FACTS OF THE CASE

Marks & Spencer Plc (M&S) held leases of four floors of offices in Paddington.  The leases ran until 2 February 2018 but M&S had the benefit of break clauses in all of the leases operable as at 24 January 2012 or 24 January 2014.

The break clauses were subject to a number of conditions, the most important of which were:

  • on the break date there were to be no arrears of the basic rent; and
  • to exercise the 2012 break, the tenant was also to make a payment to the landlord of approximately £900,000 plus VAT 'on or prior to' the break date (the 'break sum').

The break sum was approximately the basic yearly rent for one floor.  Clearly the tenant would save substantial sums by correctly operating the break clauses.

M&S made all payments required to exercise the breaks including paying a full quarter’s rent due on the quarter day preceding the break date.  M&S then sought to recover what it considered to be over payments of rent attributable to the period between the break date and the end of that quarter.  At first instance, the court implied a term into the leases requiring the landlord to repay that sum.  That decision surprised many practitioners.

The Court of Appeal has now overturned this decision and in so doing has both clarified the law in this area and re-stated the appropriate approach to be adopted when considering the implication of terms into leases and other contractual documents.

WHY IS RENT PAYABLE FOR A PERIOD BEYOND THE BREAK DATE?

To properly understand the decision in the Court of Appeal, it is important to appreciate why a full quarter’s rent is payable in these circumstances.  In summary:

  • Parliament has provided that certain rental payments can be apportioned under the Apportionment Act 1870.  However in Ellis v Rowbotham [1900] 1 QB 740, the Court of Appeal ruled that the 1870 Act only applied to sums payable in arrears.  Modern leases invariably provide that rent is payable in advance and so the 1870 Act is of no assistance.
  • Starting with Ellis v Rowbotham, there has been a line of cases in which the Courts have ruled that a full quarter’s rent was recoverable for the last quarter during which a lease was forfeit. 
  • In Capital & City Holdings Ltd v Dean Warburg Ltd [1989] 1 EGLR 90 the Court  applied the same reasoning to a lease even though rent was described as being due 'yearly (and proportionately for any part of a year)'. 
  • This principle was extended to the exercise of a tenant’s break clause in Re A Company [2007] BPIR 1, decided a year after the M&S leases were granted.
  • In PCE Investors Ltd v Cancer Research UK [2012] EWHC 884 (Ch), the court considered the argument that, because the tenant was no longer able to occupy the premises after the break date, no rent was due for that apportioned period due to a failure of consideration.  The court dismissed this argument.  A lease contained a package of rights and obligations on either side.  The tenant had agreed to pay rent in advance as part of the overall consideration for obtaining the lease so there was no failure of consideration. 
  • A similar argument failed at first instance in Marks & Spencer v BNP Paribas. This argument should therefore now be at an end.

CAN A TENANT SEEK REPAYMENT?

When exercising break clauses, tenants have felt aggrieved to be paying a full quarter’s rent on the quarter day immediately before the break date.  What is the correct approach?

The conditionality in many break clauses has meant that tenants have not been able to take the risk of paying an apportioned sum calculated up to the relevant break dates.  If this apportioned payment is not permitted by clear words in the lease, their attempt to break the lease will fail if they do not pay the full quarter’s rent (see for example PCE Investors Ltd).  Therefore M&S paid the full sums demanded on the quarter date preceding the effected break date.  The only option left was to seek repayment of the balance which they considered to have been 'overpaid'. 

Commentators had suggested for a number of years that this might be possible and, at first instance, M&S ran a range of arguments, relying on:

  • the express terms of the lease;
  • an alleged failure of consideration;
  • implied terms; and
  • restitution/unjust enrichment

They succeeded only on the basis of an implied term and argument in the Court  of Appeal was also limited to that issue.

IS AN IMPLIED TERM CALLED FOR?

At first instance, the court implied a term into the lease requiring repayment of rent applicable to the period following the break date.  The Court  of Appeal placed particular stress on two arguments:

  • It was said that, if at the time that notice was served, all other conditions were complied with then only an apportioned rental payment would have been due, and
  • The break premium amounted to approximately one year's rent (before review) and so the parties should be taken to have agreed that this was the full amount of compensation payable for exercise of the break.

