Going out of fashion? Rent concession arrangements and penalty clauses
The High Court has ruled that a rent concession letter, which entitled the landlord to claim the full backdated reserved rent in the event of any breach by the tenant, was an unenforceable penalty. Douglas Rhodes considers the implications.
In Vivienne Westwood Limited v Conduit Street Developments Limited  EWHC 350 (Ch), the High Court has issued a ruling that has potentially wide implications for the lawfulness of termination provisions in rent concession arrangements.
Vivienne Westwood Ltd entered into a 15-year lease in November 2009 at a rent of £110,000. Simultaneously, the parties to the lease entered into a side letter under which the landlord agreed to accept a reduced rent of £90,000 up to £100,000 for the first five years of the term. If a higher open market rent was determined on review in 2014, the rent was to be capped at £125,000 until the next review.
The side letter was personal to Vivienne Westwood Ltd and included a provision stating that it could be terminated with immediate effect by the landlord if any of the provisions of the lease or side letter were breached and the rents would be immediately payable under the lease as if the side letter had never existed.
The reversion changed hands in 2013 and 2015, leading to some confusion on the part of the tenant as to who to pay the rent to. This led to a delay in the June 2015 payment, following which the landlord purported to terminate the side letter with immediate effect.
The High Court's decision
The main issue in dispute was whether the landlord's right to terminate the side letter and claim rent in full under the lease was an unenforceable penalty.
The High Court applied the principles set out in the recent Supreme Court decision of Cavendish Square Holding BV v Makdessi (which substantially revised the law on contractual penalties) and ruled that the termination provision was a penalty for the following reasons:
- The lease and side letter were entered into as part of the same bargain and were to be read together, such that the tenant's primary obligation was to pay the lower rent, which only changed to a secondary obligation to pay the higher rent in the event of a breach of the lease or side letter;
- The side letter imposed the same consequences for any non-trivial breach, which was exorbitant and unconscionable in comparison with the landlord's legitimate interest in full performance of the tenant's covenants, bearing in mind that this was in addition to interest, costs or damages that could be claimed under the lease; and 3. The provisions would have been penal even if the full rent became payable only prospectively from the date of termination.
The rent concession in the side letter therefore remained in force, notwithstanding that the annual rent had subsequently been reviewed to £232,500.
Implications for rent concession arrangements
The High Court's ruling is quite remarkable, given that it has struck down a freely negotiated provision entered into by legally represented commercial parties, which is relatively common across the sector. However, the decision is reportedly not being appealed and so landlords will need to come to terms with its implications.
Landlords may wish to review their rent concession arrangements, particularly those that were entered into at the same time as the lease as part of an overall package and those with retrospective effect in the event of termination. Provided that due care is taken, it remains possible (and lawful) to protect the landlord's legitimate interests when rent concession arrangements are entered into.
A key factor in Vivienne Westwood was that the lease and side letter were entered into at the same time, because the Court decided that meant the tenant's primary obligation was to pay the reduced rent. Where a rent concession is agreed as a separate arrangement after the lease has been granted, the provisions of that arrangement will generally not be found to be a penalty clause as it should be clear that the primary obligation is to pay the reserved rent under the lease.
Notwithstanding this distinction, there are a number of considerations that potentially apply to all rent concession arrangements, such as:
- Retrospective? - Where a rent concession arrangement includes termination provisions that provide for the full rent to be paid retrospectively as well as prospectively, there is scope for argument and this has the potential to cause uncertainty as to what sum is lawfully due in the event of non-payment. Landlords may therefore wish to reconsider whether it is worthwhile to provide for rents to be payable in full retrospectively as a result of any breach of a rent concession arrangement.
- Primary obligations - Given the Court's emphasis on primary and secondary obligations, rent concession agreements should specify that the tenant's primary obligation is to pay the reserved rent under the lease and that the rent concession is a conditional right to a discounted rent.
- Termination - Thought needs to be given as to the circumstances in which the landlord can terminate a rent concession arrangement. In Vivienne Westwood, the side letter provided that the landlord could terminate as a result of any breach of the lease or side letter. The Court interpreted this as meaning any non-trivial breach, because otherwise the landlord would have been entitled to terminate the arrangement as a result of an unrelated minor breach of the repairing covenant, which would inevitably occur over the duration of the lease term and would remove the side letter of any sensible commercial effect.
Overall, the decision in Vivienne Westwood is a stark warning that parties should not assume that a court will simply give effect to what has been agreed, even where parties are well-advised and in equal bargaining positions.