The recent case of Vivienne Westwood Limited v Conduit Street Development Limited highlights the importance of careful consideration when deciding what to include in a side letter to a lease between a landlord and tenant.

Facts: In 2009 Vivienne Westwood entered into a 15 year lease of a shop in Mayfair at an initial rent of £110,000 per annum, with upwards only open market reviews in the fifth and tenth years. A side letter was entered into at the same time as the lease in which the landlord agreed to accept a lower rent for the first five years, with the rent subject to a cap after the first review. The side letter was terminable in a number of circumstances, including significantly, a breach of any term of the lease by the tenant, in which case the rent would be payable on the terms set out in the lease, as if the side letter never existed. The tenant was late in paying the rent in June 2015 and so the landlord purported to terminate the side letter. The key question for the court was whether the termination clause was a penalty and therefore unenforceable.

Decision: The court provided a useful recap of the law on penalties. Broadly, a penalty clause can exist where a secondary obligation is imposed on a breach of a primary obligation, and that secondary obligation imposes on the defaulting party a detriment that is disproportionate to any legitimate interest of the innocent party. In this case, the court considered that the reduced rent was fundamental to the bargain between the parties and so the tenant’s primary obligation was the payment of the reduced rent agreed under the side letter. The tenant’s secondary obligation was to pay the higher rent if it breached the terms of the lease, and, therefore, the termination clause could be a penalty. In terms of the burden caused by the secondary obligation, the court took into account the fact that the obligation to pay the higher rent applied both retrospectively and prospectively and regardless of the nature of the breach. Consequently, the court held that the termination provisions in the side letter could give rise to “very substantial and disproportionate financial detriment” to the tenant, and were therefore a penalty and the purported termination of the letter was unenforceable.

Lessons: This case is a reminder that parties should carefully consider the content of any side letters, where provisions could be deemed a penalty and may therefore be unenforceable. The courts will not necessarily enforce what has been agreed. Landlords should be advised to think twice before imposing particularly onerous terms on tenants in side letters – it may be more beneficial to agree a more moderate position from the outset.