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Material compliance and breaches

What happens if the tenant is in breach? Is there a minor breach? Has the tenant materially complied with the terms of the lease? Is the tenant required to pay the full-quarter's rent if the break is due to take place in the middle of the quarter? Do any of these matters prevent the tenant from exercising the break clause?

See also the page on Vacant possession, which deals with cases where vacant possession and the removal of chattels is a condition of the break.


Material compliance

Fitzroy House Epworth Street (No 1) Ltd v The Financial Times Ltd
[2006] EWCA Civ 329

Summary

This case was concerned with a lease where the tenant wanted to operate a break clause but was only able to do so so long as it was not in "material" breach of covenant. The Court of Appeal has given very helpful guidance on how one determines materiality. The Chancellor of the High Court:
    "Materiality must be assessed by reference to the ability of the landlord to relet or sell the property without delay or additional expenditure. Where the provision is absolute then any breach will preclude an exercise of the break clause. But I see no justification for attributing to the parties an intention that the insertion of the word 'material' was intended to permit only breaches which were trivial or trifling. Those words are of uncertain meaning also and are not the words used by the parties. Nor is it, in my view, of any assistance to consider whether the word 'material' permits more or different breaches than the commonly used alternatives 'substantial' or 'reasonable'. The words 'substantial' and 'material' depending on the context, are interchangeable. The word 'reasonable' connotes a different test. The issue here is whether, notwithstanding the breaches found by the judge the Tenant had, nevertheless, 'materially complied' with its obligations. The application of an ordinary English word to a set of primary facts is itself a question of fact.." (paras 35 and 36)
Facts

In this case the property was a substantial one with a rent of £595,000 per year (which was up to date when the notice was given and when it took effect). The tenant spent nearly £1 million putting the property into repair before it left. There were some repairs outstanding but the maximum value of the defects amounting to a breach of the repairing covenants was no more than £20,000, including supervision fees. However, it was not this straightforward comparison that made the outstanding breaches immaterial. As can be seen from the quote above the test is not whether the breaches were 'trivial or trifling'. It was the limited effect of those defects on the ability to relet the property that made the difference. The expert evidence was that a landlord seeking to relet the property might have to give credit for 75% of the cost of the outstanding defects to an incoming tenant. When expressed as a rent free period that would be equivalent to 9 days and in those circumstances it is likely that 'the prospective tenant would not have raised the point in the first place for fear of creating the wrong impression'. (para 31).

Decision

The judge at first instance had taken into account various irrelevant factors in coming to his conclusion that the tenant was not in material breach, such as the fact that it had used all reasonable endeavours to perform its obligations, that it had followed professional advice, that it had offered the landlord access for inspections as the works continued, that the landlord unreasonably declined and that 'it would be most unreasonable' if the tenant was unable to operate the break clause. However, on the primary evidence the judge was entitled to come to the conclusion that the breaches were immaterial because of the negligible effect, if any, on the ability to relet.

Comment

The CA has given very helpful guidance on the term 'material'. However, the case does highlight how problematic break clauses can be. A tenant with a break clause needs the certainty of knowing that it can operate the clause without difficulty. Phrases such as 'material', 'substantial' or 'reasonable' do not provide that certainty and clauses using one of these phrases can often be little more than a recipe for litigation.


Minor breach

Whether sums due at operative date – payment by cheque – very small sum outstanding

Avocet Industrial Estates LLP v Merol Ltd
[2011] EWHC 3422 (Ch)

Summary

The payment by cheque of a terminal payment that was a condition of break clause was sufficient, as there was an implied agreement, arising by conduct, that payment by cheque was acceptable. However, the failure by a tenant to pay a very small sum of interest due in respect of late rental payments meant that it had failed to comply in full with the conditions for operating the break clause. Accordingly, the lease had not come to an end.

Facts

The lease contained a break clause allowing T to terminate the lease on 17 March 2010. The right to break was subject to several conditions, including T having to pay a sum equal to six months' rent on or before the break date. The lease also stated that:
    "A Break Notice shall be of no effect if ... at the Break Date any payment under this lease due to have been paid on or before that date, has not been paid..."
Clause 14.1 of the lease also provided that:
    "If any Annual Rent or any other money payable under this Lease has not been paid by the date it is due, whether it has been formally demanded or not, the Tenant shall pay the Landlord interest at the Default Interest Rate (both before and after any judgment) on that amount for the period from the due date to and including the date of payment."
L and T had also entered into a rent deposit deed that provided for T to be paid the interest on the rent deposit every six months, unless T was in arrears with any payments (including interest) then due under the lease.

T served a break notice in the appropriate form on L. T's covering letter stated that T was not aware of any breach of the lease and noted that L had not given notice of any intention to draw on the rent deposit in respect of any breach. On the same day, T paid into its bank account, a cheque it had received from L for six months' interest on the rent deposit. L did not give any substantive response to the break notice. Between 12 August 2009 and 16 March 2010, T paid its rent or insurance rent late on three occasions, but no demand for default interest was issued by L.

On 16 March 2010, i.e. the day before the break date, T sent L a cheque for the six months' rent (£39,000), together with the keys and written confirmation that T had vacated the premises. The covering letter reiterated that T was not aware of any outstanding sums due to L under the lease.

On 7 April 2010, L wrote to T stating that T had not complied with the break clause because:
  • A cheque was insufficient: L required cleared funds by the break date.

  • T had paid rent and other sums late, so default interest was payable and outstanding.
Issues

The questions before the court were:
  • Was payment by cheque on the break date of the 6 months’ rent sufficient to comply with the condition, or did payment have to be received by the break date in cleared funds?

