On 18 November 2009, Vivienne Westwood Ltd entered into a 15 year lease of a retail shop in the heart of Mayfair. The annual rent payable under the lease was £110,000, subject to upwards only rent reviews in 2014 and 2019.
In a side letter made at the same time , the landlord agreed to accept a lower rent from the tenant. The reduced rent was stepped from £90,000 up to £100,000 for the first five years of the term. If a higher open market rent was determined on review in 2014, the rent was then capped at £125,000 for the following five years.
The side letter was personal to the tenant, Vivienne Westwood Ltd, and, significantly in this case, could be terminated by the landlord on any breach of the lease by the tenant.
On termination of the side letter, the rent would be immediately payable on the terms set out in the lease, as if the side letter had never existed.
There were a number of changes in ownership of the landlord’s reversionary leasehold interest in 2013 and again in 2015, which caused some confusion with the invoicing and payment of rent and resulted in a delay by the tenant in paying the March and June 2015 quarters.
As a consequence of the delayed June 2015 payment, the landlord purported to terminate the agreement in the side letter with immediate effect. The tenant then paid the arrears (calculated in accordance with the side letter) in full, which the landlord accepted in part payment only, on the basis that the November 2014 rent review remained outstanding and it considered that the side letter agreement capping the rent at £125,000 had been terminated.
In spite of protests from the tenant, the November 2014 rent review proceeded and was eventually determined by agreement in the sum of £232,500 per annum.
So, one of the main issues between the parties was whether:
- The side letter had been validly terminated, so the annual rent was £232,500; or
- The side letter was still in force, so the annual rent was capped at £125,000.
The key question for the court was whether or not the right for the landlord to terminate the side letter for any breach of lease by the tenant was a penalty, and so unenforceable.
Penalties – a recap of the law
The Supreme Court decision of Cavendish Square Holding BV v Makdessi restated the main principles of the law of penalties. According to the majority view, a penalty clause can be found to exist where:
- A secondary obligation is imposed on a breach of a primary obligation; and
- That secondary obligation imposes on the defaulting party a detriment disproportionate to any legitimate interest of the innocent party.
Primary and secondary obligations
The tenant’s primary obligation was to pay rent at the lower rate agreed under the side letter. The true bargain agreed between the parties was that, in return for having a tenant of the reputation of Vivienne Westwood trading from the property, the landlord agreed to accept a lower rent than it might otherwise have obtained.
If that primary obligation was breached, the tenant’s secondary obligation to pay the higher rent reserved by the lease would then bite. That secondary obligation was therefore capable of being a penalty.
In weighing up whether the termination clause in the side letter amounted to a penalty, the court took into account that:
- If triggered, the obligation to pay the higher rent applied both retrospectively (i.e. from day one of the lease) and prospectively for the rest of the term – regardless of the nature and seriousness of the breach or when it occurred; and
- The increased rent was payable in addition to interest and costs incurred as a result of the breach and damage for losses caused by breach.
Having regard to the above, the court found that the termination provision in the side letter was a “blunt instrument” that could result in a substantial and wholly disproportionate financial detriment to the tenant. Its impact on the tenant was “exorbitant and unconscionable”. Consequently, the court held that the termination clause in the side letter was penal in nature and the rent concession in the side letter therefore remained in force.
Although this case turned on its specific facts, particularly the specific wording of the side letter, it is a helpful reminder that parties should not assume that a court will give effect to whatever has been agreed between them – even where, as in this case, both parties were well-advised and in equal bargaining positions.
Going forward, a well-advised landlord should avoid imposing particularly onerous terms on its tenant in side letters; it may be more beneficial to agree a moderate and measured position that adequately and proportionately compensates the landlord in the event of tenant default and that consequently remains enforceable, rather than a provision that penalises the tenant and which may be unenforceable.
If you have a question and would like to learn more, please do get in touch. Email me at Jessica.Hopewell@blplaw.com.