Penalties Vivienne Westwood Limited v Conduit Street Development Limited [2017] EWHC 350 (Ch)

Whether the termination of a side letter that allowed a tenant to pay a reduced rent amounted to a penalty and was unenforceable as a result.

The facts

The tenant rented retail premises from the landlord. The lease was for a term of 15 years from November 2009, at an initial rent of £110,000 per annum, subject to reviews of the open market rent in the fifth and tenth years.

The parties entered into a side letter at the same time as the lease, under which the landlord agreed to accept a lower rate of rent from the tenant. The side letter was terminable by the landlord if the tenant breached any of the terms and conditions of the side letter or the lease, in which case the rents would be payable in the manner set out in the lease as if the side letter had never existed.

The tenant failed to pay the rent in June 2015 and the landlord asserted that the side letter had been terminated and that the full rent was payable. The issue was whether the terms of the side letter amounted to a penalty and were therefore unenforceable as a result.

The decision

The court found that the terms of the side letter did amount to a penalty.

The judge applied the test in Makdessi v Cavendish Square Holdings BV. The tenant’s primary obligation was to pay rent at the lower rate. That only changed if a condition of the side letter was no longer satisfied or in the event of a breach by the tenant. Whether the side letter amounted to a penalty depended upon the legitimate interest of the landlord in having the tenant comply with its primary obligations under the lease and whether the increased rent from the termination of the side letter was unconscionable compared with any loss likely to flow from the breach.

The judge found that the reduction in rent was not simply a conditional right to which the tenant was not otherwise entitled; it was a substantial term of the bargain struck with the landlord. Further, under the side letter, the same adjustment applied whether a breach was one-off, minor, serious, or repeated, and regardless of the nature of the obligation or the consequences for the landlord. The termination of the side letter also had retrospective effective, meaning that the tenant would have to pay additional rent at a higher rate from the commencement of the lease. This was penal in nature, and the purported termination of the side letter was unenforceable as a result.

Why is this important?

This decision provides further guidance on the application of the rule against penalties and confirms that an agreement and side letter may be considered together when considering whether a penalty has been applied.

Any practical tips?

When drafting or agreeing to side letters, consider whether their terms and any specified consequences impact on the parties’ primary obligations and could be interpreted as amounting to a penalty. Consider whether the letter can instead be drafted as a conditional agreement.