Commercial leases can contain covenants detailing parties obligations towards the other. Covenants may be positive, for example paying the rent on time, or restrictive, which prevent specific conduct or use. Restrictive covenants can significantly impact a tenant’s use of the premises, or limit how a landlord can deal with other areas of a larger development. As a result, they are often difficult to negotiate and hard fought. The consequences of failing to observe a restrictive covenant can be severe and include forfeiture or an injunction. So, when entering into a lease for commercial premises, either as landlord or tenant, it is crucial to have a clear understanding of the effects of any restrictive covenants and the potential consequences of non-compliance.
Here, our commercial property dispute solicitors explain what restrictive covenants are and their purpose in the context of commercial leasehold property. We consider the elements required to ensure enforceability, and how a restrictive covenant might be enforced.
Contents:
What are restrictive covenants?
Simply put, restrictive covenants in commercial leases are designed to prevent one party to the lease from doing something they would, in the absence of the covenant, be free to do. The covenant might prohibit a specific course of action or limit the use that can be made of the premises.
Purpose of restrictive covenants in commercial property
Restrictive covenants play a vital role in the value and use of commercial premises. Some of their common purposes include:
- Ensuring compliance with relevant laws
By regulating a tenant’s activities regarding matters such as noise, waste disposal or hazardous materials, a landlord can ensure the premises complies with all relevant laws and regulations.
- Preserving the value of the property
A landlord can use restrictive covenants to safeguard their investment by prohibiting a tenant from carrying out any acts that may devalue the property.
- Maintaining the harmony and character of an area or development
In premises with multiple tenants, particularly retail outlets such as shopping centres, a landlord might impose restrictive covenants to limit the use that can be made of the premises, or any alterations. This ensures the development hosts a mix of complementary businesses and maintains its overall aesthetic.
- Tenant exclusivity
Some restrictive covenants safeguard the tenant’s interests by restricting the landlord’s ability to let other premises within the area or development to businesses whose services overlap with those of the tenant. So, if the tenant is a bakery, the landlord might agree to refrain from letting other premises within a defined area, to a business that offers baked goods.
- Ensure cohesion
When the premises are part of a larger development, the landlord may seek to ensure cohesion among the tenants by imposing restrictive covenants relating to such issues as signage, opening hours and parking.
Common types of restrictive covenants
The nature of the restrictive covenants appropriate to any given premises will depend on several factors, including their nature, size and purpose. However, some types of restrictive covenants appear regularly in commercial leases. They include:
- Limiting the use that can be made of the premises.
- Prohibiting the tenant from using the premises for a specific trade or business.
- Prohibiting alterations to the premises.
- Prohibiting the tenant from opening before or after specified hours.
- Granting exclusivity to the tenant over certain trades or businesses.
- Prohibiting potential nuisances.
Elements of enforceable restrictive covenants
Generally speaking, a restrictive covenant in a commercial lease is enforceable between the original parties to the lease as a matter of contract.
However, the terms of a restrictive covenant must be clear and unambiguous. The covenant’s language and its meaning must be clear and specific, and its scope unequivocal. If there is any ambiguity, the covenant may be unenforceable.
When seeking to prevent a tenant from operating within a particular trade or industry, for example, or from selling certain goods, the covenant must make absolutely clear what business activity is prohibited. Any room for interpretation can lead to significant dispute. For example, in a case before the Irish Court, the parties spent four days arguing over whether non-food products were included in the word ‘groceries’, the sale of which was prevented by a restrictive covenant (the Irish Court found they were, incidentally).
Landlords will often seek to define the permitted use as narrowly as they can, whereas it is in the tenant’s interests for the wording to be as wide as possible to allow for expansion or diversification. Those tasked with negotiating a restrictive covenant must try to strike a balance between the parties’ competing interests. A degree of flexibility is usually required but, ultimately, the scope of any restrictive covenant will come down to the bargaining power of the respective parties.
Restrictive covenants usually last for as long as the lease is in place. This is often unproblematic when the lease is for a short term but can cause considerable issues in the context of long leases. A restrictive covenant that may suit your business requirements now may not do so years down the line, but you will remain bound by it. Further, if you wish to leave the premises and assign your lease, the benefit and burden of any covenants will pass to the assignee. Any material restrictions can significantly limit the pool of potential assignees, and you may be stuck with unsuitable premises.
Other issues can also affect the enforceability of a restrictive covenant. They include if its effects are contrary to public policy or prohibited by competition law. Often, the enforceability of any given restrictive covenant hinges entirely on the circumstances of the case.
If you have concerns or queries regarding the enforceability of a restrictive covenant, speak to us. Our expert disputes solicitors have advised considerable numbers of both landlords and tenants on all matters arising from commercial leases, including restrictive covenants. They will swiftly assess the enforceability of the covenant and advise on the best way forward.
