A fashion Disaster for landlords

Posted on 9 May 2017

A fashion Disaster for landlords

A case involving Vivienne Westwood has raised issues relating to side letters and penalties. For the first time, the High Court has decided a case on penalties in a landlord and tenant context. In Vivienne Westwood Ltd v Conduit Street Development Ltd, the judge found that the termination provision in a side letter relied on by the landlord was a penalty which was unenforceable. The decision will not be appealed, so both landlords and tenants must take note of its implications.           

Summary of decision

Vivienne Westwood Ltd (VW) entered into a lease of a store on Conduit Street, W1, for a term of 15 years. Because the former landlord was keen to have a tenant of VW’s profile, the parties entered into a concessionary side letter at the same time. This reduced the rent payable for the first five years and capped the rent due thereafter at £125,000 per annum. It also contained a provision allowing the landlord to terminate the arrangement on any breach by the tenant.

Following a series of changes in the ownership of the property, in summer 2015, VW paid its rent late and the landlord subsequently served a notice which, it said, terminated the side letter. This meant that the rent cap would fall away and a full market rent of £232,500 would become payable.

VW obtained a declaration from the court that the termination provision was an unenforceable penalty for the following reasons:

1.         The court was dealing with a “penalty”. Reading the side letter together with the lease, the primary obligation was to pay the reduced rent and the secondary obligation was to pay the (higher) market rent on VW’s breach.

2.         The tenant being obliged to pay the market rent as a result of any breach of the lease was disproportionate to any legitimate interests of the landlord.

Practical implications

The outcome here depended on the specific facts and, in particular, the wording of the side letter. Not all termination provisions in side letters will now be unenforceable. However, when issues arise in relation to historic arrangements, or when new ones are being negotiated, parties should consider carefully whether the terms are likely to be caught by the penalty regime. This is particularly so in circumstances where the side letter is entered into at the same time as the lease.

Where, during the term of a lease, a landlord grants a personal concession to the tenant reducing the rent payable or allowing the tenant to pay monthly, these side letters will not generally be caught by the penalty rule.

Acting for landlords

  • Is the primary obligation clear? Vivienne Westwood highlights the difficulty in determining what amounts to a primary obligation. You should make it as clear as possible in the side letter that the primary obligation remains to pay the headline sums that fall due under the lease - this will assist in any arguments to the contrary later. The starting point for a judge will always be the wording of the contract.
  • When can the side letter be terminated? Try not to agree a side letter that is terminable on any breach. For example, if it is a discount for prompt payment, it should be terminable if payment is not prompt.
  • What are the consequences of termination? If there is to be any onerous consequence, does your client have a legitimate interest in requiring it? If so, ensure that such justification is documented clearly in the negotiations, heads of terms or even the recitals in the side letter. VW relied on the fact that the correspondence between the parties and the subsequent agreement to reduce and then cap the rent showed that the original landlord’s legitimate interest lay in having VW as its tenant - it was not to protect its reversion or maintain cash flow.
  • Do not be greedy. Where a consequence is retrospective, it is more likely to be penal. In VW, the effect of the side letter being terminated was that VW would have to pay the market rent backdated to the start of the lease.
  • Consider whether there are other terms in the lease that provide adequate protection for your client. In VW, there was a late payment of interest clause, a basis, and a forfeiture clause. All of these gave the landlord adequate protection against late payment of rent. In each case, it is for the landlord to show that its legitimate interest in the tenant’s performance is not adequately met by these clauses.

Acting for tenants

If acting for a tenant, do not stay silent in negotiations where there is any doubt regarding a penal provision. The courts will remain reluctant to interfere with the parties’ freedom to contract and tenants should not rely on this decision as a carte blanche ability to say that termination provisions in side letters are unenforceable. There are a number of limbs to the test to determine whether a provision is a penalty and consideration will be given to the fact that the parties were legally advised.

If you consider that a term is overly onerous for your client, you are better off using the rule on penalties at the negotiation stage to try to achieve a variation to the agreed terms.

The future

The law of penalties will continue to invade property law and it is important that practitioners are able to identify when a clause may be caught by the penalty regime.

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