Side letters centre stage

Side letters centre stage

Published:

Author: Michael Callaghan and Ed John

Applies to: England and Wales

This article looks at the recent case of Vivienne Westwood Limited v Conduit Street Developments Limited [2017] EWCH 350.

Summary

In Vivienne Westwood Limited v Conduit Street Developments Limited [2017] EWCH 350, an attempt to terminate a side letter offering a rent concession operated as a penalty and was void. Landlords need to consider how side letters are worded to prevent themselves being caught by the same trap.

Background

Vivienne Westwood Limited had agreed terms for a 15 year lease with five yearly rent reviews. In a side letter, the landlord agreed it would accept a lower rent during the first ten years of the term, capped at £125,000 following the first rent review. The side letter was personal to Vivienne Westwood Limited and would come to an end automatically in certain circumstances. The landlord could also terminate the side letter if there was any breach of the terms of the lease.

Following a rent review where the open market rent increased to £232,000, the rent was paid late. The landlord served notice terminating the side letter, relying on this breach.

Penalty provisions

The tenant successfully argued that termination of the side letter operated as a penalty and was void. It argued that its primary obligation was to pay the rent set out in the side letter and that the obligation to pay the rent in the lease was a secondary obligation triggered by the termination of the side letter. Triggering the secondary obligation operated as a penalty as the landlord had no legitimate interest in doing so and it operated as an exorbitant or unconscionable bargain.

Primary obligation

The judge held the side letter created the primary obligation to pay the rent. He concluded that the original deal was to pay a rent below the market rent. There was no primary obligation on the tenant to pay the market rent reserved by the lease. The position would, it seems, be different if a landlord offered a period of concessionary rent in a side letter to a tenant who was struggling to pay the agreed level of rent after the lease was granted. However, side letters agreed on the grant of a lease are capable of creating primary obligations between the parties.

In view of this, and to avoid penalties arising, landlords will now want to make it clear that the primary obligations are those in the lease and that it is the side letter that creates a secondary obligation.

Landlord's legitimate interest

There is a genuine interest in protecting the investment value of property. However, the landlord's argument that it had a legitimate interest in the tenant paying the full rent if there was any breach of the lease failed. This was because substantial financial consequences would flow from a breach however minor or trivial. This was not part of the true bargain between the parties.

Was performance of the secondary obligation an exorbitant or extortionate bargain?

The judge concluded that triggering the obligation to pay the open market rent would be exorbitant or extortionate. The obligation could be triggered by any non-trivial breach of the terms of the lease. The judge refused to imply a term that only material breaches would permit termination. This made termination capable of operating as a penalty.

The termination of the side letter also meant that the higher rent was payable retrospectively and so this too, may have been a penalty. In practice, it did not affect the outcome because the judge considered that an obligation to pay all future rent at the higher level was out of proportion to the loss suffered by the landlord and it was a penalty.

Given that retrospective effect was raised as an issue, it is important for landlords to make it clear that the consequences of terminating a side letter do not have retrospective effect.

Conclusion

Landlords will want to review the terms upon which side letters are offered to tenants when granting leases to ensure that they are not subject to the rules about penalties if they exercise a right to terminate the arrangements.

Tenants will equally want to ensure that valuable concessions offered by the landlord cannot be withdrawn arbitrarily.

This case benefits tenants but undoubtedly makes it more difficult for landlords to manage their properties where there are side letters and tenants might use this decision to maintain their benefits whatever their behaviour.

Disclaimer

This document is for informational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.