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Eversheds Sutherland property column: Landlords' break rights: effective for the landlord, fair for the tenant

  • United Kingdom
  • Real estate
  • Real estate sector

10-06-2021

Presently enjoying their fifteen minutes of fame, termination rights in favour of landlords are now frequently included in new leases and added to existing leases, especially in the retail and leisure sectors. These rights are sometimes a reflection of the consequences of the COVID-19 pandemic, whereby rent concession arrangements are agreed with existing tenants and the break right in favour of the landlord is a quid pro quo for those concessions. Alternatively, these rights may be a reflection of the market, whereby a landlord agrees a deal for now with the hope that a better deal might come along later or that a redevelopment plan might come to fruition. Beyond the commercial terms of the deal, there are legal issues to take into account to ensure that a break right in favour of the landlord is effective for the landlord, and fair for the tenant.

Landlords' break rights and the Landlord and Tenant Act 1954 (LTA 1954)

The critical factor in relation to the effectiveness of a landlord's break right is whether the lease is within the protection of the security of tenure provisions of the LTA 1954. Contrary to what many heads of terms might say, it is not possible to contract a lease out of the LTA 1954 after it has been granted (although a lease might "fall" out of LTA 1954 protection, for example if the tenant is no longer in occupation or if section 28 of the LTA 1954 is brought into play by the grant of a reversionary lease). 

If a lease is outside the protection of the LTA 1954, a landlord's break notice will, all other things being equal, end the contractual term on the break date. The tenant will be required to leave and "end of term" obligations, such as reinstatement, will be relevant.

If the lease is within the protection of the LTA 1954, the landlord's break notice will end the contractual term, however the lease will continue until brought to an end by one of the ways set out in the LTA 1954 (section 24, LTA 1954) (most likely perhaps a hostile section 25 notice served by the landlord).

There is a significant difference in the effectiveness and complexity of a landlord's break right according to whether the lease is contracted out or not. To this end, if such a break right is to be included in a new lease a landlord will usually insist that the tenant gives up the possibility of LTA 1954 protection.

The alternative to a landlord's break right

In order to emulate the effect of a landlord's break right where the lease does have LTA 1954 protection, it is typical for a landlord and a tenant to enter into an agreement to surrender the lease, either on a fixed date, or on a date to be specified in the landlord's break notice. Either way, given that this arrangement is intended to give the landlord the option to end the lease rather than oblige the landlord to do so, the completion of such an agreement to surrender is dependent on the landlord serving notice to trigger completion. If the landlord does not trigger completion of the surrender, the lease continues to its contractual expiry.

Of course, a completed agreement to surrender does not bring about an exact replica of a break situation; a surrender will leave any subleases in place and will not trigger "end of term" obligations. So the tenant will be obliged to end any subleases (if indeed it was even permitted by the terms of the lease to grant them in the first place), and there will have to be negotiation as to the state and condition in which the tenant must leave the premises.

As an alternative to an agreement to surrender arrangement, the landlord and tenant might replace the protected lease without landlord's break right with a new contracted out lease with landlord's break right. However this comes with additional complications, such as the possibility of an extra land transaction return for the tenant and the loss of present guarantors for the landlord.

Fairness to the tenant

A tenant will have paid SDLT calculated on the full length of the term of the lease with no right to refund if the landlord ends the lease early. A landlord might compensate the tenant for this expense, or the expenses incurred by the tenant in fitting-out the premises, by way of a break premium. A break premium is chargeable consideration for the purposes of SDLT, so a landlord might have to pay tax on top of the premium. Occasionally a break premium reduces over time; the sooner the landlord serves the break notice, the higher the fee the tenant receives.

Given that it is the landlord looking to end the lease early rather than the tenant looking to walk away, most tenants will push back on "end of term" obligations such as reinstatement and liability for dilapidations. All well advised tenants will look for a refund of lease sums paid in advance for a period that stretches beyond the break date. Those tenants with LTA 1954 protection might be prepared to allow a landlord to break a lease on redevelopment grounds, but will want to protect their entitlement to statutory compensation under the LTA 1954 by obliging the landlord to serve alongside the break notice a hostile section 25 notice citing the ground in section 30(1)(f) of the LTA 1954 and no other.

A landlord's break right or not?

Landlords will occasionally look to include a break right that the landlord can exercise whenever the tenant is in breach of a lease covenant. However, there is case law to suggest that these so-called break rights are in fact rights to forfeit in disguise. As such, a notice under section 146 of the Law of Property Act 1925 should perhaps be served first and the tenant would have the right to apply for relief against forfeiture. This is not the straightforward contractual break right that the landlord was hoping for. Likewise, occasionally a lease will contain a landlord's option to call for a surrender of the lease on notice, perhaps in an attempt to leave subleases in place while ending the lease itself. Again, there is case law to suggest that such a landlord's call option, embedded in the lease itself, is a landlord's break right leading to the end of the lease, and any subleases, rather than its surrender.