Break options and surrenders: Effect on subletting

Break options and surrenders: Effect on subletting


Author: Cara Beveridge

Where a property has been sublet, the parties to the headlease must be cautious about any determination of it.

Early determination of a lease might be achieved by break option - a pre-contracted right to bring a lease to an end, negotiated by the parties. Alternatively, and if they are both willing, a lease can be ended by surrender. This can be less predictable and often depends on goodwill and mutual interest at the time of determination.

Where the headlease contains a break option, the parties to it (and to the sublease) should consider what will happen to the sublease if the headlease is ended - and what they should do about it.
There can be many reasons why a landlord and/or a tenant of a headlease might want to bring it to an end during the term and they may or may not want any sublease to remain in situ.

Without understanding that the law has a very different application in the case of determination by break option or determination by surrender, parties may find that they achieve a very different result from that which they intended - and which they could have achieved with a different structure.

Case law demonstrates four major differences in principle between the determination of a headlease by a break option and determination by surrender. Lord Millet, in Barrett v Morgan (2000), has explained these:
. a surrender brings a tenancy to an end prematurely at a time and in a manner not stipulated by the tenancy agreement. By contrast, determination by a break option ends the tenancy at a time and in a manner previously agreed between the parties.
. a landlord has not agreed a surrender in advance and so a surrender is ineffective without landlord's consent. Where a lease is determined by break option, the parties have previously agreed that this should be possible and so no further consent is necessary for it.
. a subtenant holds a derivative title. This cannot be prejudiced by the surrender of the headlease which is later than the creation of the sub-tenancy. But a subtenancy cannot survive the determination of the headlease in accordance with terms agreed before the sub-tenancy was created.
. if a headlease is surrendered, it is fictionally treated as continuing, so far as is necessary to support the existence of the sub-tenancy. If it is determined by notice, the headlease comes to 'the end of its natural life" and cannot be treated as surviving.

The case of Pennell v Payne in 1995 decided that where a head-tenant serves a notice to quit on its landlord, any underlease will end automatically and the landlord will be entitled to possession.

This differs to a surrender, which is subject to the rights of undertenants and does not extinguish the underlease. Instead, the undertenant becomes the direct tenant of the landlord under Section 139 of the Law of Property Act 1925.

In 2003, PW & Co v Milton Gate Investments Limited and another, the court contemplated whether a break clause could be recharacterised as an agreement to surrender, but it decided that it is not possible to contract out of the general rule that when a headlease is determined by exercise of a break option, any sublease is also determined. Where a headlease is brought to an end as a consequence of a consensual arrangement between the landlord and the tenant not provided for in the headlease, the sub-tenancy will survive i.e. a surrender.

So, where the parties wish a sublease to remain in place, they are advised to end a headlease by surrender.

If the headlease contains a break option when a sublease is granted, the sublease should either expire before the break option can be exercised or allow for early determination to allow for the exercise of the break in the headlease.