Key points

  • Where a break clause is conditional on all sums due under the lease having been paid, the break may be frustrated if the tenant owes interest on late payments
  • This may be the case whether the landlord has demanded interest or not
  • A cheque is not legal tender and a landlord is not normally under an obligation to accept payment by cheque

Background

In the January 2012 edition of property update, we reviewed the case of Quirkco Investments Ltd v Aspray Transport Ltd. Another case on break clauses serves as a reminder that the conditions to the exercise of a break must be strictly complied with.

Avocet Industrial Estates LLP v Merol Limited

In Avocet Industrial Estates LLP v Merol Limited, the tenant served a break notice to terminate its lease on 17 March 2010. The lease provided that the break notice would be of no effect if, at the break date, any payment which was due on or before that date had not been paid. In addition, the tenant had to pay a sum equating to six months' rent to the landlord by the break date. Time was expressly stated to be of the essence of these provisions.

The tenant delivered a letter, by hand, to the landlord on the day before the break date (16 March 2010), enclosing a cheque for six months' rent. In the letter, the tenant stated that it was not aware of any payments which were due to be have been made under the lease which had not been paid and that the tenant was unaware of any breach of the terms of the lease. Similar assertions had also been made by the tenant at the time it served the break notice, back in August 2009.

On 7 April 2010, after the break date had passed, the landlord wrote to the tenant. The landlord contended that the break had not been effectively operated, for two reasons:

  • The landlord argued that the lease required the payment of six months' rent to be in cleared funds, whereas the tenant had tendered a cheque on the day before the break date.
  • The lease obliged the tenant to pay interest on payments which were made late under the lease. The landlord alleged that the tenant owed interest which, because it had not been paid by the break date, meant that the break notice was of no effect.

The court considered each of these arguments in turn.

Payment of six months' rent

The landlord's first challenge required the court to determine whether payment of six months' rent had been made on or before the break date. A debt has to be paid by a tender of legal currency, unless the parties agree otherwise (either expressly or by implication). A cheque is not legal tender.

In this case however the landlord had accepted payments by cheque for the first three years of the lease. The tenant then unilaterally changed the payment method when it arranged for its parent company to pay the rent by BACS, which it did for approximately two years. Rent payment was interrupted in 2007 when the property, which was in Gloucestershire, suffered flood damage and the rent suspension provisions were triggered.

Although a landlord is entitled to give notice that it will not continue to accept payment by cheque, on the facts of the case the correspondence between the parties was insufficient to unilaterally terminate the implied agreement. The court ruled that the tenant's election to pay by BACS between 2008 and 2010 did not change the position that the landlord had impliedly agreed to accept payment by cheque up to 2010 when the tenant tendered the break premium.

The first issue was therefore determined in the tenant's favour.

Interest on late payments

As we have seen however, the landlord had a second argument up its sleeve. The lease provided that:

"If any Annual Rent or any other money payable under this Lease has not been paid by the date it is due, whether it has been formally demanded or not, the Tenant shall pay the Landlord interest at the Default Interest Rate [defined as 4% above the base rate of National Westminster Bank plc] ... on that amount for the period from the due date to and including the date of payment".

The tenant had paid rent and other sums late on a number of occasions during the term of the lease. However, the tenant argued that, on the true construction of the interest clause, it was not liable to pay interest unless and until it received a valid demand for payment.

The court noted that it was possible for the tenant to work out whether or not a payment which was due under the lease had been paid late. Even where payment was made by bank transfer, the tenant could make certain assumptions as to the likely length of time before the monies would reach the landlord's account. Similarly, the tenant could ascertain (if necessary by enquiry of NatWest) the rate of default interest which was payable. Therefore the court ruled that there was no real practical difficulty in the tenant knowing what sums were owing by way of interest even without a demand from the landlord.

The court reviewed the rest of the lease in order to determine whether, properly construed, interest was only payable following a demand. The court concluded that there was nothing in the interest provision which made it a pre-condition to the tenant becoming liable to pay interest that the landlord had first served a demand for it.

On the face of it, therefore, the tenant owed interest. However, the tenant then argued that the landlord was estopped from contending that, as at the break date, any sum was due and unpaid.

Estoppel

There are various different kinds of estoppel. Its essence in this context can be summed up as a person who, by their behaviour, is prevented from relying on their strict legal rights.

In the period from January 2008 to the service of the break notice on 11 August 2009, the tenant was late in paying the rent on most occasions. In that period, the landlord did not serve any demand for interest.

On 12 August 2009, the landlord paid to the tenant the interest which had accrued on a rent deposit paid by the tenant at the start of the lease. According to the rent deposit deed, the tenant was entitled to this interest, but not if there was any default by the tenant. The court thought that it was strongly arguable that, when the landlord paid the interest on the rent deposit account to the tenant, the landlord was representing that the tenant was not in default under the lease (including that the tenant did not at that point owe any interest).

