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This case regarded a dispute over a tenancy agreement between Vivienne Westwood Limited as the tenant and Conduit Street Development Limited as the landlord. The tenant had a 15-year lease of commercial retail premises in London beginning in 2009 and with an annual rent of £110,000 per annum, which was subject to an open market rent review in both the fifth year and tenth year of the term.
At the same time, the lease was entered into; the parties entered into a side letter that permitted the tenant to pay a reduced rent for the first five years instead of the rent stipulated in the lease. The side letter also capped the rent to £125,000 per annum following the fifth-year rent review. However, if the tenant breached any of the terms or conditions set out in the side letter, the letter could be terminated immediately.
Following a failure by the tenant to pay the rent in June 2015, the landlord claimed the side letter was terminated on the basis that the condition to make payment had been breached. The question for the court to consider was whether the ability to terminate the side letter amounted to a penalty clause and could be held to be unenforceable.
A penalty clause may be unenforceable if it inflicts damage on the party in breach, which is out of proportion to any legitimate interest of the innocent party. In this instance, the tenant had a primary obligation to pay the rent at a reduced rate, in addition to observing the terms of the lease. The secondary obligation was to pay rent at a higher rate in the event of any breach of the primary obligation.
The court noted that the rental payment adjustment applied whether a breach was one-off, minor, serious, or repeated, irrespective of the nature of the obligation or its effect on the landlord. Effectively, the secondary obligation on the tenant to pay rent at the higher rate was disproportionate to the interest the landlord had in allowing a reduction in rent because the rules governing a breach were too wide-ranging. The judge also noted that any termination of the side letter had a retrospective effect regarding rent, which meant that the tenant would be forced to pay the additional rent at the higher rate from commencement of the lease, as opposed to when any breach occurred. These two factors led the court to find that the side letter's terms were too severe and amounted to a penalty clause that rendered the letter's termination unenforceable.
The case is significant for landlords who regularly use side letters with termination provisions to alter the terms of a lease. Landlords will need to ensure that any terms in a side letter, such as an obligation to pay rent at a higher rate, operate from the breach's date or a future date rather than from the commencement of the lease. Landlords may also benefit from having rent provisions in a side letter drafted as a conditional agreement or a price reduction provision to prevent a side letter from being caught by the rules on penalty clauses.
You can contact our specialist Commercial Property Team for legal support on the topics discussed in this feature, along with any other commercial property-related assistance you may require. You can also contact us on 0161 941 4000 or email The Commercial Property Team.