The extravagant price of high fashion

In Vivienne Westwood v Conduit Street Development Ltd [2017] EWHC 350, the landlord entered into a side letter agreement which provided that the landlord would accept a lower annual rent than that specified in the main lease agreement. The side letter contained provision for the landlord to terminate the agreement with immediate effect in the event of breach by the tenant of any of the terms of the lease. In the event of termination, the side letter provided ‘the rents will be immediately payable in the manner set out in the lease as if this agreement had never existed’.

The tenant failed to pay a quarterly rent instalment on time and the landlord purported to terminate the side agreement. In the High Court (before Timothy Fancourt QC sitting as a deputy judge), the tenant argued that the right of the landlord to terminate the side letter upon any breach by the tenant, thereby increasing the rent payable to the amount specified in the lease, was a penalty and therefore unenforceable.

As reiterated by the Supreme Court in Cavendish Square Holding BV v Makdessi, the penalty clause doctrine only applies to secondary obligations imposed upon a breach of a primary obligation, and does not apply to primary obligations. The distinction between primary and secondary obligations depends on substance, not form.

In this case the landlord argued that it was, in substance, seeking to enforce the tenant’s primary obligation to pay the rent due, and the side letter was no more than a ‘conditional collateral right’, which imposed an obligation on the landlord to accept less than the full rent in certain circumstances. This argument was rejected.

The judge held that owing to the prestigious reputation of the tenant, the landlord had agreed to accept a lower than market rate rent if the tenant complied with the terms of the lease. If the tenant failed to do so, it would come under a secondary obligation to pay an increased rent. The position was not comparable to a discount for prompt payment and the penalties rule was engaged.

The judge considered that, on a proper construction, the side letter entitled the landlord to terminate the agreement in the event of any non-trivial breach by the tenant, and further that the secondary obligation imposed on the tenant operated retrospectively with the result that the tenant, in the event of such a breach, must pay additional rent for all the preceding years of the term that had passed, as well as paying it for the future.

The judge also considered the fact that the lease provided for interest to be paid on any overdue rent, and for the landlord’s costs to be paid on an indemnity basis. Although the judge agreed with the landlord that, in theory, failure to perform the obligations of the lease could affect the value of the reversion in ways that would not be adequately compensated by these provisions, this would arise only in the event of serious and multiple breaches of covenant. Under the side letter, the same consequence applied whether the breach was one-off, minor, serious, or repeated.

In these circumstances, the judge considered that the termination provision imposed on the tenant a detriment out of all proportion to any legitimate interest of the landlord in the performance of the primary obligation. The purported termination of the side letter was unenforceable and the tenant was entitled to continue paying rent at the rate specified therein.

This case, in which both parties were advised and had comparable bargaining positions, serves as a warning for landlords and practitioners in relation to the drafting of side concession agreements and their termination. Landlords should consider whether a concession agreement can be drafted so that the tenant’s primary obligation is still to pay the rent as specified in the lease without the termination or withdrawal of the benefit being triggered by a breach of contract.

However, as reiterated in this case, the distinction between primary and secondary obligations is based on substance, not form, and a court may not be persuaded that the rules on penalties can be avoided by clever drafting. If the penalties rule is engaged, the effect of termination must not be out of proportion with any legitimate interest of the landlord in enforcing the primary obligation. It would therefore be sensible to include a seriousness threshold or provide that only breaches of specified clauses will result in termination As this case shows, an overly ambitious termination clause may not be enforceable and may result in the side agreement becoming the only option.

Wayne Clark and Julia Petrenko are barristers at Falcon Chambers

@FalconChambers1 www.falcon-chambers.com