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Wednesday, 26 January 2011

Lease Break Clauses – What Can Possibly Go Wrong?

In my post Lease break clauses – what if you change your mind? I looked at what happens if you are a tenant, you serve a break notice terminating your commercial lease, but later on you change your mind and want to stay.

But let’s say you really want to go.

When you try to make use of a break clause to end your lease, can anything go wrong so that the lease doesn’t end and you have to carry on paying for space you no longer need and no longer want?

In a difficult market landlords will be keen not to let their tenants leave, so getting this wrong can be a disaster. You should always take professional advice to make sure this is handled properly, but here are some important things to look out for.

Do you have the benefit of the break clause?

The break clause must be read carefully before your break notice is served. If you are not the original tenant (because the lease has been assigned to you), then you need to check that the break right isn’t the kind that can only be exercised by the original tenant.

A personal right to end a lease, meaning one that was only given to the original tenant, is lost after the lease has been assigned. If the break right is not personal, then it can be exercised by you as the current tenant.

When can you end the lease?

The break clause might specify a once-only break date, or several different break dates throughout the term, or it might provide for a right to end the lease at any time after a specified date. If there is only one break date, make sure you haven’t missed it.

Have you served the break notice properly?

When drafting and serving the break notice, advisors must take great care to read the terms of the lease very carefully, both the break clause itself and the general provisions in the lease dealing with serving notices, and must comply with them to the letter.

The courts interpret these provisions strictly and a mistake can mean the notice has not been validly served and the right to end the lease has been lost.

If there are no provisions for serving notices in the lease (which is rare these days), then the position is governed by s196 of the Law of Property Act 1925 which provides that a notices can be served personally or by recorded or registered post on the landlord’s last known place of abode or business, provided it is not returned undelivered.

Make sure the notice is served on the right person. Your landlord may have changed and you may need to search the Land Registry to verify ownership. It might not be the same name that appears on rental invoices.

Whether or not you can serve a notice on the landlord’s agents depends on whether the agents have authority to accept notices on the landlord’s behalf. It is safer to serve the notice on both the agents and the landlord itself.

There is no special form of notice prescribed by law, but the lease might include a form of notice that must be used, so again check the lease carefully.

And make sure you serve the notice in the right name - see my later post Lease Break Clauses - Get Your Own Name Right!

Have you served the notice in good time?

The break clause will usually provide for prior written notice to be given to the landlord by a minimum number of months before the break date. This notice period can often be quite long, say 9 months or a year before the break date, but sometimes it may be shorter.  Whatever the period is, time is of the essence for notice periods whether the lease actually says so or not. That means if you are too late in serving the notice, even if only by one day, you will lose the right to end the lease. Notices should therefore be served as far in advance of the minimum notice period as is commercially viable (but not too far in advance, or you might change your mind!).

Do you need to send a copy of the notice to anyone?

In The Hotgroup plc v The Royal Bank of Scotland Plc [18 may 2010] the court ruled on a notice provision in a lease which said that a notice was not validly served unless a copy was also served on the landlord’s agents. This provision was designed to ensure that a notice did not "gather dust" in the landlord's offices, but came to the attention of the person with actual responsibility for the management of the property.

Although the notice was served on time, the copy was served at a later date and was unfortunately out of time. The court held that the break notice was therefore ineffective and the lease was not ended. Therefore you need to check carefully whether the lease says you must send a copy of the notice to someone. If it does, be sure to send the copy at the same time as serving the original notice.

Do any conditions need to be complied with?

Break clauses often provide that certain conditions have to be complied with by the time of the break date, and that if those conditions have not been complied with, the lease will not come to an end. Therefore it is vital you look at what conditions apply (if any). If there are conditions, make sure you comply with them to the letter.

For example you might have to pay a premium to the landlord on the break date. This would normally be specified in the break clause. If so, make sure it is paid to the landlord in good time.

Here are some other conditions often seen in break clauses which you need to look out for.

·         The rent must be paid up to date at the break date

This condition isn’t as straightforward as it looks. For example, service charge might have been reserved as rent, and that won’t necessarily be a fixed amount; or the lease might say "all sums" have to be paid. If so, you need to get from the landlord a confirmed amount of what is due to be paid by the break date.

