A side letter may amount to more than a conditional concession even where it does not expressly vary the lease30th March 2017
In the recent case of Vivienne Westwood Limited v Conduit Street Development Limited, the High Court has held that a clause in a side letter allowing a landlord to terminate the side letter and insist on payment of a higher rent – as set out in the lease – was a penalty and therefore unenforceable.
The facts in Vivienne Westwood Limited v Conduit Street Development Limited 
The Claimant, Vivienne Westwood Limited (“Vivienne”) was the tenant of a retail shop premises. The Defendant, Conduit Street Development Limited (“Conduit”) was the landlord. Conduit acquired the original landlord’s interest after the grant of the lease. The lease was for a term of 15 years from 18 November 2009 at an initial annual rent of £110,000, between Vivienne and DER Travel Service (“DER”). The rent was subject to “upwards only” rent reviews to the open market rent in 2014 and 2019.
At the same time as entering into the lease, Vivienne and DER entered into a side letter by which the landlord agreed to accept a lower annual rent from Vivienne. The rent payable under the side letter was £90,000 in year 1, up to £100,000 in year 5 and then capped at £125,000 for the next 5 years (if the open market rent was higher). The side letter was personal to Vivienne and expressed not to be a variation of the lease. The side letter provided a right for the landlord to terminate the rental agreement with immediate effect if any terms of the side letter or lease were breached by Vivienne. In the event of termination, the rent was to be payable in the manner set out in the lease as if the side letter had not existed.
After Vivienne missed a rental payment, Conduit wrote to Vivienne in June 2015 asserting a breach of the terms and gave notice terminating the side letter. Vivienne then paid the rent arrears at a later date, although Conduit only accepted them as part payment pending the first rent review. The rent review was determined at an annual rent of £232,500. Both parties agreed this would be the amount payable if the side letter did not exist.
Vivienne asked the court to determine the effect of the side letter into which it had entered.
The High Court decision
The High Court held that the right to terminate the side letter was an unenforceable penalty. This meant that Vivienne would be entitled to pay rent at the capped rate, regardless of any breach of the lease.
The High Court found that the right to terminate the rental agreement was a penalty clause owing to the following factors:
- The side letter was not purely a conditional rent discount as Conduit argued, but was a change to the primary obligation of the lease. As the side letter was entered into at the same time as the lease, the reduction in rent was part of the overall agreement between the two parties. The primary obligation of Vivienne was to pay the rent as stated in the side letter and not the lease.
- Termination of the side letter made the higher rent payable retrospectively as well as in the future. As a result, Vivienne would have found itself not only liable for an annual rent of £232,500, but also liable for the higher rent for the previous years and any interest due on the arrears. The effect on Vivienne was disproportionate to the legitimate interest Conduit had in having Vivienne comply with its obligations and as a result, the right to terminate was unenforceable.
The High Court noted that if the clause had only a future effect the issue would be less clear, however, the provision would still have been found to be an unenforceable penalty on balance.
Essential Considerations when Entering into Side Arrangements
This decision highlights that a side letter may amount to more than a conditional concession even where it does not expressly vary the lease. When entering into side arrangements it is essential to consider whether:
- The terms within the side letter change a tenant’s primary obligation. In this case the rent concession was a fundamental part of the agreement between the parties. The landlord accepted a reduced rent owing to the preferable reputation of the tenant;
- Any termination provisions apply retrospectively or only with future effect. Any termination clause that applies retrospectively will likely to be found to be penal in nature; and
- The consequences to the tenant are proportionate to the legitimate interests of the landlord.
For further information, please contact the Real Estate Disputes Team at Hamlins.