It was established long ago that for a tenant to successfully operate a conditional break clause in a lease the test of compliance is a strict one.
Accordingly, a break clause which is conditional upon payment of rent may require the tenant to pay the full rent for the last quarter prior to the break date, including any rent attributable to a period after the break date.
But should a landlord be entitled to such a windfall or is the tenant entitled to a refund when it successfully operates the break?
In Marks and Spencer v BNP Paribas, this issue has been resolved in favour of the landlord following the judgment of the Supreme Court released today, which emphasises the courts’ highly restrictive approach when it comes to implying terms into contracts.
The decision offers some clarification of the relevant case-law on implied terms and confirms previous decisions on the apportionment of rent.
M&S was the tenant of four floors of an office building in Paddington, London. M&S had the benefit of an option to determine the lease on 24 January 2012.
It was a condition of the break clause that the lease would only determine upon M&S giving written notice and provided there were no arrears of basic rent or VAT on basic rent on the break date.
The lease also required M&S to pay the landlord a premium of £919,800 plus VAT in order to exercise the break option.
The landlord invoiced M&S in relation to the “Basic Rent” (plus other sums due under the lease) for the period 25 December 2011 to 24 January 2012.
Instead of paying this apportioned amount, M&S paid the sum of £309,172.25 plus VAT due for the whole quarter.
The premium of £919,800 plus VAT was paid around a week before the break date.
The result of M&S’ actions was that it had complied with the conditions in the break clause. (This was not disputed by the landlord).
However, M&S then sought to recover all of the sums it had paid in respect of the period after the termination of the lease on 24 January 2012, which the landlord refused to refund.
At both first instance and in the Court of Appeal, it was held that M&S had been correct to pay the full rent due on 25 December 2011. This was because the break conditions had not been satisfied by 25 December 2011 and it was therefore uncertain at that time that the tenancy would end on 24 January 2012.
At first instance, Mr Justice Morgan found in favour of M&S and held that an obligation to refund the overpayment of rent should be implied into the lease.
When the case reached the Court of Appeal, M&S’ relief was short-lived: the Court disagreed that any term should be implied into the lease requiring reimbursement of “overpaid rent”.
Supreme Court decision - law on implied terms
Whilst existing case-law on implying terms into contracts was approved by the Supreme Court as representing “a clear, consistent and principled approach”, it was accepted that some of the relevant judicial observations are open to more than one interpretation.
The Court has therefore taken the opportunity to clarify the appropriate approach, although the judgment contains some debate (largely of academic interest) regarding the interaction between the exercise to interpret a contract and the question of implying any additional words into that contract.
In delivering the leading judgment, Lord Neuberger made a number of observations about implying contractual terms, emphasising that a term should not be implied into a detailed commercial contract merely because it seems fair or because the parties would have agreed it if it had been suggested to them during their negotiations.
He stated that, although the test does not require “absolute necessity”, it does require circumstances where the absence of the term causes the contract to lack commercial or practical coherence.
The majority of their Lordships agreed that disputes about implying a term into a contract should usually be approached by firstly interpreting the express words used in the document, before turning to consider whether any term should be implied.
It was also noted these two exercises are governed by different rules, although they may both consider the words in the contract, the surrounding circumstances known to both parties at the time, commercial common sense and the reasonable reader or reasonable parties.
Supreme Court decision - M&S' claim
Turning to M&S’ position, Lord Neuberger accepted that reimbursement of the overpaid rent seemed to be reasonable and equitable.
He noted that the history of the lease negotiations meant that the parties had agreed the terms of the break clause without knowing that the break dates would fall mid-quarter and he therefore accepted it as unlikely that the parties had intended the landlords to retain any overpaid rent.
He also described M&S as having made a “powerful case” that it was necessary for business efficacy for a term to be implied to refund the overpaid rent.
Unfortunately for M&S, the Supreme Court was persuaded in the end by the landlord’s counter-arguments.
Lord Neuberger noted that it has been well-established for some time that rent payable and paid in advance can be retained by a landlord and that an express term is therefore required to apportion rent payable in advance.
He felt that this legal position was generally understood in the market when the lease was negotiated.
The contents of the lease showed that the two substantial and experienced parties had carefully considered and identified their rights against each other – including payments to be made – in connection with the break option.
In these circumstances, the Supreme Court concluded that it would be wrong to imply a term to refund to M&S the rent for the period after the break date.
A particularly interesting point raised by the decision is that M&S might have been in a stronger position to secure the rent refund if it had made the penalty payment of £918,800 plus VAT before the December quarter day.
In those circumstances, it would have been clear on 25 December 2011 that the lease was going to end on the break date and this might have allowed M&S to argue that it was then only required to pay the appropriate proportion of the rent due that day (since the lease provided for the rent to be paid “proportionately for any part of a year…”).
However, whilst Lord Neuberger accepted that this difference in result might be “capricious or anomalous”, he did not consider that it made the lease unworkable so as to justify the implied term sought by M&S.
There may be some disagreement with the Supreme Court's view of the market's previous understanding of the operation of this type of break clause, as evidenced perhaps by the original rent demand from the landlord requiring M&S to pay its rent only up to the break date.
However, tenants' advisers negotiating break clauses have been mindful since the Court of Appeal judgment in this case of the need to make specific provision for the reimbursement of rent following the exercise of a break option.
Hopefully, these advisers are also seeking to avoid break dates which fall midway through a quarter!
If such circumstances cannot be avoided, tenants will need to budget accordingly when calculating the cost of operating a break.
News & Insights
Real Estate and Construction Newsletter - June 2018
Welcome to our June newsletter, bringing you legal insight into issues facing the property industry.
Legal Due Diligence on the Purchase of Off-Plan Properties in Dubai
This article summarises the key legal issues which the purchaser of an “off-plan” property in Dubai should consider.
What can a Developer carry out prior to obtaining a Development License in accordance with RERA?
This article focuses on the development license application, and what a developer is permitted to do before having a development license.