Compliance with break conditions

30/01/12

The recent High Court case of Avocet Industrial Estates LLP v Merol Ltd and Tudor Rose International Ltd provides a stark reminder of the need for tenants to ensure absolute compliance with all conditions attached to a break clause.

In this case it was held that the tenant could not validly exercise a break as it had failed to make all payments due under the lease: specifically, it had not paid £130 of default interest, which had never been demanded by the landlord and which neither party had realised was due as at the break date. However, as the break condition required that all sums due under the lease be paid up to the break date this failure has left the tenant bound for the remainder of the term, a potential liability of more than £300,000.

While the decision very much turned on its own facts, it sets a dangerous precedent for tenants: the judge acknowledged that the decision was "harsh" and that a condition of this kind attached to the break clause is "something of a trap for a tenant". Conversely, it presents another method by which landlords can look to defeat the exercise of breaks.

The facts of the case

There is nothing unusual about the drafting of the break clause, or the default interest clause, in the Avocet case. Whilst the break clause may be stricter than clauses that tenants would hope to agree today, the conditions are familiar: all sums due under the lease had to be paid by the break date; there could be no subsisting material breach of any tenant covenants relating to repair and condition; and the tenant was required to make a break payment equivalent to six months' rent.

The tenant tried hard to ensure that all sums due, including rent, service charge and insurance rent, were fully paid up. It carried out all necessary repairs. Although there was an ongoing dispute over the level of rent, it ensured that the break fee was paid at the higher rate. The tenant's solicitor wrote to the landlord twice to confirm that the tenant believed it had done everything required of it. The final letter, delivered by hand on the day before the break date, enclosed a cheque for the six month break payment and made it clear that the tenant considered all sums due to have been paid.

Does default interest have to be demanded?

The lease required that default interest be paid in respect of all late payments. The tenant had been late (in some cases by several weeks) with most of its rent payments. As the interest accrued on a daily basis, at a rate set out in the lease, the court held that the tenant could easily have worked out the amount due for itself. There was no implied requirement that the landlord had to demand the interest for it to fall due.

Can a landlord be estopped from claiming the default interest?

The tenant argued that, as it had twice told the landlord that it did not believe that it owed any sums under the lease, and the landlord did nothing to correct this mistaken belief, the landlord should be not be allowed to claim default interest. The court held that there was no estoppel as the landlord was unaware that the belief was mistaken until some point after the break date had passed. However, had the landlord thought about the fact that there was default interest outstanding when it received the second letter, and consciously decided not to alert the tenant to this, there is a good chance that the court would have decided that the landlord should be estopped from subsequently using this argument to defeat the break.

Is payment by cheque acceptable?

The landlord also argued that the breach was not validly exercised as the break fee was paid by cheque, meaning that it had not received cleared funds on the break date.

The court found that, in this case, there was an implied agreement that payment could be made by cheque because the tenant had, in the past, made numerous payments by cheque, all of which had been accepted by the landlord (the fact that more recent payments had been by BACS did not terminate this agreement). As the requirement in the lease was simply that the sum be paid by the break date, not that it be paid in cleared funds, the court saw no reason to imply a need for cleared funds. As such, provided that the cheque cleared in due course, this was sufficient to amount to payment on the day that the landlord received the cheque.

Furthermore, the court found that, even if the cheque had not been a valid payment of the break fee, the landlord had accepted the payment by waiting for three weeks to return it: he should have rejected it immediately (within a day) if he was not willing to accept payment by this method.

Practical advice for tenants

Exercising breaks

• Tenants need to remember that even a very minor breach of a break condition will prevent the exercise of the break option. This extends not only to payments of all sums due, but also to compliance with other conditions, for example redecoration and repair.
• Where a break is conditional on all monies having been paid, tenants should be very careful to check whether any default interest may be due on past arrears. It will sometimes be necessary to estimate that date on which payment was received by the landlord and in doing so it is advisable to err on the side of caution. Depending on the circumstances, these checks may need to go right back to lease grant.
• It is worth specifically asking the landlord whether any default interest is due in respect of any past sums. Whilst the landlord is under no legal obligation to respond, if he is aware that default interest is due and intends to rely on this to defeat the break his failure to respond may prevent him from relying on this ground. However, this approach may not work if the tenant is aware that default interest is in fact due and it would be risky to rely on this alone without have first conducted an audit of payments made
• Where payment by cheque is normal, payment of any outstanding sums by cheque will usually be acceptable, and will constitute payment on the day that the cheque is received. However, to avoid any dispute over an implied agreement to this effect having been established, a tenant should make payment in a way that ensures the landlord is in receipt of cleared funds on the break date.

Negotiating new break clauses

• The ideal position for a tenant is that a break clause is unconditional. However, as very few landlords will agree to this, a tenant should argue that the only conditions be that the main rent is paid up to date and that they give up occupation. Disputes relating to other sums due, and to matters of repair, can be resolved following termination of the lease.
• Where this is not accepted, it is in a tenant's interest to seek the certainty that whatever it is required to pay can be objectively quantified and ascertained prior to the break date and that the tenant is not left guessing whether it has done sufficient to comply with its obligations.
• In addition, in light of the Avocet case, where default interest clauses do not limit the landlord's claims to interest which has been expressly demanded by the landlord, tenants should ensure that their systems allow them to be certain as to when payments are made in cleared funds.

If you are intending to exercise a break clause and require further advice about what you need to do in order to comply with the conditions of the break, or you have any other questions about the issues raised in this note, please contact Katy Kirk (katy.kirk@bsdr.com, tel 01235 836627) or speak to your usual contact at BrookStreet des Roches.