What is a Commercial Lease Break Clause?
A commercial lease break clause enables either the landlord, tenant, or both to end the lease early either on specified dates or at any time during the term.
There are many reasons why tenants may be unsure about committing to long term leases, particularly in a challenging economic climate. They could be a new business, worried about the obligations of the lease or concerned about rent rises. As a result, it is now common for landlords to add a commercial lease break clause to address the concerns of tenants. Landlords can also insert a break clause to protect their own interests.
Agreeing a break clause can be advantageous for both parties:
A tenant break clause offers flexibility to a tenant when taking a longer commercial lease. The tenant may be able to decide if and when to exercise the break clause depending on the performance of their business. If they are happy with the lease they can ignore the break option and continue in the property until the term expires. However, if there needs change they can break the lease prior to the end of the term if it is in their best interests.
A commercial lease break clause gives a landlord control over when they can retrieve their property. If a landlord has plans to develop or occupy the property, a break clause can enable them to end the tenancy. A landlord is not obliged to exercise the break clause, if they wish the lease can continue until the end of the agreed term.
For a landlord to have a workable break clause the lease normally needs to be excluded from the security of tenure provisions outlined in the Landlord and Tenant Act 1954. Tenants should be aware this has far reaching consequences and they should seek advice from a legal expert before agreeing to this in a lease. If the lease is not excluded from the 1954 Act the landlord would be restricted by these requirements.
Common features of a commercial lease break clause
The terms of break clauses can be negotiated and should be discussed with a solicitor when drafting heads of terms prior to any lease agreement. There will generally be a number of standard features in a break clause that landlords and tenants should be aware of and plan for accordingly:
Usually a minimum period of advance notice must be given (in writing) by the landlord or tenant exercising the break in lease. This is normally is between three and six months but can vary depending on the specific agreement terms. If a lease is high value notice periods tend to be longer to allow for the landlord to secure a new tenant.
Tenants should be up to date with all lease payments up to the break date as a failed payment can invalidate a break clause. It is important for tenants to try and limit the sums that are payable as a pre-condition to a break (e.g. keep it to rent, service charge and insurance charges) to avoid small sums such as unpaid interest resulting in a failure to exercise the break clause. It’s also important for tenants to plan properly and not commit advance payments if they are intending to exercise a break clause as refunds may not be possible.
Landlords may take a financial hit if a tenant exercises their break clause – especially if the lease began with a rent-free period. As a result many break clauses include an agreement for the tenant to pay a penalty on the break date – this can be as much as a few months rent. Tenants should be aware of this agreement and plan appropriately.
Tenants should be wary of a break clause that requires them to agree ‘vacant possession’ as a pre-condition to a commercial lease break clause. There have been recent cases where tenants who have agreed to vacant possession have been required to remove all belongings, change any alterations and reinstate the property to the original state they received it. Most tenants should negotiate an agreement for the property to be free from third party occupation instead.
Compliance with commercial lease covenants
Landlords can request for tenants to observe and perform their tenant covenants as a pre-condition of exercising a break but this can be a difficult agreement for tenants to comply with – particularly in terms of repair and decoration. A compromise for tenant and landlord is a requirement to ‘materially observe and perform’, however tenants should still seek legal advice before accepting this requirement as a minor failure to comply could still impact on their lease.
An agreement to a tenant break clause is not an agreement to assist the tenant to exercise the lease break option and landlords are under no obligation to do so. If a tenant does not or cannot comply with the pre-conditions for exercising the break there could be serious implications. It is therefore important for tenants to fully understand these pre-conditions before signing the commercial lease.
When will the break clause come into effect?
There are no hard and fast rules for this and the tenant and landlord can agree to set any dates for lease breaks (or allow a rolling break). However, leases granted for 10 years for example normally have a break at 5 years. It is vital for tenants to plan sufficiently for the lease break as if they are no fully compliant with the pre-conditions in time to exercise the break on the agreed date they will be tied into the lease for the remainder of the term.
The party looking to exercise the break clause should be absolutely sure they want to take a break from the commercial lease as once a notice exercising the break clause has been served it cannot be withdrawn.
Overpaying and refunds
Tenants considering exercising a break clause should take careful note of their payment dates and any advance payments as in complying with their obligation to pay sums due up to the break date they may be essentially paying for services they will not benefit from. As this may be unavoidable tenants can request for a clause to be included in the lease that requires the landlord to reimburse any overpayments following the agreed break date. If no clause exists the landlord is under no obligation to refund the payments to the tenant.
Legal advice and guidance
A commercial lease break clause can be attractive to tenants and landlords alike in a fast-moving economic climate. But break clauses are notoriously tricky to navigate and both parties should seek legal advice to ensure their interests are sufficiently protected. A break notice is a formal notice and needs to be served in accordance with all other clauses contained in the commercial lease.
Many difficulties with break clauses arise when tenants fail to meet all the pre-agreed conditions associated with the break and are left unable to terminate the lease. A costly mistake that can cause problems for both parties when a break has been expected. The courts view break clause agreements strictly and it is recommended that both tenants and landlords take legal advice before agreeing to a break clause in a commercial lease. Both parties may also wish to receive advice and before serving a break notice to ensure they are fully aware of their obligations and their interests are fully protected.