Side letter falls foul of the rule on penalties

4th August 2017

Derby Office Icon

 

Side letters are often used within the retail sector to agree terms between the landlord and the tenant which are to be personal to the tenant.

However, following the recent Vivienne Westwood case in the High Court, it is important to ensure that the terms of any side letter cannot be construed to be a penalty. If terms are deemed to be a penalty they will be unenforceable.

Vivienne Westwood Ltd (VWL) entered into a 15 year lease in 2009 in respect of its Conduit Street store which contained rent reviews at 5 yearly intervals. At the same time, the parties entered into a side letter in which the landlord agreed to accept a lower rent during the first 10 years of the term. The side letter reduced the rent for the first 5 years of the term and limited it to a maximum of £125,000 for the next 5 years of the term.

The side letter contained a clause which stated that the side letter would be immediately terminated if VWL breached any term or condition of the side letter, the lease or any other supplemental document (such as a licence to alter).

The effect of termination of the side letter would mean that the rent would revert to that due under the lease as if the side letter had never existed.

In 2015 VWL was late paying the rent and the landlord terminated the side letter and following a rent review the rent was increased to £232,000 per annum.

VWL agreed that this would be the level of rent payable if the side letter did not exist but argued that the termination provisions of the side letter were a penalty and therefore unenforceable.

The matter was taken to the High Court where it was decided that the termination provisions of the side letter were a penalty because:

  • As the lease and the side letter were entered into at the same time, VWL’s primary obligation was to pay the rent in the side letter rather than under the lease, which was a secondary obligation. This is important because the court will not generally interfere with a party’s primary obligation to do something but can regulate the secondary liability that may be imposed when a party breaches that obligation.

    However, had the side letter been entered into after the lease because, for example, the tenant was struggling to pay rent the position it seems would have been different.

  • The Court found that the secondary obligation to pay the higher rent was exorbitant or unconscionable compared with the landlord’s legitimate interest in having VWL comply with its obligations in the lease due to:

  • The termination provisions allowing the side letter to be terminated for any non-trivial breach of the lease. The Court refused to imply a term that only material breaches would permit termination.

  • The termination of the side letter made the higher rent under the lease payable retrospectively as well as in the future. However, the Court noted that although the issue would have been less clear cut if the provisions had only been prospective the Court would still have found it was a penalty.

As the termination provisions in the side letter were penal and unenforceable VWL was only obliged to pay the lesser rent of £125,000 per annum as provided for by the side letter.

Landlords should be very careful when putting side letters in place and should also review any existing side letters. Tenants will equally want to ensure that valuable concessions offered by the landlord cannot be withdrawn arbitrarily.

When putting a side letter in place the following points should be considered:

  • The side letter should be clear that the primary obligations are those in the lease and that the side letter creates a secondary obligation.

  • Are any termination provisions retrospective as well as prospective?

  • The side letter should be clear about which breaches of the lease will trigger any termination provisions.

  • What consequences will flow from the agreement in the side letter being terminated?

  • It is important to ensure that the consequences to the tenant are proportionate to the legitimate interests of the landlord. It would be prudent to document the reasons for this.

If you have any queries relating to this e-bulletin or would like to know more about this topic,  please do not hesitate to contact a member of the Retail Team.

RELATED:  COMMERCIAL >> DISPUTE RESOLUTION >> RETAIL >> 


MORE FROM THE ADVICE CENTRE

News

Minister for ‘Brexit’ meets with D2N2 and East Midlands Chamber representatives at Geldards
24/10/2016
A Minister working on ‘Brexit’ met D2N2 Local Enterprise Partnership and East Midlands Chamber representatives at a meeting at Geldards Nottingham.
more...

Blogs

Brexit – another twist in the tale as snap election is called!
19/04/2017
In a statement yesterday, Prime Minister Theresa May has announced that she intends to call a general election for 8th June.
more...

Publications

Implementation of the Acts Passed by the Fourth National Assembly for Wales
07/11/2016
Request your copy of Geldards' reference guide to the acts passed or soon to be passed by the Fourth National Assembly for Wales.
more...

Content Contacts

PARTNER

David Watson

DAVID WATSON

Partner, Nottingham

+44 (0)115 983 3718
email
more...

PARTNER

Ioan Owen

IOAN OWEN

Partner, Cardiff

+44 (0)29 2039 1752
email
more...