Lease Agreements:

Landlords of residential properties have become used to the “rules of the game” being largely governed by statute, that is laws laid down by Parliament. They govern the relationship between landlord and tenant much to the exclusion of express custom clauses drawn up by the landlord and set-out in the tenancy agreement.

Many of the clauses in residential agreements are pretty standard, indeed the government now provides a model tenancy agreement that all landlords can use free of charge. It has clauses that reflect the Housing Acts, even when not expressly included, as some rules are implied. Yes, there is some flexibility whereby landlords can include their own rules by way of custom clauses, but they can only be enforced if a court deems them “reasonable.”

However, with a commercial lease things are somewhat different. Yes, there are some over-riding common law and statutory principles that lease clauses must adhere to, and there are countless clauses built-in by solicitors lease drafts based on legal precedent, to take into account almost every eventuality. But the main principle of the agreement is it’s based on contract law, whereby the parties effectively make and agree their own terms. This contrasts somewhat with the consumer-law influence now attached to a residential tenancy.

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This article is based on English law and is not a definitive statement or interpretation of the law; rules change and every case is different – only a court can decide. Other jurisdictions are similar but there are important differences. Always seek expert advice before making or not making decision.

A case that illustrates this point very well involved a dispute between commercial tenant Marks & Spencer and landlord BNP Paribas (Marks and Spencer pic v BNP Paribas Securities Services Trust Company (Jersey) Ltd), a case which in 2015 ended up at the Supreme Court, having previously gone through the Court of Appeal.

M&S had rented retail space off the landlord on a lease which included a conditional tenant’s only break clause. The conditions to exercise the break were that (1) six months’ notice was to be given, (2) a break premium was to be paid, and (3) there were to be no rent arrears at the time the break notice was served.

The dispute between the parties arose because the break itself was out of sync with a quarter’s rent paid in advance, which meant two months’ rent was paid for a period after the tenant had gone.

In all the respects the conditions of the break were met in full, the six month’s notice served, the break premium of £919,800 + VAT paid, and there were no rent arrears, indeed the converse was true – rent was overpaid.

The difficulty for the tenant was that there was no express clause in the lease either stating what would happen in the case of a rent overpayment, and nothing to align the break with the end of a quarter, but the tenant wanted the overpaid rent to be returned.

The initial court case involved a claim for the “overpaid” rent on the basis that the court should imply such a term in the lease; after all, on the face of it logic would seem to imply that any overpayment should be refunded.

The Court found in favour of M&S, and as the tenant requested, implied a repayment clause even though no express clause existed. BNP Paribas appealed the decision and it was overturned by the Court of Appeal. M&S then pursued the matter through to the Supreme Court, the final arbiter, and lost its case, and its refund.

What are the lessons for property investors?

The main principle to remember is that business leases are basically contractual agreements based on negotiations between the parties and the courts will enforce them as such. Courts do not like to imply terms in commercial leases unless there are exceptional circumstances.

In giving judgement, the Supreme Court stated that “a term will only be implied if it satisfies the test of business necessity or is so obvious that it goes without saying.” It was determined by the Supreme Court that the absence of a repayment clause in the lease was not a “business necessity” or a “practical absurdity” and accordingly it ruled that a repayment clause should not be implied by the Court. These were matters that should have been dealt with by the parties when negotiating the contract according, to the judges.

The ruling is an important one because it lends a good degree of certainty for commercial landlords regarding the position of the parties regarding the repayment of rent following a break. The Court was concerned that if had it found in favour of the tenant in this case, then numerous further disputes might arise alone similar lines where matters were not expressly dealt with in the lease.

On the face of it the decision could be construed as overly “landlord friendly” and against logic; a harsh decision on the tenant when it had paid for a period it was unable to use. This was the case even though it had paid a substantial break premium. But it was stymied simply because the date of the break did not align with a quarter day and there was no specific repayment clause.

However, the Court took into consideration that a tenant-only break clause was potentially of considerable commercial value to the tenant, and therefore deemed it fair that the landlord should not be obliged to repay the two-months’ rent when it was the tenant’s decision to break the lease.

This Supreme Court decision stands and it is an important principle for property investors and for assignees to bear in mind; that whatever the lease says binds the parties, and usually what it does not say, doesn’t. It’s important to check lease break clauses carefully when purchasing a commercial building with an existing tenant, or taking on an existing lease.

Break Clauses in Residential & Commercial Leases

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