Break Options – A Landlord’s Perspective

A break option is a provision in a lease which enables a tenant (or a landlord if it is a mutual or landlord only break option) to end a lease before the expiry of a fixed term. Break options are usually exercisable on a fixed date during the lease term although rolling breaks, which are exercisable at any time during the term, can also be agreed.

Tenant Break Options

Pros and Cons

For tenants committing to a ten-year lease or longer, the inclusion of a tenant break option in their lease is invaluable as it:

1. Provides an escape route if business does not go well or if a premises in more advantageous location or on better terms is found; and
2. Can be used to strengthen a tenant’s position when negotiating concessions or more favourable lease terms, e.g., a rent-free period or a reduced rent.

For landlords, on the other hand, there are obvious disadvantages to agreeing to a tenant break option, which include:

1. The loss of certainty that the premises will be let for the entire term of the lease; and
2. The increased risk of being left with a vacant premises and potentially lengthy rent void should the tenant decide to exit their lease early.

Notwithstanding the disadvantages outlined above, in today’s challenging letting environment landlords are becoming increasingly more inclined to agree break provisions in order to attract and secure good tenants.

Protecting the Landlord’s Position

Where a break option is commercially agreed, the landlord’s position can be protected as follows:

1. Firstly, the break option can be made strictly personal to the tenant signing the lease, thereby ensuring that if the lease is ever assigned, the break right will fall away and successor tenants will not benefit from it.
2. Secondly, the exercise of the break option can be made strictly subject to the tenant’s satisfying certain pre-conditions which ensure the landlord’s position is protected.

Break options which are personal to the original tenant are standard and generally accepted by tenants without issue. Conditional break options, on the other hand, are often met with strong resistance. This is because the terms of a break clause, including any break conditions, are strictly construed by the courts and, as a result, the smallest misstep can see a tenant’s break rights easily invalidated.

Break Conditions

The most common pre-conditions to the exercise of a break option are as follows:

(1) Service of Notice – all break options are subject to service of notice of the tenant’s intention to terminate the lease. The notice period will usually vary from 6 to 12 months prior to the agreed break date. Care should be taken when drafting a break clause to ensure there is no ambiguity in either party’s mind as to what the break date is and when and how notice must be served. Failure to serve notice within the specified period or in the specified manner will invalidate the break option.

(2) Break Penalty – break options are not always contingent on a penalty payment being made. However, if a landlord wishes to avoid any claw back in respect of landlord fit out costs or part of a rent-free period which was calculated on the basis of a full term, the payment of a break penalty, usually a fixed amount, can be made a condition of the break option.

(3) Payment of Rent – to avoid expensive and time-consuming debt recovery proceedings after a lease has terminated, it is common for landlords to make break options conditional upon the receipt of an upfront payment of all rent, service charge, insurance and other sums due under the lease up to the break date. This payment is usually sought at the time of the service of the break notice and must be made strictly in accordance with the term of the lease. For example, if the lease requires rent to be paid quarterly, the full quarter’s rent must be paid even if part of the said payment relates to a period beyond the break date. Prudent tenants will usually argue against this pre-condition on account of the difficulty in calculating the exact payment required for compliance and the risk of a mere €1.00 shortfall in payment could result in the tenant’s break rights being forfeited. While such arguments are not without merit, the fact remains that it is in the landlord’s best interests for this condition to remain. Tenants should, however, be offered comfort that any overpayments made in compliance with this condition will be refunded in full by way of an express right to this effect being included in the break provisions.

(4) Vacant Possession – another standard condition of all break options is that the tenant must deliver to the landlord on the break date “vacant possession of the premises free from encumbrances”. The test for compliance with this condition is two-pronged:

Firstly, the tenant must deliver full vacant possession of the premises on the break date. The test of vacant possession is more than just about giving up occupation. It means ensuring on the break date that all tenant stock, machinery, fixtures and fittings are removed where required by the lease or supplemental documents, that keys are returned and that no persons are present in or in occupation of the premises with the express or implied authority of tenant. As this condition can be easily breached by, for example, something as minor as a solitary box being left in the premises following the break date, its inclusion in the break provisions of lease will usually be met with resistance. As an alternative, tenants will often request the landlord’s consent to:

• Include wording in the break provisions which confirms that vacant possession for the purpose of the exercise of the break option means “possession free from encumbrances” only; or
• Make the provision of vacant possession a covenant rather than a condition of the exercise of the break.

In support of their position, tenants will argue that the landlord’s right to compensation for breach of the tenant’s repair and yield up obligations in the lease remains in any event and, as such, a break condition requiring vacant possession is unnecessary. However, for landlords with concerns about being left in a weaker negotiating position in relation to dilapidations after a lease has ended, any attempt to remove or water down this pre-condition should be pushed back on.

Secondly, the premises must be delivered free from encumbrances – this means that the tenant must provide evidence on or prior to the break date that all sub-leases have been terminated and that no statutory renewal rights have been accrued by any sub-tenants. In addition, the tenant must provide evidence that any security registered over the lease has been discharged. This condition should always be non-negotiable as it safeguards the landlord from the effects of Section 78 of the Landlord & Tenant (Amendment) Act 1980, which provides that where a lease is terminated before its normal expiration date any sub-lease will remain in existence and the landlord will become the landlord of the tenant under the sub-lease.

(5) Compliance with Lease Covenants – the exercise of a break option is also commonly made subject to the tenant’s compliance with the covenants on the tenant’s part in the lease. As the risks of breaching this condition are high, tenants will usually seek to limit their obligations in this regard to “compliance with material covenants” only. This is a reasonable qualification which a landlord should not have any difficulty with.

(6) Surrender of Lease –the delivery of the original lease and other ancillary lease documents to the landlord on or prior to the break date together with an executed deed of surrender is another common requirement of a break option. The tenant is also usually required to pay any VAT or stamp duty liability arising as a result of the surrender. This is a reasonable condition which tenants do not generally have any difficulty with.

Landlord Break Options

Break options can also be useful tools for landlords who have plans to redevelop or refurbish their premises, or who want to keep their options open in a rising rental market. Unlike tenant break options, landlord break options are usually only conditional upon the service of notice. Like tenant break options, landlord break options can be personal to the original landlord or, alternatively, exercisable by the landlord’s successors in title.

Conclusion

The above represents a non-exhaustive list of items to consider when negotiating a break option in a commercial lease. As break provisions are a common source of disputes between landlords and tenants, we would strongly advise all landlords to take legal advice prior to agreeing same.

How we can help

If you have any queries or concerns, or would like to discuss the above in further detail, please feel free to contact Keith Doyle in our Commercial Real Estate Department (kdoyle@bhsm.ie / +353 (0)1 440 8300).

This article is for general information purposes. Legal advice must be obtained for individual circumstances. Whilst every effort has been made to ensure the accuracy of this article, no liability is accepted by the author for any inaccuracies.