The case of Vivienne Westwood Limited v Conduit Street Development Limited [2017] EWHC 350 (Ch) concerns the effect of a side letter made at the same time as the grant of a lease which provided for a lower yearly rent to be paid by the tenant, Vivienne Westwood. The question for the Court to consider was whether the termination provision in the side letter was penal in nature.

Background

Vivienne Westwood is the tenant of the basement and ground floor of 18 Conduit Street, London (“Premises”). The Premises are demised for a term of 15 years from 18 November 2009 at an initial yearly rent of £110,000. The rent is subject to upward only rent reviews to the open market rent on 18 November 2014 and 18 November 2019, and is payable in advance on the usual quarter days.

The rent review provisions require the parties to try and agree on the open market rent two months before the review date, failing which the rent is to be decided by an independent valuer on the application of either party. If the rent is not agreed by the review date, the tenant must continue to pay the existing rent until the revised rent is ascertained.

On the same day as the lease completed, the landlord and the tenant agreed a side letter. The side letter recorded that the landlord would accept a reduced yearly rent from the tenant. This was to be £90,000 in the first year, up to £100,000 in the fifth year and capped at £125,000 for the next five years of the term if a higher open market rent was determined upon the first rent review. The side letter was expressed to be personal to the tenant and not a variation of the lease.

The side letter contained a termination provision which stated that if the tenant breached the terms of either the side letter or lease, the landlord could terminate the side letter with immediate effect and the rent would immediately be payable in the manner set out in the lease as if the side letter had never existed.

The facts

In March 2015, the tenant was sent a draft invoice by email for a quarter’s rent in the sum of £31,250 (equivalent to an annual rent of £125,000). The draft invoice said the invoice should be paid by 25 March 2015. A copy of the side letter was attached to the email. No final invoice was sent to the tenant but in any event, payment was made in full by them on 31 March 2015.

The tenant subsequently failed to pay the June 2015 quarter’s rent. In July 2015, the landlord told the tenant that a surveyor had been appointed to assess the market rent for the Premises for an overdue rent review. Shortly afterwards, the landlord wrote to the tenant asserting breach of the terms of the lease. Notice was given terminating the agreement in the side letter with immediate effect. The tenant then paid the rent arrears in full. This was accepted by the landlord in part payment only on the basis that the rent review was being arranged.

As the parties could not agree the rent, an independent valuer was appointed. The expert surveyor determined the open market rent at £232,000 per annum.

The parties’ arguments

The tenant’s first argument was that the demand, payment and acceptance of rent for the March 2015 quarter at a rate that was not otherwise payable under the lease or the side letter must be taken as an agreement between the landlord and the tenant that the yearly rent review due in November 2014 had in fact taken place and had been agreed at £125,000 per annum.

The Court did not accept the tenant’s argument on this point. There was nothing in the landlord’s conduct that could be said, objectively, to amount to an offer to settle the outstanding rent review at £125,000. It was inevitable that the tenant would become liable to pay rent at a maximum rate of £125,000 whilst the side letter remained in place. The Court concluded on this point that the November 2014 rent review was not determined by agreement at the rate of £125,000 per annum. It was subsequently determined by agreement, following the appointment of an expert surveyor at the rate of £232,500 per annum.

The tenant’s second argument was that the termination provisions in the side letter were unenforceable as they amounted to a penalty.

In deciding this point, the Court applied the principles of Cavendish Square Holding BV v Makdessi [2016] UKSC 67.

First to be considered was the “threshold test”. The landlord argued that the lower rent set out in the side letter was a conditional right to a discount to which the tenant was not otherwise entitled. The primary obligation on the part of the tenant was to pay rent at the lower rate. That only changed in the event of a breach of contract by the tenant. The agreement for this particular tenant to pay a lower rent was offered because this was an attractive tenant for the landlord to have trading from the property. The lower rent would cease to apply if the tenant ceased to trade from the Premises or allowed someone else to trade from or occupy them. It was also not a discount for prompt payment as the rent could be increased in the event of any breach of covenant by the tenant. The Court held that the provisions in the side letter therefore amounted to a change to the tenant’s primary obligation.

The second consideration was whether there was a legitimate interest on the part of the landlord in having the tenant comply with its obligations under the lease. The Court considered this in light of its conclusion on the threshold issue; namely that the reduction in rent payable by the tenant was not simply a conditional right to which it was not otherwise entitled but a substantial term of the bargain it struck with the landlord in consideration of taking the lease. The landlord could not therefore argue that it had a legitimate interest in seeking that the rent reverted to the market rental level. That would be a legitimate interest in non-performance of the tenant’s obligations, not a legitimate interest in their performance.

The third consideration was whether the burden of the secondary obligation was exorbitant or unconscionable compared with any loss likely to flow from breach. The landlord apparently had a right to terminate the side letter in the event of any breach of the side letter or the lease. The Court accepted, as argued by the landlord that there had to be an implied qualification to this but did not accept, as argued by the landlord that this should be “any material breach” but should be read as “any non-trivial breach”. The Court determined that the obligation to pay rent at a higher rent as from the rent commencement date of the lease, regardless of the nature and consequence of the breach and when it occurred, was penal in nature.

The Court’s decision

The Court concluded the termination provision in the side letter was a penalty by reference to several factors:

1.      The words "and the rents will be immediately payable in the manner set out in the Lease as if this agreement had never existed" meant that the tenant would be liable for the higher rent for the preceding years of the lease, as well as the future.

2.      The higher rent was payable in addition to the other remedies available to the landlord for breach of any tenant obligation under the lease.

3.      An additional rent of between £10,000 and £20,000 per annum for the first five years and a potentially higher amount for the next five years would be payable in the event of any “non-trivial” breach by the tenant, in addition to compensation for any loss caused by the breach.

4.      The additional rent may be payable for much or most of a period of 10 years as a result of a minor breach or covenant that did no harm to the landlord’s legitimate interests in preserving its cash flow and the value of its reversion. The extra financial burden to the tenant was held to be exorbitant and unconscionable in comparison with any legitimate interest that would not otherwise be compensated by interest, costs and damages.

The Court concluded that since the termination provision in the side letter was penal in nature, the purported termination of the benefit of the side letter in July 2015 was unenforceable and the tenant therefore remains liable and entitled to pay the rent at the capped rent of £125,000 for so long as it satisfies the conditions in the side letter.

Practice points

  • Practitioners acting for landlords should be careful to consider whether the provisions of a side letter could be interpreted as changing the tenant’s primary obligations, as was the case here.
  • Practitioners should also consider whether the consequences of termination of the provisions of a side letter are proportionate to the landlord’s interest in maintaining the value of its reversion and if the side letter relates to rent, to preserving the landlord’s cash flow.
  • It should be noted that the Court was well aware in this case that the parties were well advised and in equal bargaining positions.