A case update: break clauses and surrender of leases

In this month’s briefing, I am going to look at two recent cases reported on, that do not necessarily introduce new legal principles but highlight current and important topics for many landlords and tenants.

Break clauses

In the current economic climate, break clauses are becoming increasingly more significant for tenants. Tenants taking new leases want protection as they do not know what will happen to them and their businesses next year let alone in five years time and, therefore, are keen to ensure that it will be possible to get out of their lease at some stage if they need to. Break clauses are also a focus for those tenants with existing leases. As lawyers, we are receiving a higher number of instructions from tenants wishing to exercise their break clauses, for various reasons such as not needing the properties any longer to wanting to take advantage of the current property market and relocate to better premises for a lower rent. Landlords are, not surprisingly, seeking to keep their tenants for as long as possible and, when negotiating new leases for tenants, we are finding that break clauses are taking longer to negotiate given the number of conditions that landlords are trying to impose to make it less easy for tenants to exercise their break clauses.

In our March briefing earlier this year, we discussed considerations for tenants on exercising break clauses, and one of the pitfalls of not serving a break notice correctly.

The case of Hotgroup Plc v Royal Bank of Scotland Plc (as trustee of Schroder Exempt Property Unit Trust) [2010] EWHC 12419 (CH) illustrates just how easy it is to get it wrong when exercising a break clause.

Facts

Pursuant to a lease dated 22 July 2005 (“the Lease”), Royal Bank of Scotland Plc (“RBS”) let two floors of Beaumont House in Kensington Village, London, to Hotgroup Plc (“Hotgroup”) for a term of ten years from 4 July 2005 but subject to a break clause permitting Hotgroup to terminate the Lease on 3 July 2010 (“the Termination Date”) upon giving not less than nine months’ prior notice to RBS. RBS had a long leasehold interest in Beaumont House and held the building as trustee of Schroder Exempt Property Unit Trust (“SEPUT”). This building was just one of a number of SEPUT’s property assets. Schroder Property Investment Management Ltd (“SPRIM”) was the property manager of all properties in the SEPUT portfolio and had responsibility for this building since before the date on which the Lease was granted.

Hotgroup sought to exercise its break clause, and in doing so was obliged in the Lease to comply with the following conditions:

  • substantially complying with all its obligations in the Lease to the Termination Date;
  • giving up vacant possession of the Property by theTermination Date; and
  • payment of all rent and other sums due under the Lease on the Termination Date.

The notice provisions in the Lease were also very specific in that they included a particular clause that dealt with SEPUT trustees. The clause stated that:

“during such period as the reversion to this lease is vested in the trustee of SEPUT no notice will be deemed to be validly served on the Landlord unless a copy of the notice is also served on SPRIM, 31 Gresham Street, London EC2V 7QA or such other address as the Landlord notifies to the Tenant.”

Hotgroup had until 3 October 2009 to serve notice to exercise its break clause on RBS and did so on 14 September 2009. Notice was not served on SPRIM at that time. It was not until 19 November 2009 that SPRIM became aware of the notice that had been served on RBS and it was not until 3 December 2009 that formal notice was actually served on SPRIM. Hotgroup argued that its notice to exercise its break clause was effective, and that there was no express reference to time in the Lease for service of notice on SPRIM. It contended that so long as notice was served on SPRIM within a reasonable time, the notice would be effective. RBS disagreed, and sought a declaration that Hotgroup had not validly complied with its break clause.

Decision

The court looked at the various provisions of the Lease, in particular, the notice requirements, and concluded that the words, “no notice will be deemed to be validly served unless” made it clear that the requirement must be complied with for the notice to be effective. The words on their face provided that a notice served on the landlord (RBS) was not to be treated as an effective notice unless a copy of the notice was also served on SPRIM. Was the notice that had been served, validly served? The court decided that it had not been, as at 3 October 2009, which was the last date for service of the notice, no notice had been served on SPRIM and, therefore, the notice that had been served on RBS was not validly served. RBS therefore won its case.

Whilst the outcome of the case does not change the law in any way, the message that it sends to tenants is an important one. It is crucial for tenants to ensure that not only any conditions attached to a break clause are complied with but that they also follow the mechanics of the operation of the break clause itself correctly. Focus is frequently placed on the conditions themselves, which isn’t necessarily a bad thing, however, as you can see from this case, one small slip by Hotgroup has had disastrous consequences for it in that it now has to continue with its lease.

Surrender of leases by operation of law

Conduct that is inconsistent with the continuation of a lease will amount to a surrender by operation of law. Such conduct involves a handing back of the property by the tenant and an acceptance by the landlord. The tenant simply vacating the property will not be sufficient to infer a surrender by operation of law as the conduct of the parties must be unequivocal. The case of QFS Scaffolding Limited v Sable and another [2010] EWCA Civ 682 is a recent case that examined the parties’ conduct in more detail.

