In the recent case of Vivienne Westwood Limited v Conduit Street Development Limited 2017, the High Court considered whether termination of a side letter, which permitted a tenant to pay a reduced rent, was a penalty.
- In 2009, the tenant (T) took a commercial lease of shop premises from the landlord (L) for fifteen years. The rent was £110,000 per annum, with upwards only rent reviews in 2014 and 2019.
- Simultaneously with completion of the lease, T and the L agreed a side letter, concerning the rent. L agreed to accept a reduced rent of £90,000 in the first year, stepping up to £100,000 in the fifth year of the term. The rent would be subject to open market rent review on 18 November 2014, but the rent actually payable, would be capped at £125,000 per annum, for the next five years.
- The side letter was personal to T. The side letter provided the rent concession was terminable on a breach of any primary obligation of the lease and would end if T assigned the lease or ceased to trade from the property. The agreement was expressed not to be a variation of the lease.
- The side letter contained a termination provision, to the effect that, if T breached any terms/conditions contained in the side letter, or any term of the lease or documents supplemental to the lease, L may terminate the agreement with immediate effect and the rent would be immediately payable, in the manner set out in the lease, as if the side letter never existed.
- Subsequently, the reversion changed hands three times. T failed to pay the June quarter’s rent in 2015. L attempted to terminate the lease for late payment of rent, in order to charge the full market rent, which was nearly double the rent previously payable, pursuant to the side letter.
- Crucially, the High Court held the termination provisions of the side letter had the effect of a penalty, which was unenforceable, concluding T remained entitled to pay rent at a capped rate of £125,000 per annum, for so long as it satisfied the terms of the side letter.
The court considered the following arguments:
- L argued the reduced rent in the side letter, was a conditional right to a discount, to which T was not otherwise entitled to. The court disagreed and found the true bargain between the parties was that, in return for having a tenant of T’s reputation, L would accept a reduced rent. The obligations of T under the lease and side letter, when viewed together, were to pay a lower amount of rent and otherwise comply with the lease. The side letter changed the primary obligation of T.
- The reduced rent would end if T ceased to trade from the property, therefore T was an attractive tenant to have trading from the property.
- The court held the reduced rent was not a conditional right to which T would not have otherwise been entitled; rather, a substantial term of the bargain between the parties at the start of the lease. L could not argue it had a legitimate interest in seeing the rent revert to market level, as this would amount to a legitimate interest in non-performance as opposed to the performance of T’s obligations.
- The wording of the penalty in the side letter “as if the side letter never existed,” meant the termination of T’s benefits had both retrospective and prospective effect. As such, T would be liable for the higher rent for the preceding years of the tenancy as well as the future years of the tenancy. The court found that the obligation to pay rent at a higher rate, from the rent commencement date of the lease, regardless of the nature/consequences of the breach and when it occurred, was a penalty, for the following reasons:
- Even if the effect was prospective only, it would still amount to a penalty.
- The higher rent was payable, in addition to, the other remedies available to the L, for the breach of any of T’s obligations under the lease. These remedies included interest on overdue payments and costs, as well as common law damages for breach.
- A non-trivial breach of the lease would result in T being liable for additional rent of between £10,000 and £20,000 per annum for the first five years of the term. Plus, a higher rent for the next five years, in addition to compensation for any loss caused by the breach.
- L had a legitimate interest in preserving the L’s cash flow and the value of its reversionary interest in the property; however the effect of T not complying with every one of its obligations was disproportionate to L’s interests.
Commercial parties usually enter side letters to document a commercial deal between the parties because side letters (unlike leases which are registrable at Land Registry if the term is more than seven years) are confidential and not usually available for public inspection.
This case turned on the specific facts; however, we provide below a few tips for parties negotiating shop leases and side letters:
- Pay attention to the obligations of the parties as set out in any side letter to a lease. Interestingly, the court considered T’s primary obligation to be the obligation to pay rent at the reduced rate, as set out in the side letter. Therefore, parties should consider whether the side letter will be interpreted as changing the tenant’s primary obligation.
- Careful drafting so that the landlord is able to terminate a concession where it expects to do so.
- Consider the drafting and consequences of termination provisions of a side letter and whether these have retrospective/prospective effect.
- Consider whether the consequences of a tenant’s breach, as set out in a side letter are proportionate, in relation to the consequences for the tenant’s breaches under the lease and the landlord’s interest in maintaining the value of its reversion/preserving cash flow.
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