Why are Break Clauses important in Commercial Property leases?

The shift away from the standard model of office working has only solidified since COVID, with much of the UK’s workforce now taking back control as to where, how and when they undertake their jobs.

This increased expectation for flexibility has led many business owners to reassess their needs for leased office or retail space in an attempt to keep their operations agile, placing further impetus on the inclusion of break clauses within commercial property leases.

But what is a break clause? How does it work, and what are the challenges faced by both occupiers or landlords looking to either trigger these clauses, or indeed, negotiate new, improved contracts that more aptly reflect flexible working patterns?

Here we take a closer look at how the market demand of commercially let spaces has changed in recent times, and how those leasing such properties can utilise break clauses to protect their best interests.

How has the demand for commercial property changed?

Three years on from the emergence of the pandemic, its impact continues to influence daily life, particularly in the workplace. The adoption of hybrid, flexible, and asynchronous work models has become the “new normal”. A OnePoll survey by TravelPerk recently found that only 30% of UK companies now work fully on-site, compared to 57% before the pandemic. Over 40% of companies have shifted to a hybrid model, and there’s been a near 10% increase in flexible work arrangements. Fully remote work, while still uncommon, has doubled from 4% pre-pandemic to 8% now.

Despite initial concerns about office space demand as a result of COVID-19, there appears to be continued interest in premium workspaces, especially in prime locations.

Although CBRE reported a 4% decline in office space take-up in Q1 2024 compared to the previous quarter, availability has increased by 3%, reaching 19.2 million sq ft by the end of Q1. This is an 8% rise from the same period in 2023 and 19% above the five-year quarterly average.

In Q1 2024, 378,200 sq ft of office space was completed, with 52% pre-let or under offer, and 4.2m sq ft of space under construction expected to complete between 2024-2027, with 26% already pre-let.

It is clear that necessity for commercial office space still exists – most notably for the best-in-class properties – but it is the way in which these buildings are being used which represents the biggest shift. Leases need to better reflect this evolving commercial landscape, and the requirements of occupiers and their workforce. The economy is far from stable, so flexibility remains crucial, which is why break clauses are so important – now more than ever.

Why is having the right break clause so significant?

The unpredictable nature of workers physically entering the office has made it challenging for organisations to accurately determine their space and desk requirements annually. This uncertainty is likely to spark conflicts between tenants and landlords, with the inclusion of break clauses in commercial leases becoming a significant point of contention.

The evolving workplace dynamics, coupled with employees’ increasing demand for flexibility, add another layer of complexity to the traditional factors contributing to unpredictability, like fluctuating business fortunes. As a result, understanding the implications of a break clause and its role in ensuring lease flexibility is crucial for both parties.

Typically, commercial leases span five to ten years, emphasising the need for flexibility within these long-term agreements. Break clauses offer a solution by allowing either party to terminate the lease prematurely under specific conditions. For instance, an organisation might secure a 10-year lease but negotiate a break clause enabling them to exit after three, four or five years with a six-month notice period. Alternatively, break clauses can be triggered by mutual agreement after a set period, like five years into a ten-year lease, with notice provisions dictating the termination process.

What effect does a break clause have on a lease?

The inclusion of a break clause in a commercial lease provides flexibility for both tenants and landlords. For tenants, it allows them to exit the lease if their business fails to thrive and smaller premise are required. Landlords, on the other hand, can use break clauses to deal with troublesome tenants or capitalise on an increase in property value. However, tenants may be wary of landlords invoking break clauses as it can disrupt their business operations.

The downsides of break clauses stem from the intricacies of the clause itself and the interpretation of its provisions by both parties. Activating a break clause is a technical process that can easily go wrong. Disagreements over whether the conditions have been met precisely may lead to disputes and legal actions, which can be costly and time-consuming. Landlords may feel that tenants have not fulfilled the necessary requirements to terminate the lease.

In the current uncertain economic climate, more tenants may consider invoking existing break clauses or negotiating them into new leases. Understanding the intricacies of break clauses is crucial to avoid unintended consequences. Proper preparation and seeking advice are essential before action is taken. Tenants must realize that triggering a break clause can put landlords under pressure to quickly re-let under unfavourable market conditions, prompting landlords to closely review agreements for potential challenges.

What are the common disputes encountered when triggering a break clause?

The Royal Institution of Chartered Surveyors released the ‘Code for leasing business premises, England and Wales’ in February 2020. According to this code, break clauses should typically only be contingent on tenants meeting specific requirements, such as paying all outstanding rent, vacating the premises, and ensuring no subtenants or other occupants remain.