Facts

Mr Sable granted a lease of the builders yard at the rear of 65 Church Street in Slough, Berkshire (“the Property”), on 31 August 2001 (“the Lease”) to London Demolition Company Limited (“LDC”) for a term of 21 years from 31 August 2001. In 2004, the reversion to the Lease was assigned to Mr Sable and his wife (“the Sables”). LDC operated two businesses from the Property; a demolition business and a scaffolding business. LDC was struggling to operate its business and on 26 January 2006, joint administrative receivers for LDC were formally appointed. LDC stopped using the Property in around March/April 2006 and QFS Scaffolding Limited (“QFS”), a company that had been formed by LDC with a view to possibly taking over LDC’s scaffolding business, took occupation of the Property at about the same time.

In April 2006, Mr Sable contacted Mr Clifford of Quickfix Scaffolding Limited, a person who had been connected with LDC and had also been a shareholder of QFS. Mr Sable knew that Mr Clifford had been connected with the various companies that had occupied the Property over the years. Mr Sable mistakenly believed that the appointment of the receivers had led to a forfeiture of the Lease and pointed out in his letter to Mr Clifford dated 19 April 2006 that as the Lease had been forfeited, it was not possible for the receivers to assign the Lease.

This statement was not actually accurate and the true legal position was that the Lease continued until it was determined.

QFS had expressed an interest in possibly taking a new lease of the Property and, therefore, the parties entered into negotiations to formalise QFS’s occupation. By June 2006, the Sables agreed that QFS could pay them an agreed monthly sum for its continued occupation of the Property. Monies were paid to the Sables’ solicitors in November 2006 and again in March 2007. Whilst the negotiations for a new lease had started well initially, they gradually deteriorated and no new lease was actually granted.

QFS decided to take matters into its own hands and instead approached the sole remaining administrative receiver of LDC to try to see if the Lease could be assigned to QFS. The Sables in the meantime sought to claim possession of the Property from QFS and started proceedings in July 2008. A deed executed by the sole remaining administrative receiver of LDC assigning or purporting to assign the Lease to QFS for a premium of £1 was completed on 5 September 2008.

The Sables claimed that the Lease had been surrendered by operation of law and that QFS had been in occupation of the Property during the lease negotiations as a tenant at will. The Sables had terminated the tenancy at will and, therefore, were entitled to recover possession of their property. QFS disagreed and, in defending the claim, argued that the Lease had not been surrendered and it had in fact been validly assigned to QFS. Had the Lease been surrendered by operation of law? This was the question that needed to be resolved.

Decision

HH Judge Hamilton found in favour of the Sables and held that the Lease had been surrendered by operation of law, and made an order for possession against QFS. QFS disagreed with the decision and took the case to the Court of Appeal seeking a declaration that the Lease continued to exist because both the landlord and tenant had not conducted themselves in a way that was unequivocally inconsistent with the continuation of the Lease.

In focusing on LDC’s conduct in this matter, the Court of Appeal looked at the fact that LDC had stopped using the Property, had left QFS in occupation, had stopped paying any rent and had not referred to the Lease in any way. However, regardless of all this, the Court agreed with QFS and held that LDC’s conduct was not unequivocally inconsistent with the continuance of the Lease and it therefore followed that there was no surrender by operation of law. The conduct of QFS and Mr Clifford, in particular, was not the conduct of LDC and, further, both QFS and Mr Clifford did not purport to be acting for LDC. The receivers of LDC did not hold them out as having any authority to act for LDC.

As there had been no surrender (or determination) of the Lease, the Court went on to decide that it would not be right to imply the existence of a tenancy at will or licence from the Sables to QFS simply because the Lease continued to exist. The fact that the Sables and QFS were in talks for the grant of a new lease to QFS, which new lease was not in any event granted, did not support the implication of a direct tenancy at will or licence from the Sables to QFS.

As with the Hotgroup case, this case does not change in any way the law or general principles relating to surrender of leases by operation of law, but it does give both solicitors and clients a useful insight into how the courts examine whether a surrender by operation of law has or has not taken place and, most significantly, the high standard of conduct that the courts require to infer a surrender of this nature.

Andrea Beresford
andrea.beresford@rlb-law.com
020 7227 6740
© RadcliffesLeBrasseur
July 2010

Andrea has gained a wide variety of commercial property matters, acting for a diverse spectrum of clients with different objectives that comprises local landowners, individuals, property investment companies, household retailers, banks and small enterprises.


Disclaimer

This briefing is for guidance purposes only. RadcliffesLeBrasseur accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.