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“Don’t look back in anger” – it’s a penalty!

The High Court has recently considered whether the termination by a landlord of a side letter, which allowed its retailer tenant to enjoy a reduced rent, was a penalty. 

When the Lease was granted the initial rent was £110,000 per year, subject to reviews every five years.  A side letter which the landlord granted to the tenant allowed the tenant to pay a reduced rent for the first five years and also said that if the open market rent payable after the first review was more than £125,000 the tenant’s rent would be capped at £125,000 for the following five years.  The letter said, however, that it could be terminated with immediate effect if the tenant breached any of the terms of the letter or the Lease.

The tenant was confused as to the correct rent payable, which resulted in it missing a quarter’s rent in June 2015.  The upshot was that the landlord terminated the side letter. 

One of the issues the Court had to consider was whether the landlord’s right to terminate the side letter was an unenforceable penalty clause. 

The High Court decided that the effect of termination was a penalty because:-

  • When the Lease and side letter were read together the effect was that the tenant’s primary obligation under the Lease was changed to require it to pay the reduced rent with a secondary obligation to pay a higher rent if that primary obligation was breached; 
  • The requirement to pay the higher rent applied whether the breach by the tenant was a one off, minor, serious and had no regard to the nature of the obligation broken or the consequences for the landlord;
  • The obligation to pay the higher rent operated retrospectively and required the tenant to pay the higher rent as if the concession had never been allowed;
  • The landlord had other remedies available to it including an ability to claim interest on overdue rent, recovery of costs and damages; and
  • The consequence of termination was out of proportion with the landlord’s interest in preserving its cashflow and the value of the reversion.

A point to note for landlords is that it may be sensible to draft side letters so that the requirement to pay rent at the higher level in the event of a breach only operates for the future and not retrospectively.

For further information please contact James Staton, Partner, Litigation.

 

About the Author

James Staton

Partner

James is a Partner and Head of the Dispute Resolution team and primarily handles commercial…

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