Termination of rent concession was a penalty

The High Court has held that exercise by a landlord, following breach of the lease, of its right to terminate a side letter granting a rent concession and to recover the higher rent with retrospective effect, was disproportionate to the tenant’s breach of the lease, and amounted to penalty. The termination provision was therefore unenforceable by the Landlord. (Vivienne Westwood Limited v Conduit Street Development Limited [2017] EWHC 350 (ch)).

The tenant leased retail premises from the landlord for a term of 15 years from November 2009 at an initial rent of £110,000 per annum, and the parties entered into a side letter at the same time as the lease under which a concessionary rent was allowed on a stepped basis, until the first review on the fifth year of the term and following the review the rent would be capped at £125,000. The rent concession was terminable by the landlord if the tenant breached any of the terms of the lease, and the full rent under the lease would be payable, retrospectively.

The tenant breached the lease by failing to pay the rent due in June 2015 and the landlord gave notice to terminate the side letter. The tenant claimed that the termination provisions in the side letter were unenforceable as a contractual penalty.

In English law a penalty clause can exist where there is a secondary obligation imposed upon a breach of a primary obligation owed by one party to the other, and the secondary obligation imposes a detriment on the party in breach out of all proportion to the legitimate interest of the other party in having the primary obligation performed.

The Court considered that rent provisions in the lease and the side letter, which were entered into at the same time, should be read together, so that the primary obligation is to pay rent at the reduced rate. The alternative interpretation that the requirements for a penalty were not present, because the primary obligation was the obligation to pay the higher rent reserved by the lease and that the side letter conferred a conditional collateral right to pay at the concessionary rate for so long as there was no breach of lease or side letter (and not therefore not secondary obligation, which might be capable of being a penalty), was rejected by the Court.

Therefore, to the extent that the side letter purported to permit the landlord to impose a greater obligation upon a breach of the lease, that greater, secondary obligation was capable of being a penalty.

Under the side letter the same financial adjustment applied irrespective of the magnitude of the breach, and likely consequences to the landlord, and this state of affairs has long been one of the characteristics of a penalty. The provision appeared to be exorbitant and unconscionable in comparison to any legitimate interest of the landlord (such legitimate interest being the benefit of the primary obligation to pay rent at the reduced rate, breach of which would entitle the landlord to recover interest and costs), and caused a disproportionate detriment to the tenant, and was therefore penal in nature and unenforceable.

The Court also stated that the termination provision would still have been penal if the obligation to pay the higher rent only applied prospectively.

Comment

Side letters commonly include termination provisions on similar terms, and landlords should be warned that those provisions may not be enforceable. It might be possible to state in the side letter that the letter does not amend the tenant’s primary obligation under the lease and to state that the landlord has not received any consideration for the concession, but this has not been tested, and the landlord should still be aware that the potential for termination of the side letter could be construed as a penalty.