Commercial Property Rent Reviews (Part 8)
Treatment of break options in the hypothetical term:
If a Lease includes a break option, the parties should agree the appropriate treatment of that break right in the Hypothetical Lease.
A Tenant’s break option without strict pre-conditions (for example full compliance with covenants and provision of vacant possession) will potentially increase the rent payable because it allows the Tenant greater flexibility.
If the Lease includes a Tenant’s break option, Landlords will often require the Hypothetical Lease to include a Tenant’s break option on the same terms.
Conversely, a Landlord’s break option could reduce the rent payable. Tenants should therefore make sure that rent is assessed at the rent review by including a Landlord’s break option on the same terms in the Hypothetical Lease.
As a rent review clause will normally specify that the Hypothetical Lease is on the same terms as the actual Lease, then (unless the rent review provisions specifically provide otherwise) it is likely that any break options will be imported into the hypothetical Lease.
However, if the hypothetical Lease is silent in relation to any break option, then the definition of the break date in the actual Lease (i.e. whether it is a fixed date or drafted as an anniversary of the date on which the term starts) will affect the treatment of the break right in the hypothetical Lease. A fixed break date in the actual Lease that is before the start of the term of the hypothetical Lease will not be incorporated into the hypothetical Lease unless there is express provision to that effect.
Where a break option is to be expressly incorporated into the hypothetical Lease, the wording required to define the break date in the hypothetical Lease will be dictated by how the break date is defined in the actual Lease.
For example, if the actual Lease specifies particular dates, and those dates represent the fifth and tenth anniversaries of the start of the term of the actual Lease, then those dates may have passed by the relevant review date (and so will be disregarded) or may fall at a different point in the hypothetical Lease term. They may therefore have unintended consequences for valuation.
Instead, the review provisions might provide that the hypothetical Lease is: ‘otherwise on the same terms as this Lease…but the Break Date is the fifth and tenth anniversary of the term commencement date of the [relevant] Review Date’.
Tenants should resist any drafting which seeks to manipulate the break date to increase the rent.
For example, consider a Lease with a 17-year actual term, five yearly rent reviews, a break option at year 12, and the hypothetical term is agreed to be ten years. If in this case the actual break date is incorporated into the hypothetical Lease, the result is:
- first rent review (year five of the actual Lease term)—there is a break option in the hypothetical Lease at year seven of the hypothetical ten year term
- second rent review (year ten of the actual Lease term)—there is a break option in the hypothetical Lease at year two of the hypothetical ten year term
- third rent review (year fifteen of the actual Lease term )—there is no break option in the hypothetical Lease.
This might be what the parties intend, but it should be checked, and advice from rent review surveyors taken on the effect on rent of each break date.
(This article is not intended to be comprehensive or to provide specific legal advice. It should not be relied upon in the absence of specific advice given in relation to particular circumstances.)
For further information, please contact: Natalie Linehan, Andrew Williamson or David Thorp