It is not unusual for a rent concession to be documented in a side letter, keeping the arrangement both confidential and personal to the tenant. It is also common for a side letter to contain provisions which allow the arrangement to be terminated if the tenant breaches the terms of the letter or the lease (eg by paying rent late).
However, a recent High Court judgment, Vivienne Westwood Limited v Conduit Street Development Limited, has established that a termination provision of this kind may be considered to be a penalty, and therefore unenforceable.
The facts of the case
In 2009 the tenant, Vivienne Westwood Limited, took a 15-year lease of a shop. The rent was stated in the lease to be £110,000 with upwards-only reviews in 2014 and 2019.
The side letter
On the same day that the lease was completed the landlord and tenant entered into a side arrangement, agreeing a reduced rent of £90,000 in the first year, stepping up to £100,000 in the fifth year. The rent would then be subject to the 2014 rent review, but capped at £125,000. It was made clear that that agreement was not a variation of the lease.
The side letter was personal to the tenant and the termination provisions stated that if the tenant breached any terms or conditions of the agreement, the lease, or any supplemental document, the landlord would be able to immediately terminate the agreement and that the lease rent would become payable as if the side letter had never existed.
Dispute and termination
The 2014 review was not carried out, but in March 2015 the tenant was invoiced at a rate equivalent to a rent of £125,000 per annum (ie the level of the capped increase), which it paid in full. However, the tenant failed to pay the June quarter’s rent. In July, the landlord notified the tenant that it was in breach of its lease and that the side letter was terminated with immediate effect. The tenant then paid the June arrears, which the landlord accepted as part payment in light of the outstanding rent review. The open market rent was subsequently determined to be £232,500 per annum.
The tenant claimed that the March 2015 invoice, payment and acceptance of rent constituted an implied agreement that the 2014 rent review has been set at £125,000.
The tenant also claimed that termination provisions in the side letter were unenforceable as they amounted to a contractual penalty.
The court did not accept that anything in the landlord’s conduct amounted to an offer to settle the outstanding review at £125,000. However, the court agreed with the tenant that the termination provisions amounted to a penalty and were therefore unenforceable. This meant that the tenant was entitled to pay rent at the capped rate, regardless of any breach of the lease, for as long as it traded from the premises.
The court found the termination provisions to be a penalty because:
- The side letter did not amount merely to a conditional right to a rent discount (as the landlord argued) but was a change to the tenant’s primary obligation (despite not amounting to a variation of the lease): the reduction in rent was a part of the overall bargain between the parties, offered because of the tenant’s reputation. The tenant’s primary obligation was not to pay the rent as stated in the lease but to pay the rent as stated in the side letter.
- The way in which the provision operated was to make the higher rent payable with retrospective as well as future effect (as termination meant that rent was payable “as if this agreement had never existed”). The effect of this was such that on a breach of lease the tenant would find itself liable for additional rent of between £10,000 to £20,000 per annum for the first five years plus a significantly higher rent over the next five years. This was in addition to all the landlord’s usual remedies, such as interest on overdue payments. The effect on the tenant of not complying with one of its obligations was wholly disproportionate to the landlord’s interest in preserving cash-flow.
This decision is surprising in that the tenant’s reduced rent was found to be a primary obligation. It highlights the fact that a side letter may amount to significantly more than a conditional concession, even though it expressly does not vary the lease. When entering into side arrangements it is therefore essential that thought is given to the following points:
- Whether the terms of the side arrangement change the tenant’s primary obligation – if this is not what is intended it must be made clear. It is worth noting that this decision was based upon the fact that the rent concession was a fundamental part of the bargain between the parties; if it had been a period of concessionary rent granted to a tenant struggling to pay the rent at the agreed level it would not have been treated in the same way.
- Whether any termination provisions will have retrospective as well as future effect: to reduce the risk of provisions being found to amount to a penalty it is advisable to expressly provide that the rent will only revert to the lease rent in the future and not retrospectively.
- Whether the consequences to the tenant are proportionate to the landlord maintaining the value of its reversion and, where applicable, its cashflow: while a penalty clause may seem attractive to a landlord it will not be enforced by the courts.