Landlords should take note of fashion faux pas in rent concession side letters

Posted by the Property team on 29th June 2017

In the recent case of Vivienne Westwood Limited v Conduit Street Development Limited [2017] EWHC 350 (Ch) the High Court held that a clause in a concessionary rent side letter entered into simultaneously with the lease, allowing for the landlord to terminate the side letter and demand a higher rent from the tenant under the terms of the lease, amounted to a penalty and was therefore unenforceable.

The facts

The case concerned Vivienne Westwood’s (VW) flagship London store.  VW held a lease of the retail premises granted for 15 years from 18 November 2009 at an initial rent of £110,000 per annum.  The rent was subject to an upwards only rent review to open market value in 2014 and 2019.

At the same time as completing the lease, VW and the landlord agreed a side letter.  Pursuant to the terms of the side letter, a reduced rent of £90,000 per annum was payable by VW, with stepped increases up to a capped amount of £125,000 (assuming the open market rent after review in 2014 was higher) until the end of the lease.

The side letter was personal to VW and agreed because of VW’s preferable reputation.  It was expressed as not varying the terms of the lease.  According to its terms, the side letter could be terminated with immediate effect if VW breached any term of the letter or the lease.  In the event of termination of the side letter, the rent payable by VW would revert to the amount set out in the lease as if the side letter had never existed.

The dispute

The landlord claimed that VW had breached the lease terms by failing to pay rent in June 2015 after some confusion as to the amount payable.  The landlord gave notice terminating the side letter with immediate effect and sought to demand the rent payable under the lease.  The 2014 rent review was subsequently agreed at  £232,500 however VW claimed that the side letter remained in force so the rent was capped at £125,000.

The court was asked to determine the effect of the side letter and the landlord’s right to terminate it.  The court was also asked to determine whether the rent demand of £125,000 per annum sent by the landlord to VW in March 2015 amounted to an acceptance by the landlord that the 2014 rent review was settled at that sum.

The outcome

The High Court found that the landlord’s termination of the side letter amounted to an unenforceable penalty.  The rental payment obligations on VW were those contained in the side letter, not the lease and accordingly VW was entitled to pay rent at the capped amount, for so long as VW satisfied the conditions in the side letter, regardless of any breach of the lease.

The court considered the following factors:

• The side letter was not simply a conditional rent discount but a change to the primary obligation in the lease. The side letter was entered into simultaneously with the lease and therefore the rent reduction was part of the overall agreement between the two parties.
• The side letter created a primary obligation to pay reduced rent with a secondary obligation to pay a higher rent if the primary obligation was breached. The terms of the side letter were such that the financial adjustment in rent applied irrespective of whether a breach was minor, one off, serious or repeated and without regard to the nature of the breach or the likely consequence for the landlord.  The obligation to pay the higher rent was retrospective so on termination of the side agreement VW would be obliged to pay the rent under the lease “as if this agreement had never existed”.  VW would also be liable to pay interest, costs and possible common law damages.  The court found that this amounted to an unenforceable penalty on VW.  The consequences of breaching the primary obligation were out of all proportion to the landlord’s legitimate interest.
• The court found that the termination provisions of the side letter were a “blunt instrument” that could result in a substantial and wholly disproportionate financial detriment to VW. Its impact on VW was “exorbitant and unconscionable”.
• The court considered the three stage test set out by the Supreme Court in El-Makdessi v Cavendish Square Holdings BV [2015] UKSC 67 in deciding whether the termination provisions of the side letter amounted to an unenforceable penalty. The court found that the obligation imposed by the secondary obligation imposed as a result of VW’s breach of a primary obligation, was disproportionately detrimental to any legitimate interest of the landlord.
• There is a genuine interest in protecting the investment value of property. However, the landlord’s argument that it had a legitimate interest in VW paying the full market rent if there was any breach of the lease failed.  The substantial financial consequences that would flow from any breach, however trivial, was not part of the true agreement between the parties.

Landlords should note that the court found that the rent demand sent to VW in March 2015, when viewed objectively, did not amount to an offer to settle the outstanding rent review at that level.  The court held that the landlord was found to be anticipating that whatever the outcome of the rent review, VW would not be liable to pay more than £125,000 per annum due to the side letter.  Both parties were aware that the market rent at the time was nearer £200,000.

The application

Consideration should be given to the following practical points arising as a result of the court’s decision:

• A side letter may amount to more than a conditional rent concession even if it does not expressly vary the lease.
• When entering into side letters consider whether the terms change a tenant’s primary obligations under the lease. A side letter should contain secondary obligations.
• Termination provisions in a side letter that apply retrospectively as well as futuristically are likely to be seen as penal.
• The consequences to the tenant of terminating the side agreement should be proportionate to the legitimate interests of the landlord.
• The rent demand was not determinative of the rent review. This is an important point to note for the landlord as the side letter was personal to VW but had the lease been assigned by VW, the reviewed rent of £232,000 would become payable by an assignee.
• Parties should not assume that a court will give effect to whatever is agreed between them even if both are well advised and in equal bargaining positions.
• Avoid imposing particularly onerous terms on a tenant in side letters. A moderate position is preferable, with consideration given to proportionality.
• The court will protect genuine legitimate interests. Side agreements should record legitimate interests and clarify why provisions are proportionate to help ensure that the terms are not found to as penal.
• Review the circumstances in which the termination clause is triggered and whether there should be a materiality threshold or whether it can be limited to breaches of particular provisions.

Bennett Griffin are award winning solicitors based in West Sussex with offices in central Worthing and Ferring.  Our experienced and specialist solicitors offer a comprehensive service and will work with you in an honest, considered and practical manner.  Our commercial property department is able to advise and assist you in relation to leases, side letters and all landlord and tenant matters.  Please contact us on 01903 229 999 or by email at info@bennett-griffin.co.uk for more information.

The information contained in this article is for general guidance only and is not intended to be legal advice. Professional advice should always be taken on the application of the law in any particular situation.