The recent case of Vivienne Westwood Limited v Conduit Street Developments Limited  EWHC 350 (Ch) considers whether termination provisions contained within a side letter are unenforceable as a penalty.
Vivienne Westwood Limited was granted a lease of a retail shop, comprising the basement and ground floor of premises at 18 Conduit Street, Mayfair, London ("Premises") on 18 November 2009 ("Lease"). The Premises were demised for a term of 15 years at an initial yearly rent of 110,000 subject to upwards only rent reviews in 2014 and 2019.
Given the tenant's high profile within the fashion industry, the former landlord was keen to retain the tenant and the parties entered into a concessionary side letter ("Side Letter") under which, notwithstanding the terms of the Lease, the tenant would pay a reduced yearly rent. The rent was reduced for the first 5 years of the term, stepped from 90,000 up to 100,000. If a higher open market rent was determined on the first rent review in 2014, the yearly rent payable would be capped at 125,000 per year for the next 5 years. The Side Letter was expressed to be personal and contained a provision allowing the landlord to terminate the agreement on any breach by the tenant. If the Side Letter was terminated, the yearly rent would be immediately payable on the terms set out in the Lease, as if the Side Letter had never existed.
A number of changes in the ownership of the landlord's reversionary leasehold interest resulted in a delay by the tenant in paying the rent. By May 2015, Conduit Street Development Limited ("Conduit Street") had become the new landlord. As a consequence of a delayed payment in June 2015, Conduit Street served a notice terminating the Side Letter, entitling it to raise the yearly rent from 125,000 per year to the market rent of 232,500 from November 2014. The obligation to pay the higher rent was in addition to compensating Conduit Street for any loss caused by the breach itself.
The tenant argued that:
- its primary obligation was to pay rent at the lower rate agreed under the Side Letter and that its obligation to pay the higher rent in the Lease was a secondary obligation, which was triggered by Conduit Street terminating the Side Letter; and
- the termination provisions contained in the Side Letter operated as a contractual penalty and were unenforceable.
Conduit Street argued that:
- there was a legitimate interest in ensuring there was no breach of any term of the Lease and that a tenant in breach would affect the value of its reversionary interest; and
- the additional rent was not "exorbitant".
LAW ON PENALTIES
The law on penalties was revisited by the Supreme Court in the case of Cavendish Square Holding BV v El Makdessi and ParkingEye Limited v Beavis  UKSC 67, in which an 85 car parking charge was not considered a penalty and could be charged to a vehicle owner for overstaying the allocated time. When considering whether a contractual stipulation was a penalty, the Supreme Court applied the following test:
- firstly, is the provision in question a secondary obligation which bites upon breach of a primary contractual obligation;
- secondly, what is the extent and nature of the legitimate interest of the innocent party in having the primary obligation performed; and
- thirdly, having regard to this legitimate interest, is the secondary obligation exorbitant or unconscionable in amount or in its effect?
The court stated that:
- the termination provisions contained within the Side Letter were a "blunt instrument that may give rise to a very substantial and disproportionate financial detriment"; and
- as a result of a minor breach that does little to harm Conduit Street's legitimate interests (namely its cash flow and the value of its reversion), the additional rent payable was "exorbitant and unconscionable".
Consequently, the court ruled that the termination provisions were penal in nature and were not enforceable meaning the tenant was only liable for the reduced rent of 125,000 per year; not the 232,500 being market rent sought.
Rent concessions in side letters are common in commercial property transactions, however, this case provides a reminder to both landlords and tenants to give extra thought when negotiating the terms of side letters. The courts will protect genuine legitimate interests but any contractual stipulation need to be proportionate so avoid exorbitant or unconscionable figures. Landlords should avoid unduly onerous terms, such as termination provisions which impose significant financial detriment to their tenant, in order to avoid such terms being considered penalties and, therefore, becoming unenforceable.