Take a break

There is perhaps more certainty regarding Britain’s future now that the general election result is known – certainty that many businesses will welcome. Whether or not Brexit is a good or bad thing, the uncertainty has definitely been unwelcome. The property industry has seen many signs of nervousness during the lengthy Brexit debate. There’s been a drop in transactions and indecision in the commercial lease sector: tenants choosing not to serve section 26 notices at the end of fixed terms of leases and allowing the status quo to remain, fearing commitment to long term premises. From the landlord’s perspective, locking a tenant into a long-term deal is the aim in order to avoid empty commercial units.

Brexit isn’t the only challenge for tenants. There are poor high street conditions with online competition and an increase in rent, wages and business rates. Studies suggest an increase in empty stores on the high street while footfall is decreasing. It’s no surprise tenants are considering their options to retain flexibility and prevent being handcuffed to lengthy leases. Numerous famous names weren’t able to weather the storm (think Mothercare, Karen Millen, Coast and Toys ‘R’ Us). The large retailers are now attempting to flex their muscles and force landlords to accept lower rents, even where existing leases don’t allow for such reductions. The justification is obvious: if the rent isn’t reduced, the tenant may go into liquidation potentially leaving the landlord with a vacant unit – or worse, vacant with unpaid rent and service charges. Persuading a landlord to agree to something the lease doesn’t allow for isn’t a tactic available to every tenant, so tenants need to consider their options.

BREXIT BREAK CLAUSE

Last year saw the case of Canary Wharf Group v European Medicines Agency [2019] EWHC 335 (Ch). As a result of the European Medicines Agency’s (EMA) relocation to Amsterdam and with 20 years left on its Canary Wharf home, the EMA argued that Brexit was sufficient to allow termination of the lease by frustration. It was unsuccessful. The court found that fulfilling the contract despite Brexit wasn’t an impossibility. The EMA didn’t have special status because it’s an EU institution and was no different from others seeking to relocate. Furthermore, the lease could have been assigned or sublet with the landlord’s consent. Had the court’s decision gone the other way, it may have opened the floodgate of Brexit break clause cases.

BREAK CLAUSES IN NEW LEASE

A five- to 10-year lease is the norm for commercial leases, particularly those protected by the Landlord and Tenant Act 1954 (the 1954 Act). In good times, this is essential to give certainty and the chance for a business to plan for the future. In bad times, it can be a burden – restricting flexibility and keeping a tenant in unaffordable premises. One way for a tenant to avoid a lengthy lease is to ensure, when taking a new lease or renewing one, that it has a tenant break clause. Should a landlord agree to one, it can give a tenant the opportunity to terminate the lease earlier than the end of the fixed term. In these times, negotiating a break clause at the outset is vital. Any break clause must be exercised correctly. It’s essential the notice is served at the correct time in a permitted manner with the right amount of notice. Most clauses will include pre-conditions such as payment of rent/ service charges and giving up vacant possession. These shouldn’t be overlooked as failing to comply with pre-conditions will invalidate an otherwise valid break notice. Consider the extent of a rent payment precondition: does it require payment up to and including the break date, or require rent that would otherwise be due? It could necessitate the tenant to pay rent for periods well beyond the break date.

TURNOVER RENT

Not all tenants are big enough to make demands of their landlord. While House of Fraser and H&M can persuade some landlords to reduce rent, not all have the same bargaining power. Some tenants could fall back on lease renewals under 1954 Act. A tenant could choose not to take a lease renewal; or remain and contest the level of rent payable under the renewed lease (either the amount or the methodology for calculating rent). The 1954 Act details how the court should determine the terms of a new lease, for example, section 33 deals with the duration of the new lease and section 34 with rent (section 35 deals with the other terms generally). How will the court (and perhaps the tribunal) determine the rent in a new lease? This is done by assessing the market rent. Section 34 requires the court to assess market rent “having regard to the terms of the tenancy (other than those relating to rent)”. So while the court will review the existing lease’s terms generally, it should disregard those terms relating to the rent – which could preclude the current rent calculation methodology. In these tough high street conditions, tenants are seeking turnover-based rent. If it decreases, tenants reduce their rent liabilities automatically. Is this something the court should retain if it’s within the old lease? Could it be included in a new lease in circumstances where it wasn’t already in the old lease? In respect of the lease’s general terms, the lead authority is O’May v City of London Real Property Co Ltd (1982) which states the default position that the old lease’s terms apply to the new lease. If either party wants to depart from this, it’s for them to persuade the court why this should be the case.

Furthermore, the court has regard to the fact that the 1954 Act is there to protect tenants rather than landlords. Rent is a little different. It’s questionable how relevant O’May is to rent given the court is required to disregard those terms of the existing lease that relate to rent. The case of National Car Parks Ltd v Hawksworth Securities PLC (a county court case so not a binding authority) provides some assistance to tenants seeking a turnover rent, though it does turn on the facts too much. The court granted a turnover rent in the extended lease but it’s possible this case isn’t as useful as it first seems, though it can be referred to. The court took the view that in the car parks industry, turnover rent was the typical method of calculating rent. As such, in this particular market it’s the correct way of assessing the market rent under section 34. Indeed, both parties’ valuers accept the conventional method of assessing rents for car parks was profits based. The court therefore kept a turnover rent though that’s not the case for all industries. That isn’t to say tenants shouldn’t consider turnover rent and seek a lease renewal on this basis.

For the courts, it’s a matter of valuing the rent and the method of assessing it. It’s for both the parties to produce valuation evidence to persuade the court. Increasingly, tenants are seeking turnover rent and consequently becoming more relevant to assessing market rent under section 34 of the 1954 Act. Of course, tenants must also beware that if conditions improve for the high street, rents will automatically increase on a turnover based rent. Perhaps this is a price worth paying, if sales improve.