Break clauses are common in commercial leases. The opportunity to end a business lease early is useful to both commercial tenants and landlords. Whether your break notice will be valid depends on whether you have strictly observed the break clause requirements.
We recommend you consult with a commercial property lawyer in good time before serving the break notice, so the issues highlighted in this article can be dealt with.
Here we’ll be covering:
- What is a break clause?
- Negotiating a break clause
- Examples of pre-conditions often attached to break clauses
- The relationship between a break clause and other provisions of a lease
- Break clauses and payment requirements
- When and how to give notice for a break clause
- What about joint tenants?
- Can you withdraw a break notice once it has been served?
- What are the potential costs associated with exercising a break clause?
- What happens if a tenant fails to vacate the property after activating a break clause?
- Summary
What is a break clause?
A break clause can be included in a fixed-term commercial lease allowing either the tenant or landlord to bring the lease to an end early. The terms of the break clause and who can exercise it will depend on negotiations at the Heads of Terms stage. Sometimes the break clause is personal to the original landlord or the original tenant or both.
Depending on how the lease has been drafted, the right to break the lease may:
- Occur on one or more specified dates;
- Be exercised at any time during the term of the lease on a rolling basis, such as on three months’ notice expiring at any time.
A break clause may only be exercised if any conditions attached to it have been satisfied.
Negotiating a break clause
Negotiating the wording of a break clause is best done by an experienced legal professional who can guide you as to the pitfalls and implications of the terms proposed by the other party and aim to protect your interests/position. Often it is a case of striking a balance between allowing flexibility for the tenant while assuring the landlord that he or she will not be left at a disadvantage by breaking the lease. Here are a few areas to bear in mind when it comes to negotiations:
- Understand your needs: Before you enter into negotiations, it is important to clearly understand your needs and objectives regarding the break clause. Consider factors such as the length of the lease term, business growth or contraction plans, and potential exit strategies.
- Mutual or one-way: Although break rights are more commonly proposed and sought after by tenants, landlords may draft the clause to make any break right mutual. Tenants should consider what alternative arrangements they could make and what effect it could have on their operations should the lease contain a mutual break clause.
- Timeframes: Parties will need to agree on the date or period that the break clause can be exercised. This may be at specific intervals (fixed date), or at any time after a certain period has lapsed (rolling break). Tenants will be mindful to try to seek break dates that align with their business needs and trajectory - for example anticipated changes in operations or growth.
- Conditions: Both parties will need to discuss and agree on conditions that must be met to exercise the break clause (if any). The Lease Code 2007 sets out good practice in leasing and provides that the only preconditions for a tenant to exercise a break clause should be that they are up to date with the main rent, give up occupation of the premises and leave behind no continuing subleases. While this is often the starting point, many landlords seek to negotiate that all sums due under the lease are paid and that all tenant covenants under the lease have been complied with for the tenant to be able to break away. This can pose potential difficulties for example any interest on late payments will be classified as sums due under the lease and may be complex to calculate. Wide-ranging obligations to ensure all tenant covenants in the lease have been complied with can be open to debate by a difficult landlord resisting a tenant from exercising a right to break. It is smart for tenants to seek to limit any such wide-ranging obligations if insisted by the landlord to “material” or “substantial’ breaches. The type and extent of conditions agreed upon often come down to the circumstances and bargaining strength of the parties, but tenants should be mindful of the ability to comply with the wording of specific conditions. It is also helpful to specify if a condition must be met at the time the break notice is served, at the termination of the lease, or both.
- Notice period: Both parties will need to agree on a notice period required to exercise the break right. It is common practice for any notice given to be at least 3-6 months before the break date, but it will be down to negotiations. The notice period must allow enough time to prepare for the termination of the lease. Landlords will be keen to have enough time to market the property and secure another tenant to minimise rent disruption, while tenants may need to focus on winding down / relocating their operations.
- Service of notice: It is sensible to agree and set out within the lease a prescribed method for serving notice, including to who, what address and how (recorded delivery post, hand-delivery, email, or fax). Setting out the prescribed method of service can help avoid later issues about whether the notice has been deemed served. You want to try to avoid a situation in which the other party can potentially challenge the validity of the notice and dispute it.
- Break notice format: Parties may wish to agree on the format and delivery method of the break notice to ensure it is valid and enforceable.
- Recouping advance rent: As a tenant, you should insist on the inclusion of an express provision in the lease that you will be entitled to a refund of any rent paid in advance. Without such a provision, you will not be entitled to a refund and will end up paying for a period after the break date (depending on when it falls) that you are not occupying the property.
- Liquidated damages: Savvy tenants may wish to negotiate and secure the option that a landlord accepts the break notice on payment of an agreed amount as liquidated damages for any outstanding breaches of covenant. This can help with any potential disputes or challenges down the line if a landlord claims that the break notice is not valid as there are ongoing breaches of the lease.
Examples of pre-conditions often attached to break clauses
Some examples of pre-conditions often attached to break clauses are as follows:
- The tenant must have paid all the rent, or all payments due under the lease
- The tenant must have performed all its covenants
- The tenant must not be in material breach of its repairing covenants
- The tenant must give vacant possession (or that the tenant gives up occupation and leaves behind no continuing underleases)
- The landlord must have an intention to redevelop the property
- Any underlease is to be contracted out of the Landlord and Tenant Act 1954.
The break clause should specify whether the conditions must be satisfied at the date the break notice is served, or at the specified break date, or both. If any pre-conditions are not strictly complied with, the right to break may be lost.
The relationship between a break clause and other provisions of a lease
Break dates are often linked to rent review dates so that, if the tenant considers a rent increase to be too great, they can end a commercial lease early.