However, the tenant had also made late payments in the period between August 2009 and the break date. The tenant submitted that the landlord had a "duty to speak" and tell the tenant that it owed interest. The landlord knew from the tenant's letter of 16 March 2010 that the tenant believed that it did not owe any sums under the lease, and did not correct that belief.

The critical question was whether, before the end of 17 March 2010 (the break date), the landlord knew that the tenant's belief was wrong. The court ruled that, if the landlord did know that, then it could not take advantage of the tenant's mistake, and it would be estopped.

The court found that, in this case, the landlord did not have the necessary knowledge. Evidence given on behalf of the landlord was to the effect that the landlord had not then given the matter full consideration. The point was taken by the landlord for the first time in its letter of 7 April 2010 (after the break date) which, in all probability, had been drafted by the landlord's solicitors. Even though the court had construed the lease as requiring interest to be paid even where no demand had been issued, it would not have been obvious to the landlord, without specific legal advice on the point, that that was the legal position.

The degree of suspicion which would be needed to place on the landlord a duty to speak would have to amount to blind-eye knowledge. As this had not been met in this case, the landlord was not estopped. The tenant had not complied with the break clause.

Things to consider

The judge stated that:

"I fully recognise that the combined effect of [the interest clause and the break clause] represents something of a trap for the tenant. ... [The landlord] searched through its records for the preceding 5 years of the term and identified every single late payment and then calculated Default Interest throughout that period. ... However, ... I have not felt able to construe either [clause] in a way which would eliminate this trap".

He concluded that "the result ... is a harsh one but, applying legal principles, it is one which I am obliged to reach".

The total amount of interest owing was about £130, which would have been more than covered by the rent deposit held by the landlord of approximately £20,000. However, as in Quirkco, the size of the amount made no difference to the strict requirement to comply with the break clause in the lease.

Tenants

Tenants who wish to avoid finding themselves in the same situation as the tenant did in this case should try to restrict the conditions which have to be complied with in order to operate a break clause. The Commercial Lease Code recommends that the only pre-conditions to the exercise of a break clause should be that the tenant:

  • Is up to date with the main rent
  • Gives up occupation
  • Does not leave behind any continuing subleases.

When negotiating a new lease, tenants could amend the interest clause so that interest is only payable on demand. However, this could cause issues for a subsequent assignee, which may find itself on the receiving end of a demand from the landlord for interest which relates to late payments made by a former tenant. Since the obligation to pay interest will not arise until the demand is made, the assignee will be liable to pay it.

It goes without saying that tenants should strive to make payments on time. However, tenants may wish to try to negotiate a grace period on sums due under the lease before interest becomes payable. Following this case it would be prudent to keep detailed records of when (and by what means) payments under the lease are made.

The problem is that an assignee will not usually have records of when payments were made by its predecessors, and therefore will not know whether they still owe any interest. This could cause difficulties where, as in this case, a break clause is conditional on all sums due under the lease having been paid. Arguably, an assignee should request details of its assignor's payment history at the time of taking the assignment.

There is nothing to stop a tenant wishing to exercise a break asking the landlord directly whether any sums (and more particularly interest) are owing, and so try to set up an estoppel (despite the failure of this tactic in Avocet). But how will a well-advised landlord respond to such a request?

Landlords

The difficulty for landlords is that the court appears to have shown itself to be willing, in theory at least, to penalise landlords who know that a tenant has made a mistake and take advantage of it. This may mark a move away from what has been thought to be the position following the case of Fitzroy House Epworth Street (No 1) Ltd v The Financial Times Ltd.

In the Financial Times case, the question was whether a tenant had "materially" complied with its repairing obligations for the purpose of the exercise of a break. The Court of Appeal held that the landlord's behaviour was irrelevant to the question of whether or not the tenant had materially complied with the lease. However, the issue of estoppel was not raised in Financial Times, and so the two cases are not necessarily inconsistent.

The best advice for a landlord who receives a letter from a tenant asking it to confirm that the tenant has paid everything owing under the lease is to take legal advice as soon as possible. One option would be for the landlord to respond, saying that it is not the landlord's responsibility to check such matters – the tenant must satisfy itself that it has complied with the terms of the lease.

Arguably, it is better for a landlord in this position not to delve too deeply into the tenant's payment history before the break date, although admittedly this may not work where the landlord has what the judge referred to in the case as "blind-eye knowledge". Which side of what could be a very fine line a landlord's behaviour falls is likely to be determined by the circumstances of the particular case.

The key message for landlords is be on their guard, and not to give the tenant anything which could later be used to found an estoppel.