Side letters to leases between landlords and tenants have been common devices to set out arrangements personal to a tenant to try to make a lease more attractive to them.
However, the recent case of Vivienne Westwood Limited v Conduit Street Development Limited highlighted the difficulties which can arise from side letter arrangements.
Vivienne Westwood Ltd (‘tenant’) entered into a 15-year lease. Conduit Street Development Limited (‘landlord’) had agreed a reduced rent in light of the tenant’s reputation. The annual rent was £110,000, subject to upwards-only reviews in the 5th and 10th years.
In a side letter issued at the same time, the landlord agreed to accept a lower annual rent of £90,000 increasing to £100,000 after five years. On the basis that the rent review went ahead, any increase would be capped at £125,000.
The side letter was terminable if certain events took place (such as the assignment of the lease; if the tenant allowed someone else to trade from the shop; in the event of insolvency etc). The side letter was also terminable if ‘any term of the lease’ was breached. Should this happen, the rent would be immediately payable on the terms set out in the lease, as if the side letter had never existed.
The lease began in 2009. In 2014, it was established that the open market rent was £232,500 a year. However, the parties disagreed about whether the rent payable was the open market rent as set out in the lease, or the capped rent of £125,000 as agreed in the side letter. The deciding factor was whether the side letter remained valid.
The landlord argued that the tenant had breached the terms of the lease due to late payment of the rent, and therefore had (purportedly) terminated the side letter.
The tenant’s main argument (which was successful) was that the termination clause in the side letter was an unenforceable penalty. As such, the side letter had not been terminated and the rent payable should be £125,000 until the 2019 rent review, as long as none of the conditions (which would also trigger the end of the side letter) arose.
Tenancy agreements have to comply with The Unfair Terms in Consumer Contracts Regulations 1999. Accordingly, penalty clauses should be designed to compensate the landlord/agent for their loss, with the view to putting them back into the original position they would have been in had the breach not occurred.
Penalty clauses should not allow for arbitrary or excessive charges, or enable the landlord/agent to profit from the tenant’s breach. A tenancy clause which imposes an excessive financial penalty shall be deemed an unfair contract term and will ultimately be unenforceable (‘unenforceable penalty’).
The case of Cavendish Square Holding BV v Makdessi(2015) restated the main principles of the law of unenforceable penalties in leases. It established that an unenforceable penalty clause will be found to exist where:
A secondary obligation is imposed on a breach of a primary obligation; and
That secondary obligation imposes on the defaulting party a detriment disproportionate to any legitimate interest of the innocent party.
Primary and Secondary Obligations
The court found that the true bargain of the arrangement was made in the lease AND the side letter and was that, in return for having a tenant of the claimant’s reputation, the landlord would accept a reduced level of rent. Therefore, the claimant’s primary obligations were to pay the lower amount of rent as set out in the side letter in addition to fulfilling the other obligations in the lease. Therefore, the obligation to pay at the higher rate was a secondary obligation which would be engaged on breach of the primary obligation.
The High Court determined that, in accordance with Cavendish Square Holding BV v Makdessi:
The tenant’s secondary obligation to pay the rent under the lease would be imposed on breach of its primary obligation to pay the reduced rent in the side letter; and
The amounts payable by way of increased rent from the rent commencement date were out of all proportion to the nature of the breach.
Therefore, it was held that the landlord was unable to rely on the termination provision in the side letter as it was an unenforceable penalty.
The case highlights that caution should be applied before agreeing and drafting any side letters, to ensure that they do not contain an unenforceable penalty. Landlords should therefore seek legal advice where dealing with leases and side letters. Our commercial team specialises in such matters and would be happy to assist should you need expert legal advice regarding any of the above or indeed any other property law matters.
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The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.