Breaking up is hard to do

The exercise of break clauses on behalf of commercial tenants has long been fraught with danger, but the risk is heightened in the current economic climate. Many tenants with struggling businesses are desperate to get out of leases; premises are likely to be one of their biggest outlays and often the leases will have been taken out when the economy was in a better state and commercial property rents were high.

When instructed by a tenant to break a lease, the pressure is on to comply with the precise requirements of the break clause at issue. Get it wrong and your client could be locked into a lease for years until another break option becomes available, if at all. Alternatively, your client may have to pay the landlord a premium to accept a surrender of the lease; expensive for the client and for you in terms of professional negligence claims.

Whilst an option to break a lease is favourable to tenants, it is rarely good news for landlords, particularly in this time of falling commercial property rents when new tenants are difficult to attract.

Recent claims

A number of break notice claims have been notified to insurers both north and south of the border. The claims reflect a wide range of errors: failing to identify properly all relevant parties to the lease; failing even to read the lease; an inability to identify and comply with critical dates; shortcomings in communication; over-reliance on instructions from clients when the means to check the accuracy of those instructions are readily available. In the rest of this article we concentrate on how to avoid such errors.

Who has the benefit of the break option?

When instructed to exercise a break clause, always check exactly who has the benefit of rights contained in the lease. Don’t assume that the client instructing you is the correct party. A break option may be personal to the original tenant only.

Case study

An assistant in the insured dealt with the assignation of a lease from company A to company B, which were both in the same group. Six years later company A instructed a partner in the insured to exercise the break option. The partner removed the file from storage but failed to review all the documentation and missed the fact that the lease had been assigned to company B. He served a break notice on behalf of company A, but the landlord refused to accept this as the break had not been exercised on behalf of the current tenant as required by the lease. The tenant paid the landlord £190,000 to accept a surrender, which the tenant in turn claimed from the insured.

Check the landlord’s identity

Case study

An assistant in the insured was instructed by a commercial tenant to exercise a break option. He assumed that the landlord named in the lease was the current landlord and served the break notice on that company. In fact, that landlord had assigned its interest under the lease. The notice was invalid. In response to the resulting negligence claim from the client seeking the costs of surrendering the lease, the insured admitted that the assistant should have checked the identity of the current landlord, both by asking the tenant client and by carrying out a search in the Land Register. The cost of the omission: over £100,000.

Get the date right

Break options must be exercised by the date specified in the lease. Miss the date and the break notice will be invalid.

Case study

Whilst at a previous firm, an assistant negotiated a lease for a client. The client subsequently instructed the assistant, who was now employed by the insured, to operate the break clause which was exercisable six years from the date of commencement of the lease. The assistant misunderstood the break clause and calculated the six year period from the date of the lease, which was seven months later than the commencement date. The tenant instructed new solicitors who negotiated a surrender of the lease. The tenant claimed the surrender amount and its new solicitors’ fees from the insured.

Always check for yourself

It’s dangerous to rely on what clients tell you about break dates.

Case study

An assistant in the insured gave advice to a tenant on the break provisions of a lease. The assistant entered in her diary

4 September 2008 as the date by which a break notice had to be served. The assistant received emailed instructions from the client to exercise the break notice which incorrectly stated that the deadline was 12 November 2008. The assistant had a heavy workload and passed the file to another fee earner, failing to point out the mistake in the tenant’s email. The assistant who took over the file relied on the tenant’s instructions; she did not look in the electronic diary or at the lease. She did not in fact look at the file and the lease until after 4 September, when, to her horror, she realised that she had missed the deadline. The tenant was locked into the lease for six years until another break right became available and claimed £375,000 from the insured in respect of rent payable for this period.

Get the service right

When it comes to serving a break notice you must check what means of service the lease requires and whether this is mandatory or permissive. If mandatory, a failure to serve in the specified manner will mean that the notice is invalid, even if it gets to the landlord. In the recent English case Orchard (Developments) Holdings plc v Reuters Ltd [2009] EWCA Civ 6, a lease stated that any notice “is valid only” if served by hand or sent by registered post or recorded delivery. The tenants “served” two notices: the first was served by letter, but was delivered to the wrong letterbox, and was therefore invalid. The second was sent by fax, but this was also ineffective as service by fax was not permitted under the terms of the lease.

If a lease specifies where a notice should be served, it’s vital to serve at the correct address. Where a registered office is specified, carry out a company search to ensure that you will be serving on the landlord’s current registered office. Failing to do so can be expensive.

• Always keep a record of when and how you’ve served a break notice. You’ll have proof of service if challenged.
• Get break clauses right Read the lease Identify the rights of all the parties under the lease Advise your client of conditions precedent 
• Communicate clearly with clients and colleagues
• Get the contents of thenotice right
• Get the date right
• Serve the notice in accordance with the requirements of the lease

Advising clients

It is important that solicitors advise their clients of other possible pitfalls which could prejudice their ability to take advantage of a break option.

Disputes – Landlords will often try to use the fact that there is a dispute to frustrate the operation of a break clause, on the basis that the tenant has broken a condition to pay the amount due. One method of avoiding this situation is for the tenant to pay any amount that the landlord claims is due on a without prejudice basis and seek to recover this after the break option has been exercised.

Rent – Where a tenant intends a lease to be broken between rent days, the tenant should still pay the rent for the full period, rather than paying rent only up until the date of the break. Otherwise the landlord may argue that the tenant has not paid the full rent as required by the lease and therefore cannot exercise the break option. Solicitors should make clear to the client that, if they do pay, there is no guarantee that they will be able to recover any element of the disputed service charge or any pro rata rent payment.

Before breaking the lease, the tenant should ask the landlord for a statement of the amounts the landlord considers to be outstanding so that no sums will go unnoticed.

Repairs – Conditions that a tenant has complied with all the repairing obligations in a lease are often expressed in absolute terms and are usually strictly enforced, sometimes seemingly against common sense.

Payments – Some break clauses require the tenant to make an early termination payment to the landlord before the break date. A payment on the day will not suffice. This has caught out many a tenant and solicitor. In Credit Lyonnais v Russell Jones & Walker [2002] EWHC 1310 (Ch) the tenant’s solicitors failed to advise their client of the importance of paying before the break date. The tenant made the termination payment on the break date and the landlord rejected the break notice. The tenant bought its way out of the remainder of the lease and brought a successful negligence claim against its solicitors.

If it is agreed with the client that you are to be responsible for making the payment on its behalf, make sure you obtain the landlord’s bank details and cleared funds from the client well in advance of the break date, and make the payment in time. Effective diary management is crucial. If the client is making the payment, make clear, in writing, the date by which they have to do so and the consequences if they fail to make the payment in time.

Lindsay Kerr is an assistant risk manager at Zurich Professional & Financial Lines. Lindsay can be contacted at riskman@uk.zurich.com .

The information contained in this article provides only a general overview of subjects covered and is not intended to be taken as advice regarding any individual situation, and should not be relied upon as such.