (UK) Ltd [2016] EWHC 1508 (Ch)
[5] a limited partnership is not actually a legal entity in its own right and so it cannot hold an interest in land and it cannot, therefore, be a landlord
[6] [2010] EWHC 1241 (Ch)