A break option can generally be described as a right conferred upon a tenant to terminate its tenancy prior to the expiry of the term of a lease. In the current economic environment, with the spike in commercial properties available for rent at increasingly competitive rents, break options are of particular importance to both landlords and tenants and can be the subject of intense negotiation both at the time of the grant of the lease and at the time of its exercise.
For a tenant, a break option gives it the opportunity to exit a potentially onerous or unsatisfactory lease arrangement and allows it to take advantage of the lower rents available in the open market. Even for a tenant happy in its present accommodation, the existence of a break option may improve its bargaining position and potentially assist in any attempts it may make to secure an improvement on its existing lease terms.
Conversely, landlords will more than likely regard the existence of a break option as an unwelcome addition to the difficulties they are already encountering in these increasingly uncertain times. The exercise of a break option for a landlord means being left with a vacant property which is not generating any income with prospective tenants in short supply. Moreover, the existence of a break option in the first place as part of any lease agreement can sometimes have a significant negative impact on the investment value of a property, as it reduces the certainty regarding the future income stream.
A break option therefore represents a significant, and potentially contentious, facet of any landlord and tenant relationship.
The fact that a break option confers a right upon a tenant to terminate a lease prior to the formal expiry of the term, and therefore represents a departure from the standard lease agreement, means that it has long been considered a privilege (rather than a right) by the courts. A tenant must therefore take great care to ensure that it has strictly complied with the conditions of the break option, as failure to do so will more often than not render the exercise of the break option void. By the same measure, a vigilant landlord may also be successful in defeating the purported exercise of a tenant's break option by monitoring the tenant's compliance to ensure that the break conditions are observed.
The most common circumstances in which a tenant's purported exercise of a break option have been defeated generally involve issues with the service of the break notice (time limits and addressee particularly) or a failure by the tenant to ensure all payments due under the lease are fully up to date at the break date. An issue which has become the subject of scrutiny in recent time, however, has been the defeat of a break option due to the failure of the tenant to comply with the repair/yield-up obligations under the lease at the break date.
The first limb of a tenant's yield up obligation (and therefore the most important in the context of the exercise of a break option) is generally that "vacant possession" of the premises be delivered to the landlord. UK case law suggests that vacant possession cannot have been delivered where the tenant has left the premises in such condition to materially prevent or interfere with the ability of the landlord to subsequently re-let the premises to a third party. The premises should therefore, in layman's terms, be "empty" and any objects, possessions, or chattels that constitute a "substantial impediment" to the use of the premises must be removed.
Prudent tenants will therefore generally remove all loose objects from a premises before the break date, however confusion often arises in situations where a tenant does not remove its fit-out (e.g. office partitions) yet asserts that vacant possession has been delivered.
In those circumstances, and in the absence of any express covenant in the lease to the contrary, the courts have tended to draw a distinction between "fixtures" and "chattels" in determining whether vacant possession has been delivered. Chattels can "loosely" be described as objects that can be easily removed from a premises without injury to the object itself or to the premises, and it follows that they must therefore be removed from the premises before vacant possession can be deemed to have been delivered. Fixtures, on the other hand, are objects that have become annexed to the premises such that the removal of same cannot be effected without injury to the object itself or the premises to which it is attached.
The above situation can be contrasted with that where the break option is conditional upon compliance by the tenant with all lease covenants at the break date, in which case both the landlord and the tenant must pay close attention to all provisions of the lease and any ancillary agreements (such as side letters or any licences for works) when determining compliance with the break option - especially those in relation to repair and yield-up. In order to effectively exercise the break, the tenant must therefore deliver the premises to the landlord in such state of repair and condition as accords with its obligations under the lease and failure to do so will render the tenant's break option void.
In this regard, the UK courts have had cause to consider those break clauses which state that a tenant is to be in "material compliance" with its obligations under the lease as a pre-condition to exercising the break. In Fitzroy House Epworth Street (No. 1) Limited -v- The Financial Times Limited, the Court of Appeal considered the effect of such wording and decided that a pre-condition relating to material breaches had the effect of modifying the strict rule regarding compliance with the lease in order for the break to be effective, however the materiality of this compliance is, the court said, to "be assessed by reference to the ability of the landlord to re-let or sell without delay or additional expense".
It would therefore seem sensible, in light of the foregoing, for both parties to a lease to exercise caution when considering the inclusion of a break option in a new lease and also in the procedure adopted once a break notice is served. Failure to observe the conditions attached to a break option can have grave consequences for tenants, but can be of great relief to landlords, and should therefore be treated carefully by both landlord and tenants alike.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.