How to enforce a restrictive covenant
If a tenant breaches a restrictive covenant, the options available to a landlord to enforce it depend on the nature of the breach and the terms of the lease.
The most common methods of enforcement include:
Forfeiture
Forfeiture is a landlord’s most powerful remedy. It allows them to terminate the lease and take back possession of the premises. A lease can be forfeited either through peaceable re-entry or issuing forfeiture proceedings at Court. The right to forfeiture does not arise automatically and must be expressly provided for in the lease. Most commercial leases include a right to forfeiture clause.
Even if the lease contains a right to forfeiture, that right can be easily lost in the context of some breaches. If the landlord treats the lease as ongoing, even unintentionally, they will potentially waive their forfeiture right. If you are a landlord, it is, therefore, vital to ascertain the nature of a breach as soon as you become aware of one and avoid taking any action in connection with the premises until you have sought legal advice.
In the case of all breaches except for non-payment of rent, the first step that must be taken in the forfeiture process is service of a statutory Notice under section 146 of the Law of Property Act 1925. If the breach is capable of remedy, the Notice must give the tenant a reasonable time in which to do so. If the tenant fails to remedy the breach as required, the landlord can proceed with forfeiture.
When contemplating forfeiture, it is crucial to take expert legal advice. It is a potent remedy but can be a trap for the unwary. If you purport to forfeit the lease in circumstances where such action was not warranted, you may be subject to a wrongful forfeiture claim. The remedies for wrongful forfeiture include an Order allowing the tenant to re-enter the premises, and damages for trespass and any losses sustained as a result of being forced to stop trading, which can be significant. Commercial considerations are also important. Is forfeiture the best option for your business? If you take back possession of the premises, will you be able to relet them easily? If there a risk you will be stuck with vacant premises, other courses of action may be more appropriate.
When addressing a breach of a restrictive covenant, our property disputes solicitors will not only consider your legal position in relation to forfeiture but also its potential practical effects on your business operations.
Injunction
Injunctions play a crucial role in restraining breaches of restrictive covenants. Unless the restrictive covenant is unenforceable for any of the reasons listed above, or another reason makes it inequitable for an injunction to be granted, an application for injunctive relief will often succeed. The Defendant will then be permanently prohibited from breaching the restrictive covenant. If the prohibited action has already been undertaken, the Court can order it to be undone. Interim injunctions are often granted to maintain the status quo until the Court can properly consider the matter at a hearing.
A breach of an injunction is a serious issue and carries severe penalties, including a fine and even imprisonment.
Damages
Damages might sometimes be awarded instead of, or as well as, an injunction. The basis upon which the Court will calculate the damages depends on the circumstances of the case. The Judge will usually base damages on the losses incurred by the landlord as a result of the breach, which the landlord will be expected to prove. Sometimes, however, damages might be calculated with reference to the amount the landlord might reasonably have charged to modify or remove the restrictive covenant.
How to prevent a breach of restrictive covenant dispute
Breach of restrictive covenant disputes can be lengthy, expensive and their outcome uncertain. Whilst disputes are sometimes unavoidable, prevention is always better than cure. So, to minimise the chances of becoming embroiled in such a dispute, consider taking the following steps:
- Ensure any restrictive covenant is clearly worded and unambiguous. Make sure both parties understand the scope of the covenant and its purpose, and the wording mirrors their agreement. Try to future proof the restrictive covenant insofar as possible to allow for expansion and diversification.
- Ensure the restrictive covenant does not fall foul of laws such as those relating to competition, which may render it unenforceable.
- Familiarise yourself with all restrictive covenants and ensure that your business operations, signage, renovations and any other activity adheres to them.
- Educate employees, contractors and other stakeholders on the terms of the restrictive covenants to avoid any inadvertent breach by them for which you will be liable.
- Address any potential issues promptly, seeking legal assistance where appropriate. By facing any problems head on and taking timely legal advice, you will avoid doing anything to jeopardise your position and may prevent the matter from escalating.
Our commercial property solicitors are able to review your commercial lease agreement and can help negotiate heads of terms on your behalf. They will be able to identify any onerous restrictive covenants that may exist within the lease agreement.
Summary
Restrictive covenants are essential to many commercial property transactions, but their far-reaching effects can lead to hard fought disputes. If a restrictive covenant is impacting your business operations or you are concerned that you may have breached your legal obligations under one, early legal advice is crucial. Our expert commercial property disputes solicitors have considerable experience in all matters relating to restrictive covenants. If the issue is capable of remedy by negotiation, they will liaise with the other party on your behalf and secure the best possible outcome. If legal action is required, our solicitors will take swift, decisive action to prevent or remedy the breach by seeking urgent injunctive relief or damages, as appropriate.
