Exercising break options in commercial leases – getting it right

Break clauses have been the subject of much litigation in recent years with landlords seeking to protect income streams from their property investments in a depressed commercial rental market and tenants looking to extricate themselves from onerous lease terms.

However a recent Court of Appeal case has re-affirmed the need for strict compliance with the terms of the lease when exercising break options, and risk that a failure to satisfy the most minor or trivial requirements of the break clause will render the break ineffective.

In the case of “Friends Life Ltd v Siemens Hearing Instruments Ltd [2014]”, the tenant had a lease of commercial premises in Crawley, granted on 27 January 1999 for a term of 25 years.

Why attention must be paid to the exact wording

Clause 19 of the lease contained a tenant-only break clause. This break option enabled the tenant to terminate the lease on 23 August 2013 by giving the landlord “not more than 12 months’ and not less than six months’ written notice”, provided the pre-conditions in clause 19.3 of the lease were satisfied.

These pre-conditions included a requirement that any break notice given by the tenant “must be expressed to be given under section 24(2) of the Landlord and Tenant Act 1954” (the Act).

In September 2012, the tenant served notice on the landlord to exercise the break option and terminate the lease. The notice did not confirm that it was given under section 24(2) of the Act and made no reference to the Act at all. In all other respects, it complied with the requirements of the lease. The landlord argued that the notice was invalid because it did not refer to the Act.

At the initial hearing, the court found in favour of the tenant, and held that the notice was valid. Among the reasons given by the judge were that the missing wording had no impact whatsoever on the break notice.

In allowing the appeal, the Court of Appeal held that the requirement for the break notice to refer to the Act was mandatory and that the tenant’s failure to satisfy this requirement meant that the notice was invalid and thus the break option had not been exercised.

The tenant’s argument that there was “sufficient” compliance was not accepted. The Court of Appeal confirmed that, if the exercise of an option does not satisfy both the formal and substantive provisions of the clause, it will be ineffective.

The Court of Appeal re-iterated the famous statement from Lord Hoffman in “Mannai Investments Co Ltd v Eagle Star Life Assurance Co Ltd [1997]” that if a clause required a notice to be on blue paper, it would be invalid if served on pink paper, no matter how clear it may have been that the tenant wanted to terminate the lease.

Lord Justice Lewison concluded with a message for both landlords and tenants to commit to memory:

“…The clear moral is: if you want to avoid expensive litigation, and the possible loss of a valuable right to break, you must pay close attention to all the requirements of the clause, including the formal requirements, and follow them precisely…”

The lessons for landlords and tenants

The message from the Court of Appeal is clear. It is essential to comply with all the requirements of a break clause, no matter how trivial they may appear to be, otherwise the ability to terminate the lease early may be lost.

For tenants, this is another decision in a long line of recent cases that highlights that it is essential to seek appropriate advice when negotiating the terms of a break option at the outset and again prior to exercising the break to make sure that all formal requirements can and are complied with, otherwise the tenant could be saddled with an unwanted liability for the remainder of the term of the lease.

A stark recent example of the unfortunate consequences that can follow from the failure to comply with the terms of the break clause is a recent Scottish case, where the Court of Session found that a tenant was liable to pay rent until 2023 at around £750,000 a year after it failed to discharge its repair obligations prior to seeking to exercise the break clause.

Landlords will be encouraged by this decision, but they would be well advised to make sure that the break option is well drafted and the requirements for exercise of the break are clearly specified when the lease is negotiated. They must also seek immediate advice on receipt of a break notice as to whether the tenant has complied fully with the terms of the break clause.

For more information on this, or any other property litigation matter, contact Colin Fenny on 01772 258321. Colin is the head of Harrison Drury’s litigation department at our Preston office.