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Conditional break clauses in leases

05 March 2013

 Avocet Industrial Estates LLP v Merol & anr [2011] EWHC 3422 (Ch) 19 December 2011 highlights how strictly the courts construe the pre-conditions commonly found in conditional break clauses in leases.

Background

Merol Ltd (the Tenant) was the tenant at premises pursuant to a ten-year lease granted by Avocet Industrial Estates LLP (the Landlord). The lease contained a break clause entitling the Tenant to break the lease on 17 March 2010 on not less than three months' notice in writing. The break clause contained a number of pre-conditions that, if not satisfied at the break date, would prevent the Tenant from breaking the lease. The conditions required, inter alia, that there be no material breach of repairing covenants nor any unpaid sums due under the lease at the break date, together with a separate requirement to pay a sum equal to six months' rent (the Break Payment). The lease also contained a clause requiring interest to be paid on any sums unpaid or paid late and due under the lease (a fairly standard lease provision). During the life of the lease, the Tenant made several late payments of quarterly rent in relation to which the Landlord had demanded interest be paid on some, but not on others.

On 11 August 2009, the Tenant purported to give notice to break its lease on 17 March 2010 and made various statements and enquiries of the Landlord regarding dilapidations and the various other break clause conditions. On 16 March 2010, the Tenant hand-delivered to the Landlord's offices a letter re-asserting its right to break, together with a cheque in the amount of the Break Payment and the keys for the property, which it had vacated.

On 7 April 2010, the Landlord wrote to the Tenant stating that its break notice was ineffective because it had paid the Break Payment by cheque rather than cleared funds into the Landlord's bank account. Further, it had failed to pay default interest on various amounts that had been paid late during the course of the tenancy. The Landlord returned the cheque and the keys.

The Tenant disagreed, saying that cleared funds were not necessary and that it was not liable to pay default interest on any outstanding payments unless the Landlord formally demanded such interest, which it had not. The Landlord issued proceedings.

What did the court have to decide?

There were two main issues before the court. First, was the Tenant in arrears of rent by virtue of having paid the Break Payment by cheque (as opposed to cleared funds)? Secondly, had the Tenant failed to pay default interest and, if so, did this mean that there were unpaid sums due which prevented the Tenant from breaking the lease?

The decision

The court found in favour of the Landlord and held that the Tenant had not complied with the break pre-conditions and that therefore the lease was continuing. With regards to the first issue, the court found that the Tenant had not failed to pay the Break Payment by virtue of having paid by cheque. The common law rule that payment must be made by legal tender (which a cheque is not) had, in this case, been displaced. The Tenant had provided evidence to support a course of dealings between the parties where the Landlord had previously accepted cheques. This constituted an implied agreement to accept payment by cheque. The court therefore concluded that the Tenant had paid the Break Payment in accordance with the break clause.

On the second issue, however, the Tenant's case failed. The Landlord was not obliged to demand formally default interest before the liability to pay crystallised and the Tenant had therefore failed to pay sums due at the break date. Further, the Landlord was not estopped from challenging the break notice on the basis that it should have told the Tenant that it owed default interest: the Landlord did not, at the break date, know that the Tenant was mistaken in its belief that it did not owe any interest. Only after receiving legal advice did the Landlord discover that the Tenant was in default and that this put it in an advantageous position with regards to challenging the break notice.

Comment:

The annual rent under the lease at the break date was GBP 67,500 and the Tenant was tied into the lease for a further five years. The amount of default interest at the break date was GBP 130. Concluding that the lease was continuing, the judge in this case described the outcome as "harsh" but said that he was bound to the conclusion on the basis of legal principle.

The appeal against this decision was due to be heard in October 2012 but the parties have now reached an agreement in court. The High Court decision therefore remains good law.

This decision underlines that tenants (and their advisers) wanting to break their leases need to ensure that they undertake a thorough review of the lease to ensure that all pre-conditions to a break have been met. Break clauses will be construed strictly and if the wording of a lease requires that a sum be paid, then tenants must make sure that they discharge their liabilities so as not to find themselves tied into a costly tenancy that is no longer required.

This case also serves as an important reminder about payment of rent. The general rule is that a landlord must have money in its bank account by the due date or the tenant will be in default. Whilst this rule can be set aside (it was in this case) each case will be decided on its facts and in the event of dispute the onus will be on the tenant to prove that the parties' conduct justifies its displacement. In the absence of express agreement, the prudent approach is therefore to ensure that the landlord receives funds in its account by the appropriate date.

Further information

This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 (0)20 3088 3710.