The clause might only require the “principal” rent to be paid up to date. However, if the rent is paid quarterly in advance then that means a full quarter’s rent must be paid for the last quarter, even if the break date doesn’t coincide with the quarter day. So for example if the break date was 10 October 2011, you would still have to pay a full quarter’s rent on 29 September 2011 and you won’t get back what you have paid for the period 10 October 2011 to 24 December 2011 even though you have gone! This is because there is no common law right to apportion rent.

You might be lucky and the break date will fall on the quarter day; or if not sometimes the lease might oblige the landlord to reimburse you the balance of the quarter’s rent. However, unless the lease actually obliges the landlord to refund to you any rent or other sums paid beyond the break date, you are not automatically entitled to a refund. However, it is still better to make the payment in full and hope the landlord might give you some of it back than to lose your right to end the lease.

·         The lease covenants must be complied with at the break date

It can be very difficult to be certain you have complied with this condition (which is why, as a tenant, you should never agree to it in the first place!). The landlord might say the break clause hasn’t been complied with even if there has only been some minor breach, such as a bit of minor disrepair.

The condition might instead require that there is no “material” breach of covenant at the break date. Your position as tenant is stronger here. A court would try to look at this objectively. A material breach is not a trivial breach; it must affect the landlord’s ability to sell or re-let the property without delay or additional expense. Minor breaches of repairing or decorating obligations that do not affect those dealings are unlikely to amount to material breaches.

Have a survey carried out to determine what work needs doing and do all of it before the break date. You might need to move out before the break date so that all the work can be done. You cannot leave on the break date without doing the work and then offer to pay damages in the way you can with dilapidations on a normal expiry of a lease term.

·         Vacant possession must be given at the break date

This condition often causes problems, as landlords might be able to argue that vacant possession has not been given if you have left anything behind at the property.

Does accidentally leaving an old coffee cup on the floor mean you haven’t given vacant possession? Probably not, but the best thing is simply to clear everything out to avoid any argument. If any employees remain at the premises, or if you carry on using part of them for storage, you are likely to be found not to have given vacant possession.

Give the keys back! Keeping the keys beyond the break date will probably mean you have not given vacant possession. If the keys have been lost, change the locks and give all the new keys to the landlord. If you have installed an alarm, give the code to the landlord so it is not prevented from entering the premises.

Get rid of any trespassers! If any trespassers are present on the property on the break date then you haven’t given vacant possession. Clearly this is a concern if you have actually left the premises some time before the break date. You need to make sure the premises are kept secure for the period leading up to the break date and keep regular checks to make sure no one has broken into them.

If you have any subtenants or someone sharing the premises (such as a concessionaire or franchisee), you have to make sure they all vacate the premises by the break date too. Your break clause will only work if you know you can terminate any subleases or sharing agreements and get rid of the subtenants or sharers by the break date.

Finally, don’t forget to leave!

Even if there is no condition to give vacant possession, don’t forget to leave the premises on the break date. If you outstay your welcome the landlord might choose to invoke its right under s18 of the Distress for Rent Act 1737 and claim double rent for the period in which you remain there as a trespasser. They took a hard line in the eighteenth century!

Breaking up can still be hard to do even if you haven’t changed your mind. The moral this time is if you really want to go, make sure you do everything the lease says you have to do to comply with the notice provisions and the break clause.

Thursday, 13 January 2011

Overage – Can It Ever Be Future Proof?

What is overage?

Overage is basically the right of someone who is no longer the owner of a piece of land to share in the increased value of that land at some future date. It is often an additional payment that is made to a seller at some time after completion of the transfer of the property (sometimes many years after) and is usually triggered by some event that enhances the value of the property.

In the public sector it is often called “clawback”.

For example, a seller might want to share in future increases in value triggered by the grant or the implementation of planning permission, or take a percentage of future sales following the grant of planning permission.

Perhaps the seller is a farmer selling off bits of land to a developer, and the farmer is only willing to do so if he gets a piece of the action down the line when the developer has built expensive homes and started selling them off. Or maybe an initial sale of land was at a low price to reflect unquantifiable problems such as contamination or something nasty on the title. If curing the problem turns out not to be as expensive as first feared then the seller might want to take a share of increases in value or sale-on proceeds.