  • Was the failure to pay interest on late payments, without a demand for the interest, a failure to comply with the condition?
Decision

Acceptance of payment by cheque: Morgan J (at para 50) pointed out the general common law rule that payment must be by tender of legal currency unless there is an express or implied agreement to the contrary:
    “The general common law rule will not apply where there is an express or implied agreement to the contrary. Such an agreement can be inferred from conduct. A common course of conduct which is considered in the cases is where there has been a practice of a party making periodical payments by cheque and where the cheques have been accepted.”
And at para 63
    “It is well established that an acceptance of a cheque results in payment of the sum due but subject to the condition that the cheque is in due course met on presentation and, when the cheque is met, payment is effective as at the date of the tender of the cheque. It is also relevant that there had never been any difficulty with a cheque not being met on presentation…”
The judge went on to hold that there was an implied agreement that L would accept payment by cheque as, for the first three years of the term, T had made all payments by cheque, which L accepted. This was a consistent course of dealings giving rise to the implied agreement, which could have, but had not in fact, been ended by L. The judge came to that conclusion even though the cheque payments had later been replaced by BACS payments:
    “I do not think that the voluntary adoption by the tenant of a system of payment by BACS transfers shows that the tenant has abandoned the benefit of the implied agreement that it may pay by cheque rather than by currency”
The landlord was not therefore entitled to reject tender of the cheque. In any event the landlord had taken too long to return the cheque and so must be taken to have accepted it (para 82).

Failure to make payment of interest: Unfortunately, for the tenant the judge however also found that a very small sum of “default interest” was outstanding at the break date (£130). There was nothing in the wording of the clause to suggest that interest was only due on receipt of a demand from L. On the evidence in this case, the court held that L did not know that T’s belief that it had paid all sums due was wrong, before the end of the break date and did not take advantage of T’s mistake. If L had known of the situation and deliberately kept quiet, the result may have been different. The consequence was that the break clause had not been effectively operated! Morgan J:
    "I fully recognise that the combined effect of [the interest clause and the break clause] represents something of a trap for the tenant. ... [The landlord] searched through its records for the preceding 5 years of the term and identified every single late payment and then calculated Default Interest throughout that period. ... However ... I have not felt able to construe either [clause] in a way which would eliminate this trap".
The interest was £130 and would have been more than covered by the £20,000 rent deposit. The judge concluded that "the result ... is a harsh one but, applying legal principles, it is one which I am obliged to reach".

Comment

The tenant took very careful steps to ensure that it fully complied with the conditions making the break effective but still made a small mistake that had disastrous consequences. This case demonstrates, once again, that break clauses with conditions are very often worthless. (An appeal was lodged but the case settled before it was heard by the Court of Appeal.)


Break clause operable in middle of a quarter

Conditional upon payment of full quarter's rent

PCE Investors Ltd v Cancer Research UK
[2012] EWHC 884 (Ch)

Summary

A break clause operable on condition that the tenant pays the rents was held to require the tenant to pay all the rent, without apportionment. The landlord was not estopped from claiming that full amount of rent was due as it had served a rent demand for the full amount and did not respond to the tenant's assertion that only an apportioned sum was payable.

Facts

A lease provided that the tenant (T) was entitled to terminate its lease on the 11 October 2010, a date which fell shortly after the immediately preceding quarterly rent payment day of 29 September 2010. The break clause required the tenant to give vacant possession and pay "the rents reserved and demanded by this Lease up to the Termination Date". T paid an annual rent that was payable in quarterly instalments.

In due course T served a notice on the landlord (L) to terminate the lease on the break date. Shortly before the 29 September 2010 the tenant sent to L’s agent an e-mail stating that T had paid the rent due from 29 September 2010 to 12 October 2010, and asking L to "please confirm that this is the correct basis for calculating the liability for the short period". The landlord did not respond to the email.

L’s agent sent the tenant an invoice for the September quarter's rent and sent a further copy (at the tenant’s request) on 21 September 2010.

On 2 November 2010, L’s solicitors informed T that the break notice had been ineffective as it should have paid the whole of the September quarter’s rent by 11 October 2010. T rejected this and argued that L was estopped from arguing that the purported break was ineffective.

Issues
  • Did the lease entitle T to pay rent only from the quarter day to the break date?


  • If not, was L estopped from denying that the lease had been brought to an end under the terms of the break clause by its failure to respond to T’s email?
Decision

Rent: The High Court (Smith J) held that a full quarter's rent fell due on the September quarter day. It was payable in advance, and on the due date it could not be certain that the lease would end on the break date, as the tenant might not comply with the other elements of the conditional break clause. The court rejected an argument that there was a failure of consideration where rent is paid for the period after the break date, Smith J said that the lease:
    “… contains a bundle of rights and obligations on both sides and as part of that .. the Tenant agreed to pay rent in advance as part of the overall consideration for obtaining the [lease]. Merely because the provisions obligate him to pay rent in advance even after the Termination Date does not mean that there is a failure of consideration as regards that payment merely because beneficial use of the premises is not taken”
Estoppel: Although there might be cases where, on the particular facts, a person is under an obligation to point out an error by the other party, there was no general rule that where one party perceives the other side is making a mistake they have a duty to correct it. If there were a duty in this case, L had discharged the duty by demanding the September quarter’s rent. The demand, the court said, spoke for itself. It was not necessary for L to repeat the demand by replying to the tenant's email: "it was up to the tenant... to make the running".

The only indication that T had from L was a demand for the full amount; T therefore took the risk that the short payment would not be enough. The court did not think that L had contributed to that risk in a misleading way.


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