A recent Supreme Court decision has finally resolved an important point for those in the hospitality sector involved in the termination of a lease by way of break notice.
Prior to the High Court decision in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd and another in 2013, it was accepted law that, if the break date was in the middle of a rental period, any rent paid in advance in respect of the period after the break date was only recoverable by the tenant if the lease expressly provided for this.
A court may however imply a term into a specific contract to fill a gap in the contract's drafting. The rationale for implying a term in this way is to reflect the parties' intentions when the contract was entered into. However, the test is an objective one. The court will consider what a reasonable person would have understood the parties' intentions to be, given the background knowledge reasonably available to the parties at the time they entered the contract.
The tenant (T) in this case had a lease which was due to expire on 2 February 2018. The lease contained a break clause allowing T to determine the lease on 24 January 2012 (break date).
The lease obliged T to pay the rent yearly and "proportionately for any part of a year" by equal quarterly instalments in advance on the usual quarter days ( www.practicallaw.com/2-107-7097) . T was also required to pay service charge, an insurance charge and a car parking licence fee. However, the words "proportionately for any part of a year" did not appear in the provisions of the lease requiring T to pay these amounts.
The lease also contained a break clause which required T to give six months' notice and was conditional on:
- There being no arrears of rent (or VAT on the rent) on the break date.
- T paying a penalty of an amount equivalent to a year's rent on, or prior to, the break date (break premium).
The lease did not contain an express provision entitling T to a refund of the rent or other payments for the period after the break date.
However, the lease did provide that, if T did not exercise the break clause on the break date, the landlord (L) would pay the tenant £150,000 by crediting it against T's liability for the rent due on the following quarter day.
More than six months before the break date, T served notice on the landlord (L) to exercise the break clause. In December 2011, L invoiced T for the rent, service charge and car parking licence fee due on the December quarter day. The invoice for the rent and the other payments was from the December quarter day to the break date. T in fact paid a full quarter's rent, service charge and car parking licence fee. T had already paid the insurance charges in August 2011 for the period 1 July 2011 to 30 June 2012.
On 18 January 2012, T paid the break premium.
On 24 January 2012, the lease ended in accordance with the break clause.
In February 2012, T asked L for a refund of the rent and the other payments that T had paid in respect of the period after the break date.
L claimed that T was not entitled to a refund and stated that the invoice issued in December 2011 had been incorrect as it should have been for a full quarter's rent, service charge and car parking licence fee.
T issued proceedings for a repayment of the rent and the other payments in respect of the period after the break date.
The High Court held that T was entitled to the refund of the rent, the insurance charge and the car parking licence fee for the period after the break date, despite the fact that the lease did not contain an express provision to that effect. The dispute in relation to the service charge had been disposed of between the parties in the High Court proceedings.
L appealed. The Court of Appeal overturned the High Court decision and held that it was not appropriate to imply a term into the lease that entitled T to a refund of the rent, car parking licence fee and insurance charges that it had paid in advance.
T now sought leave to appeal which the Supreme Court granted.
T's main argument was that:
- The lease provided that the rent be "paid yearly and proportionately for any part of a year by equal quarterly instalments in advance". The words in bold meant that, if the lease had run its full course to 2 February 2018, T would only have had to pay an apportioned part of the rent due on 25 December 2017. This was because, as at 25 December 2017, the parties would have known that the lease would expire before the next quarter day, 25 March 2018.
- In this case, because T had not paid the break premium before 25 December 2011, then, as at 25 December 2011, the parties did not know whether the lease would come to an end before 25 March 2012. T therefore had to pay the quarter's rent in full: it only became clear that the lease would determine on 24 January 2012 when T paid the break premium on 18 January.
- However, if T had paid the break premium before 25 December 2011, it would have been clear on 25 December 2011 that the lease would end on 24 January 2012. Consequently, the tenant would only have had to pay an appropriate proportion of the rent on 25 December 2011.
Therefore, commercial common sense should be applied to put the tenant in the same financial position whether it paid the break premium before 25 December 2011 or chose to wait (as it was entitled to) until after 25 December 2011 to pay that sum.
T also claimed that the fact that the rent was payable "yearly and proportionately for any part of a year" supported the argument that there was an implied term requiring a refund of sums paid in advance for the period after the break date.
L relied on the fact that the lease was a very detailed document, which had been entered into between two substantial and experienced parties, and had been negotiated and drafted by expert solicitors. In particular, the lease made provision for a large number of contingencies.
Decision of the Supreme Court
Unanimously, the Supreme Court found in favour of L and dismissed T's appeal.
Essentially, the judgment clarifies that in order for a term to be implied into a contract it must be either necessary for business efficacy or so obvious that it goes without saying. In addition, the process of interpreting a contract is separate from the process of implying terms; a contract must be construed before terms can be implied.
Implying a term into the lease
The court ruled that it was not appropriate to imply a term into the lease that entitled T to a refund of the rent, car parking licence fee and insurance charges that it had paid in advance in accordance with the express terms of the lease because:
- The lease was a very full and carefully considered contract. It included express obligations of the same nature as the proposed implied term (that is, financial liabilities in connection with T's right to break). An implied term requiring a refund of advance payments made in respect of the period after the break date would lie uneasily with those provisions.
- The words "proportionately for any part of a year" did not support the tenant's claim for an implied term. Instead, the fact that the lease expressly provided that only part of a quarter's rent was to be paid in some circumstances, undermined the notion that a term which had a similar effect should be implied in other circumstances.
Save in a very clear case, the court considered it would be wrong to attribute to a landlord and a tenant an intention that the tenant should receive an apportioned part of the rent payable and paid in advance, particularly when:
- The parties had entered into a full and professionally drafted lease.
- It was clearly established law that the Apportionment Act 1870 did not apply to rents payable in advance.
Case law clearly provided that rent payable and paid in advance could be retained by the landlord, save in very exceptional circumstances (for example, where the contract could not work or would lead to an absurdity). Consequently, express words would be needed before it would be right to imply a term to the contrary.
Also, the following clauses in the lease showed how carefully and fully the parties considered and identified their rights against each other in relation to the break clause:
- The clause stipulating that a break notice would have no effect if there were arrears.
- The clause providing that a break notice would only be effective if the break premium was paid on or prior to the break date.
- The clause which provided that T would be paid £150,000 if it did not exercise its right to break.
These provisions showed that the parties had addressed the specific question of what payments were to be made between them in connection with the break clause, and in particular, what sums were to be paid if the right to break either was exercised or not. Therefore, it was inappropriate for the court to step in to fill what was no more than an arguable lacuna.
The reasons for rejecting T's argument in relation to the rent applied equally to the car parking licence fee.
The position was less clear in relation to the insurance rent. However, unless it could be shown to have been unreasonable for L to have insured the building for the whole of the ensuing year when it did so, the reasons for dismissing this appeal in relation to the rent and the car parking licence fee applied equally to the insurance rent. Property owners invariably insured their properties on an annual basis, unless there was a specific reason not to do so. This was clearly the established practice in this case.
It may be that L could not have recovered the insurance rent for a full year in a case where it would have been unreasonable for them to have expected T to pay for a full year’s cover.
This decision had been eagerly anticipated. Landlords will now breathe a further sigh of relief following this judgment.
When negotiating terms for a lease that contains a break clause, a tenant should seek an express refund of rent and any other payments for the period from and excluding the break date up to and excluding the next rent payment date. If an express clause is not included in the lease, the tenant will not be entitled to a refund. It may be that the landlord refuses this request if it is in a strong bargaining position. However, tenants need to address their minds to this issue.