Commercial leases may have a clause which allows a landlord and/or a tenant to end a fixed term lease early, this is known as a break clause. The right to exercise a break clause is subject to the terms of the clause itself and may arise on one or more specified dates or may be exercisable at any time on a rolling basis.
The coronavirus (COVID-19) crisis is forecast to cause a period of economic downturn. During such periods, many tenants and landlords seek to exercise break clauses. Landlord’s may wish to exercise a break clause to remove a non-paying tenant (especially in light of the recent moratorium on forfeiture, discussed in our article) and a tenant may wish to exercise a break clause to free themselves from the obligation to pay future rent. In anticipation of an increase in the exercise of break clauses, we set out below a note on the basics of break clauses and the effects coronavirus may have.
The break clause
There are a variety of break clauses, some being exercisable only by the landlord, some being exercisable only by the tenant, and some which are mutual. When considering whether to exercise a break clause, it is vitally important that the terms of the break clause are carefully reviewed. Exercising a break clause is notoriously easy to get wrong and the consequences of getting it wrong can be severe.
The terms of a break clause are interpreted very strictly by the courts. A failure to exercise a break clause properly will likely result in the lease being deemed to have survived, meaning a tenant is still entitled to occupation and remains liable for rent. As some break clauses only grant the right to end the lease at certain intervals, the exercising party may not have another opportunity to exercise the break clause for a number of years.
The break notice
Invariably, a break clause will require the exercising party to serve a notice. This is the primary pitfall for many parties hoping to exercise a break clause. A break clause will usually provide specific requirements regarding the notice’s content and method of service. The requirements of a notice as set out in the break clause must be strictly adhered to. For example, in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd  AC 749, Lord Hoffmann stated:
"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."
The form of the notice must therefore meet any requirements set out in the break clause. It would be unwise for any party exercising a break clause to be under the impression that a minor change in the form of a notice would be of no effect. If a party was to send a notice on pink paper when the clause specified blue, their attempt to end the lease would fail.
The break notice should be drafted very clearly, and the recipient should have no doubt that it is a break notice in accordance with the break clause. A common error in a notice is a failure to correctly identify the landlord or tenant. The landlord or tenant may have changed during the term of the lease and it is crucial that the correct parties are identified in the break notice.
Service of the notice is equally important, if the clause specifies that notice must be served in a particular fashion (e.g. personal service, recorded delivery or courier) and at a particular place, it is vital that the serving party complies with those provisions.
Break clause conditions
A break clause commonly requires certain conditions to be met prior to a party exercising the clause. In the case of a tenant, this is usually that they have paid the rent (although how much and by when may be different for each lease), complied with all their obligations under the lease and give vacant possession (i.e. vacating the property and removing all their belongings). In the case of a landlord, the lease may specify that they can only exercise the break clause if they intend to redevelop the property. As break clauses are interpreted strictly by the courts, it is crucial that prior to attempting to exercise a break clause, the party ensures they have met all the conditions.
In practical terms, if a party is intending to exercise the break clause in a lease, they should conduct a thorough review of the terms of their lease and ensure they are compliant. This is especially relevant for tenants and their repair obligations. Commonly, tenants will be under an obligation to keep the leased property in a good state of repair and if the break clause requires them to comply with all their obligations, a tenant cannot exercise the break clause if the property is in a state of repair below the standard required of them.
Advice for exercising a break clause
For a party intending to exercise a break clause, it is advised that the following steps are taken:
Step 1 - Review (and review again)
The break clause and the lease as a whole should be thoroughly reviewed, with the following questions being asked:
- when can I exercise the break clause?
- what conditions do I have to meet to exercise the break clause?
- how do I exercise the break clause?
- if exercised, is it likely to be disputed?
Step 2 – Exercise
If upon a thorough review, a party concludes that they have the right to exercise the break clause and decide to, they should do so cautiously. In drafting the break notice, a party should ensure:
- the notice is compliant with the break clause;
- the notice is drafted clearly and contains all the relevant information;
- the notice correctly identifies the other party;
- the notice is addressed correctly; and
- it is obvious on the face of the notice that it is a break notice in connection with the relevant lease.
The importance of a break notice cannot be understated. A minor technical error in the notice could invalidate an attempt to exercise a break clause.
Step 3 – Service
Once the break notice is drafted, the serving party should ensure that it is served in the manner and at the address specified in the break clause. If the break clause states the notice should be served at a specific address unless the other party specifies otherwise, all correspondence should be reviewed to ensure the other party has made no such variation. If the break clause states the notice should be served at a party’s “registered office” it should be checked that this has not changed.
If possible, it would be best practice to try and get the other party or their solicitors / advisors to acknowledge receipt of the notice and confirm that it is indeed effective.
Effect of a break clause
The exercise of a break clause brings a lease to an end on the date specified in the lease (commonly defined as the “Break Date”). It ought to be noted that if a tenant remains in possession of the property having satisfied all of the conditions required, after the Break Date, they will be treated as a trespasser and the landlord may be able to claim double rent.
Effect of coronavirus on the exercise of break clauses
In the wake of the coronavirus, businesses are seeking to minimise their overheads. For businesses with multiple premises (especially within the retail and hospitality sectors), this may mean scaling back their operations and choosing to exercise break clauses where possible. We therefore expect to see a rise in break clauses being exercised by tenants. Landlords concerned about the current rental market may wish to retain their tenants and could seek to take advantage of any procedural error tenants may make in attempting to exercise break clauses.
However, with the UK currently being in lockdown, there are practical issues involved in exercising a break clause. One such issue may be service of the break notice, as if the clause specifies that the notice must be hand-delivered, this would also be largely prevented by the lockdown.
A further issue will be compliance with any conditions. Tenants will likely have to do some works to their property to meet their repair obligations and generally, a tenant is obligated to provide vacant possession when exercising a break clause. This would be largely prevented by the restrictions imposed by the lockdown, making the exercise of a break clause very difficult.
Where the time limits imposed by the break clause allow, it would be advisable to wait until the restrictions imposed by the lockdown are lifted. If this is not possible, those wanting to exercise a break clause should plan carefully on how they will fulfil the conditions and serve the break notice. Historically, the commercial decision to serve a break notice is almost always finalised at the last minute. That is unlikely to give enough time in the current circumstances and if you have the opportunity to operate a break at any point this year, now is the time to start thinking about it.
Tenants and landlords need to consider their options very carefully and wherever possible, talk to each other, negotiate and try to reach an amicable agreement. The exercise of a break clause without any prior discussions may only serve to sour the relationship.
The exercise of a break clause should not be done lightly. It may be that the ability to exercise the break clause is instead brought up in negotiations and assists in focusing parties’ minds. Knowing that the lease may be ended by the exercise of a break clause could lead to agreements whereby landlords offer reductions in rent during the coronavirus crisis with the arrears to be paid by a payment plan, meaning landlords retain their tenants and tenants retain their premises.
As discussed above, there are many pitfalls that await those wanting to exercise break clauses. If you are considering whether to exercise such a clause, it is recommended that you seek professional legal advice.
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