Sometimes it might just be “icing on the cake”, the seller will add it on to the terms if it can get away with it.

In the public sector, there may be political reasons why a local authority or government organisation might want to claw back some of the value of land it has sold. If such an organisation sells public property to the private sector and that land subsequently shoots up in value, it will not want to be seen by the voters to have sold it too cheaply, and such bodies have to think of their fiduciary duties to the public as well. In those circumstances it is common for the organisation to try and get a share in future value.

So what will be the trigger that makes overage payable? This is where the seller and its advisers need to try and see into the future and predict what will happen to the land that so enhances its value that the seller can ask for more money. It often calls for some complex and creative drafting of contracts, but a seller needs to be careful that the costs of doing all that don’t outweigh any future gains. It can sometimes be an expensive guessing game.

Can overage ever be future proof?

No, not really. That oft-quoted distillation of profound philosophical truth made by Donald Rumsfeld in 2002 illustrates the problem:

“There are known knowns; there are things we know we know.
We also know there are known unknowns; that is to say we know there are some things we do not know.
But there are also unknown unknowns – the ones we don't know we don't know

That is not to say overage is a weapon of mass destruction, although I once received an overage clause about 30 pages long which certainly had a pretty devastating impact on my mood that day (and “blew the bloody doors off” any hopes my client may have had to get the deal done quickly).

We can try and deal with all the “known unknowns” we can think of, like whether planning permission will be granted for something juicy, or whether it will be implemented, or whether the market will go through the stratosphere. These are circumstances or outcomes that are known to be possible, but we don’t know whether or not they will take place.

But what about the “unknown unknowns”, the things we haven’t conceived of when we sell the land? Or to put it another way, the things the client will probably expect you to have known but which no sentient being could realistically have predicted!

There was a case in 2010 which illustrated the “Rumsfeldian Overage Trap”, as no one is calling it. In Hildron Finance Ltd v Sunley  Holdings Ltd [2010] EWHC 1681 (Ch) a company failed in its claim under an overage agreement to a share in the proceeds of sale of a flat because the sale was triggered by a long leaseholder excercising its statutory right to acquire the freehold, and not by a sale on the open market, which is what the overage clause in the sale agreement provided for. The agreement had been entered into in 1986, but it wasn’t until 1993 that the law was changed giving the leaseholder the right to acquire the freehold. How could the seller’s advisers have known, in 1986, that the law would be changed in 1993 which would then lead to a situation in which the overage clause was basically “frustrated”, as the court held?

The lesson is that you cannot, unless you are a Timelord (in which case I would venture to suggest you should probably have more interesting things to be doing), draft overage agreements to cover all future possibilities.

Any practical tips (apart from investing in a TARDIS)?

Try not to make the overage period too long. The greater the length of time, the more risk there is of an “unknown unknown” materialising.

Throw in as many triggers for payment as you can think of, whilst being realistic and staying within the bounds of reason and sanity.

If it all seems too difficult, forget about it altogether and try and put the price up. Although, given the way things are at the moment, to do that you might need the gift of time travel.

Friday, 7 January 2011

Lease Break Clauses – What If You Change Your Mind?

What happens if you're a tenant, you serve a break notice terminating your commercial lease, then subsequently change your mind? 

Let's say you are a medium sized company operating from premises that are starting to seem too big for you now that you might have to let a bunch of people go. 

The lease stretches ahead for a number of years but then you remember there’s a break clause giving you a once-only opportunity to cut and run. 

It’s in a year’s time, but you have to give at least 9 months’ notice in writing. You ask your lawyer to serve it straight away, so you don’t miss the deadline later on. Your lawyer serves the break notice on your landlord and you start looking around for somewhere smaller and cheaper.

Then a couple of months down the line a big new order comes in together with the opportunity to take on new staff. That new space you’ve found won’t be big enough now. In fact, the best thing of all would probably be to stay put. 

What are you going to do about the break notice?

You have to get on to the landlord quick, and what happens next doesn't just depend on whether the landlord says yes you can stay or no you can’t.

If the Landlord says no you can’t withdraw your break notice (because it has already lined up a new tenant, for example), can you withdraw it unilaterally? 

The answer is, no. Once it has been served, that’s it. You cannot take it back unless the landlord agrees.

