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Break Option - The Devil is in the Detail

24/02/2016

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Ireland

A break option in a commercial lease gives a tenant an opportunity to terminate a lease prior to the expiration of the term. This option is invaluable as it allows flexibility for a tenant e.g. to seek alternative accommodation (smaller or larger premises) in accordance with their business needs at the break option date, whilst affording an opportunity to avail of the full term (by not exercising the break).A key factor in regulating break options is that due consideration...

A break option in a commercial lease gives a tenant an opportunity to terminate a lease prior to the expiration of the term. This option is invaluable as it allows flexibility for a tenant e.g. to seek alternative accommodation (smaller or larger premises) in accordance with their business needs at the break option date, whilst affording an opportunity to avail of the full term (by not exercising the break).

A key factor in regulating break options is that due consideration is given to the wider obligations under the lease at the time the break option is drafted and establishing the “full” cost of exercising the break. Usually the exercise of the break option is subject to all payments under the lease being made up to the termination date, and all covenants and conditions in the lease being complied with including dilapidations, etc.

The general principle applying to break options is that they are strictly construed, for example, the Courts have upheld strict adherence to time frames for serving notice etc. However, the devil is in the detail and beak options thought to be beneficial to the tenant, could be very onerous financially, and otherwise if not carefully drafted.

A recent English judgment of the UK Supreme Court (02/12/2015) Marks and Spencer plc (“M & S”) v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2015] UKSC72  highlights just how harsh the outcome for a tenant can be where the drafting of the terms of the break option does not address all scenarios.

This case concerned the rental of office space by M & S under a lease. The case turned on whether M & S were entitled to have a term implied into the lease which would have entitled them to a refund of rent for a period after they had vacated the property, having validly exercised a break option. To exercise the break M & S had paid Stg £919,800 plus VAT and a further £200K by way of advance rent to cover a period after the break date (when they would no longer be in occupation of the property). The general principal in exercising break options is that there must be compliance with the lessees covenants on the lease to include ensuring that no arrears of rent are outstanding and all other payments due under the lease are up to date, service charges etc. The lease validly terminated on the 24th of January 2012 but the additional £200k was in respect of rent up to the 24th March 2012.

After the break was exercised the tenant sought to recover from the landlord the advance rent, service charge, insurance and parking charges for the period from when it had vacated the building on the 24th of January up to  the 24th of March 2012. The landlord did refund the advance payments in respect of service charge, parking charges, and insurance, as the lease provided for this, but refused the rent refund request as there was no provision in the lease providing for such a refund. On an objective view it would seem unfair that the Landlord should get a further £200k which could be described as a “windfall”.

The Tenants case was that a term should implied into the Lease requiring the Landlord to return the £200k. The Tenant was successful in the UK High Court. The Landlord then took the case to the UK Court of Appeal, where The High Court’s decision was overturned.  The Tenant appealed to the UK Supreme Court, where it upheld the Court of Appeal’s decision. The Supreme Court held that the tenant was not entitled to a refund of the  advance rent payment of £200k as it was not provided for in the terms of the lease and as it had not been established in evidence that this was the intent of the parties when drafting the lease the court would not imply such a term.

This decision highlights the need for a tenant to carefully look at all consequences of the exercise of a break option and to establish the financial cost on the day the lease is drafted as the courts are unwilling to imply terms unless there was clear evidence of an intent by the parties that such a term formed part of their bargain.

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