UK: Break clauses - material compliance with tenantís covenants as a pre-condition

Last Updated: 26 January 2006
Article by Caroline Potter

Where a tenantís option to determine its lease is conditional upon material compliance with its covenants in the lease does this mean that any disrepair in the premises will deprive the tenant of his right to break? This was the issue that was recently discussed in the High Court in Fitzroy House Epworth Street (No. 1) -v- The Financial Times [2005] EWHC 2391 (TCC). The court held that if the breaches are minor, the tenant will still be in a position to exercise the clause.

Tenant break clauses have become increasingly common in leases over recent years. They have also become a regular source of dispute between landlord and tenant usually because the landlord does not want his tenant to leave, either because the tenant is currently paying a higher than market rent or because the landlord foresees difficulty in reletting the premises. Care must therefore be taken by the tenant in following the precise conditions of the break clause as regards the service of the break notice and the fulfilment of any pre-conditions.

Historically, break clauses were drafted so that the tenant could only exercise the break if he was in strict compliance with the terms of the lease including the payment of rent and any repairing or decorating covenants. Tenants became alert to the problems that strict compliance brought and started to delete these pre-conditions. Often as a compromise tenants and landlords agreed that "material compliance" or "substantial compliance" with the tenantís covenants was all that was required.

What does material compliance with the tenantís covenants actually mean in this context? This has been considered in the recent High Court decision of Fitzroy House Epworth Street (No. 1) -v- The Financial Times [2005] EWHC 2391 (TCC).

The lease provided a right to break that allowed the FT, as tenant, to determine the lease on serving at least 13 months notice before the relevant termination date of 1st April 2004. The lease would only be determined if the FT had materially complied with all its obligations under the lease up to the date of determination. The FT served the appropriate notice to break and then undertook substantial repairs and renovations costing in the region of £1million. They vacated the premises on the 1st April 2004.

Prior to carrying out the extensive programme of repairs, the FTís surveyor made reasonable efforts to meet the landlord in order to agree upon the works needed to ensure that the FT were in compliance with all its repairing obligations. The FTís specification of works was sent to the landlord for comment but none was forthcoming. The landlord prepared its own specification but did not give this to the FT until after the break date had passed.

The landlord, Fitzroy, argued that the tenant was in breach of the repairing covenants and that the lease was not broken and remained in existence. Fitzroy argued that material compliance was to be narrowly construed so as only to apply to trivial breaches. Much was at stake as if the FT failed to terminate the lease, it was liable for a further six yearís of rent payments at the rate of £600,000 per annum.

The basic principle set out in the 2001 case of Commercial Union Life Assurance Co Ltd -v- Label Ink Ltd L & TR 29 is that a breach is material if, but only if, having regard to all the circumstances, and to the proper efforts of the tenant to comply with his covenants, as well as the adverse effect on the landlord of any failure to do so, it would be fair and reasonable to refuse the tenant the privilege that the lease otherwise grants.

The repairing obligation in the lease required the FT to put and keep the premises in repair. The court ruled that not every defect, however minor, had to be put and kept in repair. The obligation is to put and keep the premises in substantial repair. Minor defects would not be included in that obligation. A breach of the repair obligation would only be material if the landlordís legitimate interests are jeopardised by the breach. The landlordís interest in ensuring compliance with the tenantís obligations before the tenant departs is in order for it to be able to relet the premises quickly and thereby preserving its income stream. The court concluded that the FT had materially complied with all its obligations and was therefore entitled to break the lease on 1st April 2004.

Rights to break may require the tenant fully to comply with its obligations. Faced with a covenant in that form, the court may have been unable to ignore minor defects and the tenant would have lost his right to break the lease. Where the obligation is materially to comply, the court was entitled to be more lenient. The outstanding defects in the property had no effect on Fitzroyís ability to obtain a further tenant, nor on any terms it could reasonably expect to negotiate. The limited nature of the remaining breaches meant that the damage to the reversion was negligible or nil.

Break clauses that qualify their exercise by "substantial compliance" with or "reasonable performance" of the tenantís covenants are to be avoided because of the potential for uncertainty and dispute. Although this case shows that the court was willing to ignore relatively minor breaches of the repairing covenant the landlord has been given leave to appeal. It would a safer course for any tenant to insist on a break clause that contained either no pre-conditions or merely a requirement that the rent has been paid.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 25/01/2006.

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