Cutting costs : Commercial break clauses

By Gavin Vollans, partner, and Rhodri Preece, senior associate, at Katten UK

The UK is bracing itself for Rachel Reeves’ Autumn Statement, Labour’s first in 14 years and one that the government has already warned will likely be “painful”. Earlier this year, we saw the Chancellor attack the economic inheritance left behind by the Conservatives, with Prime Minister Sir Keir Starmer hinting to tax hikes this autumn. As businesses try and prepare for higher bills come the autumn, many will be looking at making savings somewhere.

The retail and leisure sectors have faced significant pressures over recent years which cannot be blamed solely on Covid. The “death of the high street” has been a worry for quite some time, only exacerbated by the pandemic, and with the likes of business rates forcing many to shut shop, alcohol duty rises causing the closure of pubs across the four nations, and a rise in tourist taxes keeping people away, commercial space will no doubt be high on the list for the chop.

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However, exercising break clauses in commercial leases can prove to be a legal minefield for all involved. There are a number of considerations to bear in mind when considering exercising a break option, as the courts have historically taken a very strict interpretation against any failure to comply strictly with any conditions attached to them.  This article will break down what break clauses are and explain how to stay compliant with conditions and notice requirements to successfully navigate a break clause.

Break clauses are typically included in leases to allow the tenant, or sometimes the landlord, (and occasionally both parties) to terminate the lease prior to the natural end of its contractual term. In recent times, the courts have tended to rule against a party who has failed to comply with the conditions attached to a break clause, so it is currently common practice for break clauses in commercial leases to be heavily negotiated (particularly on the tenant side) so as to contain as few conditions as possible, thereby making compliance with their terms easier to satisfy. Some common types of conditions that are generally accepted include for example:

• That the notice is to be in writing and served by post rather than email. Important to note, is that parties looking to serve a notice by a particular date should be careful of sending it by email or on the break date itself. Standard notice clauses in leases will fall back to the standard postal delivery position — namely, that service is only deemed to have occurred on the second day after posting, rather than the date written on the actual notice. Therefore, time should be allocated to allow for posting the notice at least three to five working days prior to the notice period.
  
  
• As crucial as the method of service is to break notices, timing is also key. Break clauses often state that “time is of the essence”, which predictably means that if the deadline for service of the notice has been missed, the right to exercise the break could have been lost without a rolling break option.
  
  
• Often a source of contention, break clauses are sometimes worded to say that the tenant must return the premises to the landlord with Vacant Possession. The recent Court of Appeal decision of Capitol Park Leeds v. Global Radio Services reinforces the principle that a break clause can be frustrated if a tenant leaves behind too many of personal chattels or fixtures and fittings. This decision ruled that the break clause had been validly executed even where the tenant had been accused of being too aggressive in its strip out — leaving the premises in an un-occupiable state by doing so. The best practice when agreeing to the break clause wording would be for tenants to only agree to return the premises free from occupiers so as not to fall foul of a potentially onerously high standard of strip out.
  
  
• A break premium is usually a fixed sum payable by the tenant upon exercising the break and represents a repayment, sometimes in part, of a rent-free period that the tenant has benefitted from. Failure to pay this premium on the break date or on any stipulated date can also frustrate the break clause.

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Some leases contain even more strenuous terms, requiring, for example:

• Payments of all sums due. This typically encompasses all payments due under the lease, including service charges, insurance and any other charges. Whilst payments of rent and potentially insurance (if demanded far enough in advance of the break date) can be reasonable payment conditions to accept on behalf of a tenant, service charges should be resisted because the amounts payable by the tenant often vary from month to month and may not have been properly communicated, which again can frustrate the break option. Further, payment of all rents can also surprisingly include interest amounts on overdue rents even if a landlord had not previously demanded them.
  
  
• “Compliance with other covenants” typically encompasses all tenant covenants, most notably repairing and decorating covenants, which have in some instances tripped up tenants. Given the difficulty of complying with, this clause should be resisted by tenants.

Worth bearing in mind, is that the Code for Leasing Business Premises, England and Wales 2020 sets out a number of requirements of expectations for Royal Institution of Chartered Surveyors (RICS) members who have chosen to be RICS regulated, concerning the manner in which they provide services and/or the consequences of their actions. With respect to break rights, although the code does recognise that parties may have agreed to stricter conditions, it stipulates that tenant break clauses should only be conditional on:

• The tenant paying the basic rent up to the break date; and
• The tenant giving up occupation and leaving no subtenants or other occupiers at the premises.

Finally, correctly serving a break notice can mean the difference between a valid termination of the lease or a costly mistake. Failure to validly exercise the break could mean being stuck with the lease until its ordinary expiry date or until the next available break date.

As mentioned above, break rights will need to be exercised to comply with the correct notice period — typically between three to six months, depending on the commercial importance of the lease.

In conclusion, navigating break clauses can prove to be a costly mistake for both the tenant and the landlord where they are not observed properly. They continue to be an area of real estate law filled with pitfalls and potential traps that could be easy for people to fall into, and often with very costly consequences.