The effect of a side letter on capped rent and rent review of commercial premises
The claimant tenant occupied the basement and ground floor premises as a retail outlet at 18 Conduit Street, London under a lease dated 18 November 2009. The lease was granted for a term of 15 years, with an initial annual rent of £110,000 paid quarterly in advance on usual quarter days.
‘Upwards-only’ rent reviews were to take place to open market rent on 18 November 2014 and 18 November 2019. The lease set out the rent review procedure, stating that time was not of the essence and that, where the rent review is not completed and the new rent ascertained by the rent review date, the tenant is to continue paying rent at the previous rate until the new rent is determined.
The parties agreed a simultaneous side letter to the lease whereby the landlord agreed to accept a reduced rent, stepped from £90,000 pa in year one to £100,000 pa in year five. The rent was then capped at £125,000 for a further five years. The terms of the side letter were stated as being personal to the claimant, and the agreement could be terminated in the event that the claimant breached any terms of the lease or other supplemental documents.
The landlord subsequently changed on a number of occasions; each landlord made rent demands in sums that accorded with the side letter. A demand was made by the agent for the defendant which was unpaid by the claimant; the agent had not made it clear for whom he was acting. The defendant therefore claimed a breach of the lease due to unpaid rent, and the side letter agreement was terminated immediately. The tenant paid in full thereafter. A rent review was commenced by the defendant, which was contended by the claimant on the basis that it did not consider a rent review to be due and rent was payable at a rate of £125,000 pa. The rent review continued, and rent was determined at £232,500 pa; the claimant then issued proceedings to determine the position.
The Court needed to assess firstly whether the rent review at £125,000 pa was binding between the parties. The claimant contended that its payment, and the defendant’s acceptance, of the demands constituted agreement that the rent was reviewed to £125,000 pa. In considering the parties’ subsequent conduct, the defendant argued that the subsequent rent review was progressed within the knowledge of the claimant.
The claimant’s success depended on whether it could demonstrate the fundamental aspects of contract law; whether the defendant had made an offer to review the rent at the rate of £125,000 pa and whether the claimant accepted that offer. The Court did not feel that the defendant’s behaviour suggested it had made an offer to settle the rent review.
The Court also assessed whether the landlord’s termination of the side letter constituted a penalty which was unenforceable, or whether it was merely punitive; it concluded that this was a matter of interpretation of the language used rather than a consideration of circumstances.
It rested with the claimant to demonstrate that the liability in the side letter constituted terms which were exorbitant, extravagant or unconscionable. The side letter could be construed as penal, given that it permitted the landlord to impose a greater obligation where any breach of the lease occurred. It was the case that, here, the landlord may have a greater interest in the claimant’s non-performance of its obligations (ie. breaching a term of the lease, which would result in the payment of higher rent) than it its performance, which would maintain payment of rent at a lower rate. The side letter could be terminated on any minor breach.
It was held by the Court that the defendant had not made an offer to settle the rent review at £125,000 pa that was capable of being accepted by the claimant. The rent was subsequently determined following conclusion of the rent review at a rate of £232,500 pa.
However, further the Court held that the termination provision in the side letter constituted a penalty and was therefore unenforceable. The financial penalty to the claimant was found to be exorbitant and unconscionable, and the rent remained payable at a rate of £125,000 pa.
JB Leitch’s Phil Parkinson comments on the decision:
“Side letters are a common feature of landlord and tenant arrangements, particularly in commercial lettings. This case demonstrates the importance of careful negotiation and equitable consequences; it must always be preferable to a landlord that a claimant performs its obligations, rather than non-performance of a minor breach resulting in a significant financial benefit to the landlord. Landlords are advised to consider whether any aspect of an agreement may result in a circumstance which could be viewed as ‘exorbitant, extravagant or unconscionable’; where it could, negotiation should turn to focus on positively ensuring the tenant observes its obligations.”
It rested with the claimant to demonstrate that the liability in the side letter constituted terms which were exorbitant, extravagant or unconscionable.