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Landlord loses its “bit on the side”

Vivienne Westwood Limited -v- Conduit Street Development Limited [2017] EWHC 350 – High Court

Summary

The High Court has found that a clause which enabled a landlord to terminate a side letter if the tenant committed any breach was in fact a penalty. Consequently it was held to be unenforceable, and the landlord was unable to increase the rent.

The case provides a useful reminder of the principles that will govern when a provision is in fact a penalty, and parties should be aware that such clauses may not prove enforceable in practice.

The Court also gave some helpful commentary on the potentially far-reaching consequences of a side letter to a main agreement, which may be more significant than the parties appreciate.

The facts

Vivienne Westwood Limited (“VW”) enjoyed a tenancy of premises in Conduit Street pursuant to a lease entered dated 18 November 2009. The lease provided for an initial yearly rent of £110,000. However, when the lease was completed, the parties also entered into a side letter that effectively reduced the yearly rent for the first 5 years. The letter capped the rent at £125,000 for the next 5 years of the term, if that figure was lower than the open market rent.

It appears that this arrangement suited the landlord at the time, as it was keen to secure VW as a tenant, given its reputation in the fashion industry.

The side letter was expressed to be personal to VW and terminated immediately if the lease was assigned, or if someone else traded from the premises, or if it became insolvent. More importantly, the side letter continued to say:

… “if you breach any of the terms and conditions contained in this agreement or any term of the Lease and/or any document supplemental to it (for example a licence to alter), we may terminate this agreement with immediate effect and the rents will be immediately payable in the manner set out in the Lease as if this agreement had never existed.” …

In 2013-2015 the landlord changed on a few occasions and, at one point, there was confusion as to whom VW should pay rent. As a result, payment was not made in respect of the rent due on 24 June 2015. The new landlord, relying on the right to terminate set out above, sent a letter confirming the termination of the side letter, citing the breach of the covenant to pay the rent.

The landlord then demanded rent at the higher level. In response, VW argued that the termination provision amounted to a penalty and, therefore, was not enforceable.

There was also another issue as to whether or not the rent review had been compromised by the conduct of the parties. The judge found that it had not been. However, this aspect is outside the scope of this note, as the real interest in this case is the point on penalties.

The law

The law on penalties was examined recently by the Supreme Court, and we have reported previously on the Parking Eye case: RED Alert.

Parking Eye concerned whether a charge of £85 by a car park operator for overstaying amounted to an unenforceable penalty. The Supreme Court ruled that it was not a penalty and, therefore, could be charged to the vehicle owner.

The Supreme Court held that the following points apply when considering whether or not a provision is a penalty:

  • A penalty clause can only exist if a secondary obligation is imposed by a contract when there is a breach of a primary obligation; and
  • It is necessary to consider whether that secondary liability:
    • imposes a detriment out of proportion to any legitimate interest of the other party; or
    • is exorbitant, extravagant or unconscionable in comparison with the value of that legitimate interest.

Vivienne Westwood’s arguments

  • The landlord’s legitimate interest did not extend to being paid a higher rent when it had agreed to reduce the rent by accepting Vivienne Westwood as the tenant. Obtaining a higher rent on any breach, however minor, was not part of the true bargain; and
  • The consequence of having to pay the higher level or rent in the future and in respect of the previous five years on the occurrence of any breach, however trivial, was “exorbitant, extravagant or unconscionable”.

For these reasons, VW argued that the termination provision was unenforceable as a penalty.

The Landlord’s arguments

  • There was a legitimate interest in the landlord ensuring that there was no breach of the lease, and a defaulting tenant would affect the value of its reversionary interest;
  • The detriment suffered was not “exorbitant or unconscionable” as the breach referred to was in the penalty clause and only applied to a non-trivial breach as a matter of interpretation; and
  • The parties had both been advised on the nature of the clause and had equality of bargaining power at the time the lease and side letter were completed. Therefore the Court should not interfere with the provision.

The decision

The matter was heard before Timothy Fancourt QC, sitting as a Deputy Judge of the High Court. Mr Fancourt QC found that:

  • The termination provision only applied in respect of a non-trivial breach by VW, so the provision was not struck down for being “exorbitant or excessive”;
  • However, the termination provision did not protect a legitimate interest of the landlord, as serious harm to the landlord’s reversionary interest would only occur if there were serious breaches;
  • Furthermore, the obligation to pay the higher rent retrospectively and prospectively did constitute a disproportionate detriment to the legitimate interest of the landlord in ensuring that there was no breach of the lease;
  • Consequently, the termination provision operated as a penalty and was not enforceable.

This meant that Vivienne Westwood was liable only for the reduced rent of £125,000pa - considerably lower than the market rent of £232,500pa.

Our comments

Rent concessions in side letters are very common, particularly in difficult markets when tenants often ask to pay rents monthly instead of quarterly. The provision in this matter is not unusual and landlords should be aware that terminating such side letters may well not be effective in light of this decision.

Parties should also note that the Court found VW’s primary obligation was to pay rent at the reduced rate set out in the side letter – not the market rent expressed to be payable in the lease. This highlights the far-reaching effects that side letters can have, even if they say that they do not vary the lease. Both landlords and tenants should be aware of this and should consider:

  • Whether the letter could be interpreted as changing a primary obligation in the main document;
  • Whether there would be any consequences if the side letter were to be terminated;
  • If so, whether those consequences would be prospective or also retrospective; and
  • Whether the consequences would be proportionate in the right context. In this example, that context was the landlord’s desire to maintain the value of its reversion and its cash flow.

It remains to be seen whether or not the landlord appeals. Watch this space!

Saleem Fazal
Partner – Head of Real Estate Disputes
Taylor Wessing LLP

Read more articles in RED Alert - Spring 2017

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