Like afternoon tea, cricket and other great British institutions, the real estate law of England and Wales can be a bit of a mystery for those who are not familiar with it.

This article considers three areas of the real estate law of England and Wales that can give rise to significant problems if parties are not aware of the risks.

Pre-contract negotiations

Many jurisdictions require parties to act in good faith in their dealings with other parties. Unless the parties agree otherwise, there is no duty to act in good faith in England and Wales. Therefore, parties are free to negotiate and behave according to their own self-interest.

In the case of real estate contracts, this freedom is supported by section 2 of the Law of Property (Miscellaneous Provisions) Act 1989, which stipulates that a contract for a real estate transaction must  (a) be in writing, (b) incorporate all of the terms of the agreement between the parties and (c) be signed by the parties. Until the parties have entered into a contract that meets those requirements, they are usually free to withdraw at any stage. Letters of intention to enter an agreement (also known as "heads of terms") should be endorsed with the words "subject to contract" to indicate that a formal contract has not yet been created.

The unexpected consequences of section 2 were illustrated in the case of Dudley Muslim Association Limited v Dudley Metropolitan Borough Council [2015] EWCA Civ 1123. The parties wished to vary an existing section 2-compliant contract and the High Court decided that a failure to ensure that the agreed variation also complied with section 2 meant that the agreed variation was not binding on the parties.

Security of tenure for business tenants

The Landlord and Tenant Act 1954 provides security of tenure for tenants who occupy premises for business purposes. In any commercial letting scenario in England and Wales, parties should take care to properly understand the effect the 1954 Act may have on their ability to either stay at the premises or take back the premises, as the case may be.

Security of tenure under the 1954 Act is a very powerful and valuable right for tenants. The main consequences are:

  • Tenants can acquire security of tenure without a written lease because the right derives from the tenant’s occupation of the premises. This is a serious risk where the basis of a tenant’s occupancy is not validated and they are permitted to occupy premises for an extended period.
  • Unless the statutory requirements to either renew or terminate the tenancy are followed, or the tenancy is terminated by forfeiture, a break option or an agreed surrender, the tenancy continues on the same terms after the contractual expiry date provided the tenant remains in occupation of the premises.
  • If the landlord wishes to terminate the tenancy pursuant to the 1954 Act, it can only do so if it meets one or more of the seven statutory grounds stipulated by the 1954 Act:
    1. disrepair - breach of tenant’s obligations;
    2. persistent delay by the tenant in paying rent;
    3. other substantial breaches of the lease by the tenant;
    4. alternative accommodation can be provided for the tenant;
    5. possession required for letting or disposal of the property as a whole;
    6. demolition or reconstruction of the premises;
    7. landlord’s own occupation of the premises.
  • If the parties are not able to agree the terms upon which the tenancy will be renewed or terminated, either party can apply to the court for a determination of the terms of the new tenancy or the landlord’s ground(s) for termination.
  • If the court is called upon to determine the terms of the new tenancy, it will do so according to its statutory powers which provide for a maximum term of 15 years and an open market rent. Those powers provide the basis upon which any negotiations as to renewal terms will proceed.
  • If court processes are engaged, it will usually take between nine and 12 months to reach the trial at which the terms are determined or the tenancy is terminated.

Parties can "contract out" of the security of tenure provisions of the 1954 Act by following statutory notice and declaration processes. The effect of contracting out is that the tenant will not have security of tenure and the lease will terminate on its contractual expiry date. This is an important consideration for any landlord that may wish to take back the premises at a later date, let them to another tenant or negotiate renewal terms with the existing tenant in the open market.

The benefits to the landlord of contracting out were demonstrated in the case of Erimus Housing Limited v Barclays Wealth Trustees (Jersey) Limited & Anr [2014] EWCA Civ 303. The Court of Appeal decided that when a tenant remained in occupation of the premises even after the expiry of its contracted out lease while the parties were negotiating a new lease, the tenant occupied the premises as a "tenant at will" rather than as a true tenant even if the negotiations were slow and protracted over a period of year. Tenants at will are expressly excluded from 1954 Act protection, and the tenant in this case did not have security of tenure.

Tenant break options in leases

Many leases contain provisions by which the tenant can terminate the lease on non-fault grounds. These provisions are often referred to as break options and commonly require parties to meet certain conditions precedent otherwise the break option will not operate and the lease will continue.

Common conditions precedent include:

  • service of a notice at the time and in the form required by the lease;
  • paying sums such as rent falling due before the break date;
  • complying with the tenant covenants; and
  • delivering vacant possession of the premises on the break date.

Problems that have been litigated in recent years include:

  • Form and timing of the notice - serving the notice on the wrong person, serving the right person but at the wrong address and miscalculating the break date.
  • Payments - apportioning rent up to the break date and failing to pay interest which has become due on historic late payments of rent even if not demanded.
  • Complying with the tenant’s covenants - misunderstanding pre-conditions requiring "material" or "substantial" or "reasonable" compliance, failing to follow the absolute requirements for decoration and leaving it too late to reinstate alterations.
  • Delivering vacant possession on the break date - sub-contractors completing last minute works beyond the break date and leaving office furniture behind.

In many cases, the problems that can arise when a break option is being operated can be eliminated or, at least, made less significant by looking very carefully at the terms of the break option when it is being negotiated in heads of terms and/or the lease. For example:

  • The term "vacant possession" is commonly seen in break options but it has no defined legal meaning and will mean different things in different circumstances. Therefore, parties should clearly set out in the lease either what is meant by "vacant possession" or simply state that the tenant will have ceased to occupy the premises and will have determined any interest deriving out of this lease by the break date.
  • In English leases rent is conventionally payable in instalments four times a year. Each payment of rent is intended to relate to the three months following the date for payment. Perhaps surprisingly, if the date on which a break option takes effect is part way through one of those three-month periods, the tenant must still pay a full three months’ rent in advance and is not automatically entitled to any refund for the period following the break date. The parties may however agree to include an express term in the lease providing for such a refund. Commonly, additional capital payments over and above the rent due must be made by tenants to exercise a break right. In all such cases, the parties should seek to eliminate any uncertainty as to what has to be paid and by when. If the intention is that the rent for the full rent period is to be paid but that the tenant will be entitled to recover any "overpayment" of rent for the period after the break date, if the break option operates successfully, the lease should include provisions entitling the tenant to do so. This will ensure the tenant knows it has to pay the full rent but that it can recover the overpayment. In addition, the parties should stipulate precisely what payments are required - all sums under the lease or just the principal rent?

In 2015 the UK’s Supreme Court unanimously dismissed an appeal by a tenant who contended that a term should be implied into its lease by which the tenant would be entitled to recoup overpaid sums after exercising its break option. The decision reinforces best practice:  If parties want to be able to claim back overpaid sums, then they should ensure the lease includes express apportionment or recoup provisions that entitle them to do so (Marks and Spencer Plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2015] UKSC 72).