If a headlease is terminated by the exercise of a break clause of either party, then any underlease also ends. This applies even where the underlease was granted with the consent of the head landlord. If Part II of the Landlord and Tenant Act 1954 applies to the underlease so that it is a protected tenancy, a statutory tenancy for the undertenant will arise on the termination of the underlease.
There may be general obligations that apply at the end of the term of the lease, which will need to be complied with before the break date. For example, the lease may require the tenant to remove signage, reinstate alterations and redecorate the property. Reviews of any supplemental documents should also be made, such as any licences granted for works to the property in case these contain obligations that are relevant to the break.
A tenant may ask the landlord for confirmation of the steps required to comply with any conditions in the break clause. As a tenant, you will want to ensure that you have complied with your repairing obligations under the lease. To do this, you may ask the landlord to prepare a list of items that are in need of repair and for which you are responsible under the lease. This list is known as a schedule of dilapidations.
If a tenant agrees to carry out works to the property before the break date, be careful to ensure that the works are completed, and vacant possession is given by the break date.
A tenant will also want to ensure that any waiver of a break clause condition by the landlord is not made ‘without prejudice’ and it is clear to which condition(s) the waiver applies.
Break clauses and payment requirements
Considerations on payments connected to break clauses should include the following:
- Pay any outstanding sums due, even if these are in dispute. Payment can be made on a ‘without prejudice’ basis and discussed later
- Late payment interest may be payable. There may also be interest due on historic arrears, even if the arrears have been cleared and the landlord has not requested the interest. It is safer to overestimate the amount due for interest. The exact amounts owed can be settled later
- Make sure that payments are made in cleared funds by the required date unless the landlord has expressly agreed to accept a cheque
- Don’t assume the tenant is obliged to pay only an apportioned part of sums due under the lease, for the period up to the break date. The lease may require full payment
- If the tenant is obliged to pay any sums in advance, such as rent, service charge or insurance rent, check to see if the landlord is obliged to refund any part of those sums that can be attributed to the time after the lease ends. The tenant will not normally be entitled to a refund of rent paid in advance unless there is an express provision in the lease to the contrary
- Consider asking the landlord to accept the break notice on payment of an agreed amount as liquidated damages for any outstanding breaches of the covenant. Liquidated damages are a fixed or determined sum agreed by the parties to be payable on breach of a lease obligation by one of the parties
When and how to give notice for a break clause
As a tenant, you will want to consider carrying out a compliance audit with a surveyor’s advice before serving the break notice. You can then take steps to remedy any breaches of the lease. This is particularly important where such compliance is a condition of the break clause.
You should serve the break notice in good time and strictly follow the terms of the lease. The lease may contain provisions relating to serving the break notice that is not in the break clause itself.
Keep evidence of the method of posting or delivery of the notice. If there are no provisions in the lease that relate to serving the break notice, the party serving the notice could request that the receiving party acknowledge receipt, although the receiving party is not obliged to comply with that request.
If the notice is being served by an agent, make sure the receiving party is aware of the existence of the agency arrangement and the agent’s authority.
What about joint tenants?
Only a person with the benefit of a break clause can exercise the clause. In the case of joint tenants, this typically means that the right to break must be exercised by both (or all) parties unless there is a specific provision in the lease that this is not the case/explicit authority that one party can exercise the break clause on behalf of others.
Can you withdraw a break notice once it has been served?
Unless the lease states otherwise a break notice cannot be withdrawn unilaterally. A party seeking to terminate must be certain that they wish to bring the lease to an end. If a tenant has served a break notice and changes their mind, the landlord may agree to its withdrawal, but this is entirely up to the landlord.
Even if the landlord and the tenant both agree to waive the break notice, this does not prevent the lease from ending. Instead, the landlord will have to grant a new lease that will take effect immediately after the original lease ends under the break clause.
What are the potential costs associated with exercising a break clause?
- Rent and other payments: You will need to ensure all your rent, and in some cases, any other outstanding payments under the lease are settled up to the break date including arrears, insurance, service charges etc.
- Costs of repair: You may need to bear the costs of repairing any dilapidations or bringing the property into good condition as required by the lease to validly exercise the break clause and return the premises to the landlord
- Complying with lease covenants or liquidated damages: You may have to bear any other costs associated with bringing the lease into compliance with tenant covenants or pay any amount in respect of liquidated damages negotiated in respect of breaches.
- Moving and relocating costs: You will need to bear the costs of vacating/moving your belongings or fittings from the property which may include removing any alterations such as internal partitioning depending on the terms of your lease, redecorating, taking down signage, fees for disconnecting any utilities as well as the costs of finding a new property.
- Stamp duty loss: You will typically forgo any stamp duty paid in respect of the whole lease term paid at the start. There is no such entitlement to a refund.
- Break penalty: Although not common, some leases may require a tenant to pay a one-off (break penalty) fee for exercising the right to break.
What happens if a tenant fails to vacate the property after activating a break clause?
Once a tenant has exercised a break clause validly, they must vacate the premises and return the property (and keys) to the landlord on the break date as per the terms of the lease. Unless the landlord agrees otherwise, failure to vacate the property after activating a break clause technically puts the tenant in breach and they can be treated as a trespasser. It is open to the landlord to initiate legal proceedings to enforce the break clause and regain possession of the property. This could result in additional time and expenses for both parties.
The tenant may also be liable for rent payments and other obligations under the lease agreement until they vacate the property, even after activating the break clause. The landlord may pursue legal action to recover any outstanding rent, incurred costs or damage resulting from the tenant's failure to vacate, such as loss of rental income or legal fees.
Summary
Break clauses provide a useful and flexible mechanism for business tenants to exit a lease depending on their commercial situation. It is important to make sure that the mechanics and wording of the break clause are clear, as any ambiguity can lead to costly mistakes or disputes further down the line.
