Mind the break: drafting break clauses in commercial leases

Nature of the break option – Who, what, when

Who can break?

A break option gives the “breaking party” the right to terminate the lease early. A break option can be a tenant-only break, a landlord-only break or a mutual break.

A tenant will often seek a break option where they require flexibility and in tenant favourable markets.

Landlord break options are less common and are generally used if the landlord is potentially planning to redevelop.

When is the break date?

A break option can be for a fixed date – a “one chance” only option. Alternatively, the option may be a rolling break so the option can be exercised at any time after a certain point. Rolling break options offer greater flexibility particularly to tenants.

What is the notice period?

The break option will set out the notice period that is required to be given to the other party. Commonly, the parties will agree six months, but it is a point of negotiation. However, parties should be aware that, if the notice period is too short, this may not give parties enough time to plan; too long may defeat the purpose of flexibility.

Beware! Break conditions

Tenant break options often require the tenant to satisfy certain conditions, otherwise the break is ineffective. Both parties benefit from having clearly drafted provisions to minimise uncertainty and potential disputes.

For tenants:

• Vacant possession: A break option normally includes some wording regarding the tenant vacating the property. Care needs to be taken as to the specific wording agreed as there has been considerable case law on what constitutes “vacant possession”. If a tenant fails to meet the legal test, then the break option will not be effective.
• Rent and payment obligations: A landlord commonly requires all sums to be paid under the lease up to their due date. “All sums” can include annual rent, service charge, insurance rent and interest. A wise tenant would seek to narrow the payment obligations at the break date so that it is clear exactly what needs to be paid.
• Compliance with covenants: A requirement to have complied with “all tenant covenants” is not recommended as any trivial breach may frustrate the break. If the landlord insists on such conditions, at the very least, the tenant should negotiate materiality thresholds or limit the condition to non-material or continuing breaches.

For landlords:

• Whilst the tenant will be looking to minimise any break conditions, the landlord is seeking protection against the tenant walking away without meeting their obligations – reasonable conditions can encourage responsible exit behaviour.
• A landlord may wish to consider including a break penalty or a repayment of incentives (e.g. for a rent-free period or capital contribution). Such payments may focus the mind of the tenant and offer the landlord some income while they market the property to find another tenant.

Rent apportionment and overpayment

If rent is paid quarterly in advance and the lease ends mid-quarter via a break, is the tenant entitled to a refund of rent for the unused period?

This answer depends on the wording in the lease. The Supreme Court in Marks & Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] held that rent paid in advance is not refundable unless there is an explicit clause in the lease covering this point.

Best practice: we recommend including a clause expressly dealing with repayment of any apportionment of rent and other sums following a break.

Key drafting tips

• Include in the HOTs what the parties have agreed regarding the break option conditions. as this saves both time and legal costs when finalising the lease terms.
• Consider carefully what conditions to accept on a break clause and the precise wording of such conditions. Any conditions will be strictly interpreted by the courts.
• Include provision for any rent relating to a period after the break date to be repaid.

Conclusion

Break options are useful tools for managing long-term lease commitments and can offer a tenant comfort when entering into a lease. However, they are fraught with legal and practical risks if not carefully negotiated and drafted.

Obtaining legal advice when you agree the terms of the lease will ensure that there are no nasty surprises when you decide to exercise your break option. For more information on drafting break clauses in commercial leases get in touch by email or call +44(0)3333 231580.