If the landlord says yes, then it’s good news so far as staying put is concerned, but it doesn’t mean you can simply carry on as though nothing has happened and let bygones be bygones. 

The law, in another of its “beware of unintended consequences” moments, says that if both parties agree to a withdrawal of a break notice, then an implied new lease takes effect from the expiry of the break notice, even if the landlord and the tenant agree to withdraw the notice before it expires.

This is thanks to a case decided way back in 1868 (Tayleur v Wildin), which a lot of learned folk think was wrongly decided, but it has nevertheless been followed ever since and remains the law until someone is brave enough to challenge it.

The implied new lease will be on the same terms as the old lease, save as to term length (which will start on the break date and continue until what would have been the last day of the old lease). 

On the face of it that might seem no big deal, but the unintended consequences of a new lease being implied could be very unwelcome, to both parties. 

The knock-on effects might be as follows (the first five being potentially more of a problem for the landlord than the tenant):-

·         The implied new lease won’t be excluded from the Landlord and Tenant Act 1954 even if the old lease was excluded. The tenant might therefore get security of tenure through the back door.
·         A guarantor under the old lease would be released.
·         If the old lease was an “old” lease under the Landlord and Tenant (Covenants)Act 1995, the implied new lease will nevertheless be a “new” lease under the 1995 Act. Former tenants and guarantors under the old lease would be released. The usual release provisions would apply on future assignments of the implied new lease, and the landlord would have no express right to ask for an authorised guarantee agreement.
·         Repairing obligations requiring a tenant to repair to a standard at the beginning of the lease would now relate to the beginning of the new implied lease, potentially leaving the premises in a worse state of repair. Any claims for dilapidations began under the old lease would be extinguished. Likewise any outstanding claims the tenant might have against the landlord would also be lost.
·         The position under any outstanding rent reviews and the backdating of revised rent to a review date under the old lease is unclear.
·         It may be the case that consents should have been given to a new lease, eg from a superior landlord or a mortgagee. The absence of those consents might make the implied new lease at risk of forfeiture.
·         There may have been side letters and supplemental  licences (eg licences to alter) relating to the old lease and benefitting the tenant which would no longer apply.
·         Because there is no common law right of apportionment when a break date falls between quarter days, although the tenant might have already paid under the old lease for the period from the break date to the next quarter day, the tenant would be liable to pay for this period again under the implied new lease.
·         If the tenant forgets to register the implied new lease then it will only have an equitable lease. If the landlord later sells on its interest, the tenant will only be protected against the buyer if it is in actual occupation (it might not be if it has sublet).

If both parties want to agree to the withdrawal of a break notice, the safest course of action is to document this by putting in place an actual new lease and dealing with 1954 Act exclusion, consents and guarantees as necessary. 

If appropriate, earlier licences and side letters can be incorporated in the new lease by reference.

However, there might even be an unintended consequence of putting in place an actual new lease rather than living with the implied new lease, which is that there may be SDLT to pay on an actual new lease if no overlap relief is available (especially if an increased rent is payable, or the premises have been extended). 

This is one instance where the situation could actually be better if you don’t document a new lease and is a rare instance of the Revenue being generous. 

This is because the Revenue’s SDLT Guidance (SDLT M17030) states that although an implied new lease is created by rule of law when both parties agree to withdraw a break notice, the Revenue will treat the implied lease as though the old lease is continuing for SDLT purposes, which would mean there is no more SDLT to pay. 

However, any benefit from an SDLT point of view would have to be weighed against all the other potential downsides of an implied new lease.

There might be some clever ways round the problem created by Tayleur v Wildin

One possible ploy would be for the parties to vary the lease so as to provide that the notice could be unilaterally withdrawn before it expires, and then to withdraw the notice. 

This has never been tested in the courts however, so it might not work. 

Another possibility would be to vary the break clause to include some pre condition (such as giving up vacant possession on the break date), or it might already contain such a condition anyway, and then simply not comply with the condition. 

This is very risky however if you are the tenant, because the landlord might simply choose to waive the condition at the last minute and so keep the lease alive. 

It’s also not been tested in the courts.

The moral of all this has to be don’t serve a break notice unless you are absolutely sure you want to go. 

Breaking up may be hard to do, but getting back together again can be a nightmare.