We will return to the first of those arguments below.  In the Court of Appeal, the principal focus was on the correct test for implying a term.

For many years, it was considered that the test for implying a term into a contract was a severe one.  The term had to be either necessary to give business efficacy to the contract or to represent the obvious, but unexpressed, intention of the parties (see Chitty on Contract para 13-004 31st Edition).  This 'traditional' approach was disturbed by the Privy Council’s decision in AG of Belize v Belize Telecom Ltd [2009] 1 WLR 1988.  That decision explained that the implication of terms was simply one aspect of construction of a contract.  As Lord Hoffman said: “There is only one question:  Is that what the instrument, read as a whole against the relevant background, would reasonably be understood to mean?”

This was the test applied by the court  at first instance and this approach was criticised by the Court of Appeal. 

Arden LJ emphasised that to imply a term the court is still required to pass a high test.  This test was put in a number of ways:  

  • it 'requires a high level of loyalty to the parties’ agreement';
  • 'the starting point is that, if there is no express term, none should be implied because if the parties intended that particular term should apply to their relationship they would have included a term to that effect.'; 
  • 'the court  will not imply a term as a matter of interpretation following the Belize approach – unless it is necessary that the agreement should contain such a term to achieve the parties' express agreement'; 
  • 'as Lord Hoffman said in Belize 'an unexpressed term can be implied if and only if the court  finds that the parties must have intended that term to form part of their contract'.

In short, the Court of Appeal considered that the implication of a term in favour of the tenant in Marks & Spencer Plc v PNB Paribas was a product of focusing too much on what was reasonable rather than whether the high bar necessary for implying a term had been reached.

As the court  said: “In my judgment, when all the circumstances are considered, the correct influence to draw is that the parties proceeded on the basis that the loss from a payment of rent for the broken period should lie where it fell.  Thus no term for repayment is implied.”

THE UNANSWERED QUESTION

In general terms therefore it is now clear that:

  • when a conditional break clause is exercised one generally will not know on the preceding quarter day whether the conditions will be complied with and whether the lease will terminate on the break date;
  • accordingly, unless there are express words to the contrary, a full quarter’s rent will be payable on the quarter day preceding the break date, even if the break date falls part-way through that quarter;
  • a term will not be implied that an apportioned part of those payments will be refunded once the lease had come to an end, even where the tenant has agreed to make a termination payment as a condition of exercise of the break;
  • the fact that rent is expressed to be payable 'proportionally for any part of the year' only refers to the fact that the tenant makes a proportional payment in the first and last years of the term and does not affect the amount payable immediately prior to exercise of a break.

WHAT IF THE BREAK IS UNCONDITIONAL?

In its analysis of the tenant’s payment obligations, the court  at first instance considered what happened when a lease expires by effluxion of time part way through a quarter.

Both at first instance and on appeal it was accepted that words such as 'proportionally for any part of a year' in relation to rent meant that at the end of the contractual term rent only had to be paid for a period up to the last day of the lease.  Morgan J considered that the same result was achieved even if these express words were not used (see York v Casey [1998] 2 EGLR 25).

He also held that if on the last quarter day preceding the break date, it was by then clear that the lease was bound to end on the break date, only a payment of rent apportioned up to the break date, would be due.

This could apply in two circumstances:

  • where there was no conditionality attached to the exercise of the break clause; or
  • where any condition specified had been fully satisfied before the final quarterly payment became due.

The Court  of Appeal did not hear full argument on this point but was of the view this, 'would seem to be correct'. 

In practical terms:

  • where a break is unconditional, a tenant will be able to pay an apportioned final payment on the last quarter day and leave it to the landlord to bring a claim that additional monies are due;
  • where a break is conditional and there are significant financial consequences of failing to exercise the break, tenants will not be willing to take the risk of a court  deciding that a full quarter’s rent is payable and are unlikely to be able to seek recovery following payment;
  • a tenant would be advised to seek early determination of the issue from the court  well in advance of exercising the break and having to pay the rent due on the last quarter.