The Court of Appeal has applied a literal approach to the interpretation of underletting conditions. This overturns an earlier decision that applied commercial common sense to reach a tenant-friendly outcome.
In Warborough Investments Ltd v Lunar Office S.A.R.L, Warborough Investments Ltd ('Warborough') owned an investment property comprising shops and offices. A 99-year building lease had been granted in 1980 and Lunar Office S.A.R.L ('Lunar') was the current tenant.
The lease contained various conditions relating to underletting and two of these were in dispute. The dispute arose because it was unclear from the lease whether the original parties' intention was that there should be an 'and' or an 'or' between the conditions. They comprised:
- An absolute prohibition on underletting any part of the premises for less than 10 years and of anything less than complete floors or shop units at rents and on terms which accorded with the principles of good estate management;
- A prohibition on underletting of any part of the premises without the consent of the landlord (which was not to be unreasonably withheld) and except at the best rent reasonably obtainable between willing parties.
A former tenant had granted an underlease which was not of a complete floor area and was for less than 10 years. Accordingly it did not fall within the first condition.
Warborough claimed this to be an unlawful underletting and sought to forfeit the lease for breach of covenant. It took the view that the sub-clauses were part of a cumulative series of covenants which set out what the tenant had to do to grant an underlease. Nothing in the lease suggested that the conditions were alternatives.
Lunar argued that the two sub clauses were self-contained alternative routes to the grant of lawful underletting and so it did not have to comply with both of them. Even though the underlease did not comply with the first condition, it did comply with the second condition, and therefore there was no breach of covenant.
The court had to interpret the meaning of the sub-letting provisions in order to decide whether the underlease amounted to a breach of the lease.
High Court decision
At the hearing of this case in the High Court, the judge considered that neither side was "obviously right or wrong" but he said "there is no good commercial rationale I can see to explain why the lessee should be forbidden from underletting at all in the last 10 years". If the conditions were to be construed cumulatively, this would be their effect.
In support of this, he considered that the purpose of the headlease was to enable the tenant to recoup the cost of constructing the building from future rental income.
The Court of Appeal decision
On appeal by Warborough, the Court of Appeal overturned the High Court's decision, and held that although restrictive, both of the conditions on underletting had to be satisfied in order for there to be a lawful underletting. They were part of a series of negative covenants to be observed.
The court considered that it was wrong to approach a document with pre-conceived ideas about what the parties would have intended commercially, and to allow those ideas to 'subvert the clear language of the document'. It was not the function of a court to interpret an agreement to rescue a party that had made an ill-advised commercial deal.
There was no express proviso to the first condition to indicate that there were alternative routes to lawful underletting. Although this resulted in the tenant being unable to underlet in the last 10 years of the term, this was understandable from the landlord's point of view to ensure that there was not a complex patchwork of underlettings at the end of the term.
The key lessons from this case are:
- Clarity of intent and drafting is essential: the court suggested that if there was to be a series of conditions that needed to be met before underletting would be permitted, that could have been better drafted by a single clause with a single set of conditions or exceptions;
- When acquiring a leasehold investment property, any existing breach of covenant will be of interest to the incoming tenant as this may have an impact on its future enjoyment of the property and its security, both practical and financial;
- Where a proposed underletting will not comply with the conditions of the lease, the landlord will have an absolute right to refuse consent.
Warborough Investments Limited v Lunar Office S.A.R.L  EWCA Civ 427