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11 June 2016

Penalties fit for fit-out

Question

I am a tenant who entered into an agreement for lease which required me to carry out certain fit-out works by 7 May 2016 (time to be of the essence).

Both the landlord and I were represented by specialist solicitors in negotiations for the contract. The agreement for lease provided for a reverse premium of £1m, but the landlord would be entitled to retain £500,000 of that sum if I did not complete the fit-out works by the relevant date.

There has been a delay in completing the fit-out works due to unseasonable weather, which has also meant a delay to works to the common parts and the landlord is now retaining the money.

What is my position and can I argue for payment of the full reverse premium?

Answer

Depending on the contract and the circumstances in which it was agreed, you may be able to argue that the clause is an unenforceable penalty and you are entitled to the full reverse premium.

Explanation

Whether or not the landlord’s ability to retain £500,000 is an unenforceable penalty clause will involve an analysis of that clause and the context in which it was agreed.

The law of penalties was recently reconsidered by the Supreme Court in Cavendish Square Holding BV v El Makdessi; Parkingeye Ltd v Beavis [2015] UKSC 67; [2016] EGLR 15. The court expressly moved away from the approach taken in the Court of Appeal, which concentrated on whether the clause was a genuine pre-estimate of the loss caused by the breach of contract. Instead, the judges said that a clause would only be an unenforceable penalty clause if the obligation that it imposed on the contract-breaker was out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.

So, the first question is whether your landlord had a legitimate business interest in you completing the fit-out works by 7 May 2016. For example, you mention that this has now delayed works to the common parts and your landlord may argue that the delay has had a negative effect on its neighbouring tenants, who had been assured that the works would be completed by 7 May 2016. The works overrunning may leave him in breach of covenants in those other tenants' leases.

If your landlord did have a legitimate business interest in the works being completed by that date, the next issue is whether the retention of £500,000 was “extravagant, exorbitant or unconscionable” (per Lord Mance at [152]). You will know the reasons for agreeing to the retention of £500,000 and presumably received legal advice on the position. In considering whether a payment was so extravagant, Lord Mance said “the extent to which the parties were negotiating at arm’s length on the basis of legal advice…” was relevant. In addition, he noted the parties “had every opportunity to appreciate what they were agreeing to”.

There were presumably good reasons for you agreeing the amount of the retention as it seems that the delay would have had an impact on the landlord. In addition, you received the benefit of legal advice before entering into the transaction.

Consequently it is unlikely that you will succeed in arguing that the retention is an unenforceable penalty.

Can I claim relief for forfeiture

Question

In fact, I completed the works by 16 May 2016. The delay was caused by unseasonable weather, which delayed the delivery of fixtures. I understand that the delay in our works meant that works on the common parts were also delayed.

If the clause is not a penalty, can I claim relief from forfeiture in respect of the £500,000?

Answer

Relief from forfeiture might be an option, but the law is far from clear. If it is available, the court has a wide discretion, but you will almost certainly have to pay compensation to the landlord for any losses that he has suffered due to the delay.

Explanation

In Cavendish, Lords Mance, Toulson, Clarke and Hodge all considered that the doctrines of penalty and relief from forfeiture might be relevant in relation to the same clause. When a contractual clause means that the breach by one party leads to a forfeiture of sums otherwise due the court should first consider whether it is an unenforceable penalty. If it is not unenforceable, the court can “then consider whether under English law it should grant equitable relief from forfeiture, looking at the position of the parties after the breach and the circumstances in which the contract was broken” (Lord Hodge at [227]).

It should be noted, however, that this was not part of the ratio of the case and previously courts have considered that relief from forfeiture can only be granted when what is forfeited is an interest in land or a “proprietary or possessory right” (see Lords Neuberger and Sumption at [17]).

You will need to argue that the purpose of the retention of £500,000 by the landlord was to provide security for your promise to complete the fit-out works. It was security for the primary obligation.

If you convince the court that this is a case in which relief from forfeiture should be considered, the discretion to grant such relief is extremely wide. It is very helpful that you have now (albeit belatedly) completed the works. It is also useful to you if the delay was out of your control, as seems to be the case here. It is likely that the court will require you to pay the landlord any losses incurred by virtue of your breach. I note that the works on the common parts were affected; if this caused the landlord any loss you will need to pay compensation. You may also need to pay the landlord’s legal fees, although this will depend on how any proceedings develop, and, indeed, the terms of the costs covenants in your lease.


For more information please contact Chloe Benson on +44 (0)20 7203 5145 or chloe.benson@crsblaw.com

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