Navigating break clauses in commercial leases

A break clause is a common feature in a commercial lease which many will be familiar with.

It provides a landlord or tenant with the contractual right to terminate a lease before the end of the contractual term. For in-house lawyers, and in-house legal teams, understanding these clauses is crucial.

Courts treat break clauses as strictly interpreted contractual mechanisms and, if a break fails, a tenant remains liable for all lease liabilities until the end of the contractual term. Due to these far-reaching consequences, tenants need to have meticulous attention to detail when it comes to the form, service and any pre-conditions (commonly referred to as conditions) attached to the break.

In this article we set out how tenants should approach exercising a break clause and some practical suggestions which may minimise the associated risks.

Service

Break dates are usually a number of years after the lease has been entered into. Unless it is a rolling break, a break notice often needs to be served by a specific date with a relatively lengthy notice period. As soon as the lease completes, diarise the break date well in advance (taking into account the time period for service – see below) to give you time to consider whether you want to exercise the break and get the break notice prepared and served.

Service involves:

• Length of notice – in addition to the notice period, you need to factor in time for preparation and service of the notice. If you work to a strict six month notice period only for preparation and service for the break (assuming that is the notice period) you are unlikely to be able to get it served in time
• Service method – assuming it’s provided for by the lease, arranging hand delivery via a process server is the safest way to mitigate risk, as you immediately know that the notice has arrived where it needs to be. You also have independent third-party verification as evidence of service. Postal delivery is not always guaranteed and a notice returned undelivered can result in the break being invalidly served (such as if s.196 of the Law of Property Act 1925 applies)
• Address for service – cross-checks should be undertaken between the lease, rent demands and land registry office copies. More often than not a notice will need to be served at more than one address. If a landlord notifies you of a different address for service, keep a record as this will likely be needed to effect good service
• Deemed service – this is the key date, rather than the date the notice is posted. The service provisions often provide that a notice is deemed served two working days after it is posted. If the break notice is being served close to the deadline and you are relying on postal service alone, the break notice may not be deemed served in time.

Once a break notice has been served it cannot be withdrawn, so be sure of your intentions prior to serving.

Break conditions

Break clauses frequently include conditions. If a break is subject to conditions, the break will only take effect if a valid break notice is served and the conditions are complied with. When it comes to assessing compliance with break conditions, case law interprets these strictly – it’s often considered draconian, leaving tenants with little grace.

Common conditions include:

The tenant must have paid all the rent or made all payments due under the lease

Beware apportionment. Depending on the wording of the lease, you may not be able to apportion some of all sums due under the lease to the break date.

Consider how “rents” and “payments” are defined and drafted in the break clause. It could be limited to annual rent or be so broad as to encompass all sums due pursuant to the lease. A common oversight is that this can include interest on any late payments, so a forensic analysis of all payments due, demanded and invoiced may be required.

The tenant must have complied with all tenant covenants and conditions

This condition is incredibly strict and a subsisting breach of covenant or condition in the lease, regardless of how trivial, will cause the break to fail.

Tenants will often oppose such strict drafting and instead propose that the obligations are qualified, so that the tenant is only required to have ‘materially’, ‘substantially’ or ‘reasonably’ complied with its obligations. Whilst qualifying obligations can provide greater flexibility, it’s still considered a very onerous break condition.

In either scenario, a surveyor will need to be instructed to assist with compliance. However, if compliance with tenant covenants is a break condition in any way, shape or form, tenants should put in place a strategy to negotiate a surrender of their lease with the landlord.

The tenant must give vacant possession

The definition of vacant possession is described as the “holy trinity” of being free of people, chattels and legal interests. It is fact specific and something as trivial as leaving partitioning in place can cause this break to fail. Assessing the physical condition of the premises is important – consider whether any licences for alterations were entered into or whether there are any other agreements which document changes which have been made to the premises. These can be a useful guide in assessing what you need to do to provide vacant possession. Whilst guidance can be taken from case law, it is fact specific.

The tenant must leave the premises free from occupation.

There is no legal definition of what “free from occupation” means. Arguably this could be interpreted as the tenant being caught, unintentionally, by an obligation to give vacant possession. Whilst this may seem an appropriate concession at the drafting stage, when exercising the break, a tenant can find itself subject to a higher bar.

If you know you want to exercise your break when the lease is being entered into, or want to keep that option open, keep this in mind when negotiating the break clause wording. Break conditions can very much be the “law of unintended consequences”.

Common pitfalls

If a tenant is unsure whether it wants to vacate, it can serve a valid break notice but fail to comply with the break conditions. However, the lease may contain the ability for the landlord to waive compliance with the break conditions. If the waiver has been effectively given, this can leave a tenant having to vacate the premises by the break date in any event. Unless a compromise can be reached, if the tenant remains in situ, it will remain a trespasser and a claim for double rent for the occupation post-break date could be made.

Landlords may try and invoice tenants to the break date or give assurances that payments only need to be made up to and including the break date, which can be contrary to what the lease says. If a tenant is relying on these assurances, whilst estoppel arguments can potentially be raised to prevent a landlord from reneging on its position, there is significant risk to the tenant proceeding on the basis of the landlord’s word.

Conclusion

Due to the rigorous compliance required at each stage of exercising a break, a forensic approach needs to be taken. Whilst the Mannai principle can step in to potentially save errors in service, a well-advised tenant will not take comfort from that and will instead take steps to deal with a break well in advance.

There is no one size fits all with breaks. At HCR Law, our Real Estates Disputes team has significant experience working with clients to exercise breaks subject to a multitude of conditions and manage tenant exits of commercial premises, particularly where break conditions can pose a challenge.