Key points

  • In the case of an alleged failure to correctly exercise an option, there are two questions:
  1. Is the provision in question a requirement of the agreement?
  2. If yes, has it been complied with?
  • If the answer to the second question is no, then the exercise of the option will be invalid
  • There is no room for the concept of substantial compliance 

Background

In our September/October 2013 update, we considered the High Court decision in Friends Life Ltd v Siemens Hearing Instruments Ltd.  The High Court held that a break notice was effective, even though it didn't comply with the requirements of the break clause in the lease.  The Court of Appeal has now reversed this decision.

The break clause required written notice to be given to the landlord, and was subject to notice timing and other pre-conditions for the exercise of the break. Unusually, the break clause also required that the tenant's notice "must be expressed to be given under section 24(2) of the Landlord and Tenant Act 1954".

Within the notice period specified in the break clause, the tenant served a notice on the landlord.  The notice made reference to the break clause in the lease, but no reference was made in the notice to s.24(2) of the 1954 Act. The landlord claimed that such an omission rendered the break notice ineffective.

Why did the break clause refer to the 1954 Act?

The reference to s.24(2) of the 1954 Act was not a mistake. Its inclusion was a result of a debate raging in the legal world at the time the agreement for lease was entered into.  There was a school of thought that a tenant could, at the same time as serving a break notice, also serve a notice on the landlord under section 26 of the 1954 Act.  Section 26 enables a tenant whose lease is protected by the Act to request a new lease from the landlord.  The concern was that a tenant could use this mechanism in a falling market to break an overrented lease, and at the same time secure a new lease at a lower rent.

This possibility was removed by a case called Garston v Scottish Widows Fund and Life Assurance Society.  However, the draft lease to be entered into by the tenant in Friends Life was left unamended to allow for the possibility of the decision in Garston being appealed, and so the lease was granted with the 1954 Act wording still left in the break clause.  

High Court decision

Although the High Court had concluded the break notice did not comply with the break clause, it nevertheless held that the omission of the required wording did not invalidate the notice.  It thought that the information that would have been provided to the landlord by the omitted wording was neither necessary nor relevant. The judge thought the consequences of non-compliance should be considered, and the parties could not have intended that exercise of an important right like a break right would be "dependent on compliance with a meaningless formula".

Court of Appeal

The Court of Appeal reversed the High Court decision.  It noted that options (including break options) are a form of unilateral, or "if" contract.  In a simple form of option agreement, it is up to the promisee whether he does or doesn't do the thing (usually, serving a notice) which will trigger an obligation on the part of the promisor ("If I do this, then you will do that").  But, if he does it, then the promisor's obligations will crystallise.

There is a well-established principle of law that the terms of unilateral contracts such as options must be fully and strictly complied with.  Failure to do so invalidates the exercise of the option. This is so that the promisor can know whether his obligations have been triggered or not. In this sense, options are interpreted differently, and more strictly, than other contractual and statutory provisions. 

Two questions

The Court of Appeal held that there were essentially two questions. 

  1. Was the stipulation that the notice should be expressed to be given under section 24 of the 1954 Act a "requirement" of the break clause?  The court thought that the word "must" in the break clause was "an emphatic and imperative word".  Compliance with the stipulation was therefore mandatory and not merely permissive. 
  2. Had the requirement had been complied with?  Clearly, it had not – and this had not been in dispute by either party.   

In other cases of contractual interpretation, there might then be a third question – what are the consequences of non-compliance?  However, where unilateral or "if" contracts are concerned, the answer to this is simple and well established by the common law – the exercise of the option is invalid.  There is no room for the notion of substantial compliance.  The question is whether the relevant event has occurred – and that question has a yes or no answer.

The break clause required the break notice to say on its face that it was being served under section 24 of the 1954 Act. The break notice did not do this. The break had therefore not been validly operated.

Things to consider

The courts are increasingly being asked to rule on questions of compliance with pre-conditions to the exercise of break clauses.  Establishing full compliance with the terms of such conditions is key, given that break provisions will be strictly construed against a tenant. This case presented a rather different issue, with the tenant seeking to establish the validity of its break notice despite the failure to follow the required form of wording.

The High Court's comments on interpretation and construction issues (see our earlier alert) were seen as introducing an unwelcome element of uncertainty for landlords when trying to assess the effectiveness or otherwise of defective break notices. The Court of Appeal's reversal of the High Court decision may be seen as a return to a more consistent approach on the question of the need for compliance where a particular form of notice has been specified, however "meaningless" that requirement may appear to be.

In the case of options, the Court of Appeal emphasised that although each case would depend upon construction of the particular terms of the provision in question, a consistent approach was important and radically different interpretations of commercial lease break clauses with evidently similar intentions should be avoided.

The clear message is to ensure that when exercising break rights, all the relevant provisions are carefully considered and every requirement fully and strictly complied with, however irrelevant or trivial such requirements may seem.