Despite the seemingly straightforward nature of these conditions, many landlords tend to impose additional, more stringent terms that surpass the voluntary code’s stipulations. In the current market climate, tenants are advised to leverage the reduced demand landlords are facing to negotiate break clauses more assertively, adhering closely to the voluntary guidelines.

Landlords might try to link the trigger for a break clause to broader lease covenants, like the property’s condition upon return or the reversal of any alterations made during the tenancy. Unless the lease specifies otherwise, landlords are not obligated to confirm a tenant’s compliance with all relevant covenants.

In case of a dispute, any remarks made by the landlord on lease conditions could serve as grounds for challenging the landlord’s attempt to block a break clause, especially if the tenant can argue they believed they had fulfilled the stipulated conditions. Therefore, tenants uncertain about meeting such conditions should consider engaging a specialist surveyor to assess the premises and identify any necessary remedial actions. If the specialist indicates that break clause conditions cannot be met, the tenant may opt for negotiating an early termination of the lease based on mutually agreed terms with the landlord. Seeking advice in advance of acting is crucial in these situations.

To ensure compliance with a break clause in a lease agreement, tenants must not only consider any break penalties but also maintain rent payments up to the break date. Commercial rents are typically paid in advance, either quarterly or monthly. Therefore, even if the break date falls after a rent payment date, tenants are often required to pay for the full period, including any months beyond the potential break date. Landlords are not obligated to negotiate return of overpaid rents, and successful activation of a break clause hinges on full payment of all due rent.

What could go wrong when triggering a break clause?

When dealing with a break clause, it is crucial for all involved parties to adhere precisely to the requirements for serving notice, including details on how, when, where, and to whom it should be served. Lord Hoffman’s famous quote in Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd [1997] UKHL 19 illustrates this point by highlighting that even minor deviations, such as the colour paper the notice is written on, could invalidate the notice.  He stated;

“If the clause had said that the notice had to be on blue paper, it would have been no good serving a notice on pink paper, however clear it might have been that the tenant wanted to terminate the lease”.

Therefore, tenants and landlords must understand that failing to meet the specific conditions outlined in the tenancy agreement can render the break clause ineffective.

For instance, the notice may have to follow a specific format attached to the lease, and any deviation from this format would invalidate it. Additionally, the notice must be served to the correct individual, necessitating verification that the landlord identified in the original lease remains the current landlord. This verification can be confirmed through the Land Registry for individual landlords or Companies House for corporate landlords. Given the complexity and risks involved, tenants should not bear the sole responsibility for this.

Furthermore, tenants must provide evidence that they have fulfilled the clause’s requirements. While demonstrating rent payments is relatively straightforward, they must also prove that the notice was served to the correct address(es).

Finally, to satisfy the requirement of ‘vacant possession’, tenants must go beyond simply leaving the premises empty. An illustration of this complexity is evident in the case of Capitol Park Leeds Plc v Global Radio Services Ltd [2020] EWHC 2750 (Ch).

Here, the landlord contended that the legal standard for vacant possession had not been met, rendering the break clause invalid. The crux of the matter did not centre on the mere absence of the tenant from the property – as commonly perceived – but on whether the tenant had not only reversed alterations made to the property but also removed specific original fixtures.

The court ruled in favour of the landlord, emphasizing that vacating the premises in itself does not necessarily fulfil the conditions of a break clause stipulating vacant possession. It is crucial to understand that ‘vacant possession’ holds a precise legal definition that extends beyond its literal interpretation.

Why is timing key when triggering a break clause?

Tenants should understand that once a break clause is activated, it cannot be retracted legally, irrespective of whether circumstances change within the six-month notice period, or both parties agree to cancel the break clause. Once triggered, it remains in effect. The only recourse is for the tenant to continue paying rent while a new lease is drawn up.

Before activating an existing break clause or drafting a new one, tenants must carefully consider the implications of the different conditions and terms. Understanding these aspects is crucial for utilizing the flexibility that a break clause provides when necessary.

The era of standard commercial leases without clauses safeguarding both parties’ interests is likely behind us. Therefore, staying informed about current practices and seeking legal guidance before discussing contract modifications is highly recommended.

For assistance in negotiating break clauses in new or revised leases, or guidance on activating an existing break clause, feel free to reach out to our team of experienced commercial property professionals. We are dedicated to helping you achieve the best outcome for your business.