Marks & Spencer Plc (M&S) held leases of four floors of offices in Paddington. The leases ran until 2 February 2018 but M&S had the benefit of break clauses in all of the leases operable as at 24 January 2012 or 24 January 2014.
The break clauses were subject to a number of conditions, the most important of which were:
The break sum was approximately the basic yearly rent for one floor. Clearly the tenant would save substantial sums by correctly operating the break clauses.
M&S made all payments required to exercise the breaks including paying a full quarter’s rent due on the quarter day preceding the break date. M&S then sought to recover what it considered to be over payments of rent attributable to the period between the break date and the end of that quarter. At first instance, the court implied a term into the leases requiring the landlord to repay that sum. That decision surprised many practitioners.
The Court of Appeal has now overturned this decision and in so doing has both clarified the law in this area and re-stated the appropriate approach to be adopted when considering the implication of terms into leases and other contractual documents.
To properly understand the decision in the Court of Appeal, it is important to appreciate why a full quarter’s rent is payable in these circumstances. In summary:
When exercising break clauses, tenants have felt aggrieved to be paying a full quarter’s rent on the quarter day immediately before the break date. What is the correct approach?
The conditionality in many break clauses has meant that tenants have not been able to take the risk of paying an apportioned sum calculated up to the relevant break dates. If this apportioned payment is not permitted by clear words in the lease, their attempt to break the lease will fail if they do not pay the full quarter’s rent (see for example PCE Investors Ltd). Therefore M&S paid the full sums demanded on the quarter date preceding the effected break date. The only option left was to seek repayment of the balance which they considered to have been 'overpaid'.
Commentators had suggested for a number of years that this might be possible and, at first instance, M&S ran a range of arguments, relying on:
They succeeded only on the basis of an implied term and argument in the Court of Appeal was also limited to that issue.
At first instance, the court implied a term into the lease requiring repayment of rent applicable to the period following the break date. The Court of Appeal placed particular stress on two arguments:
We will return to the first of those arguments below. In the Court of Appeal, the principal focus was on the correct test for implying a term.
For many years, it was considered that the test for implying a term into a contract was a severe one. The term had to be either necessary to give business efficacy to the contract or to represent the obvious, but unexpressed, intention of the parties (see Chitty on Contract para 13-004 31st Edition). This 'traditional' approach was disturbed by the Privy Council’s decision in AG of Belize v Belize Telecom Ltd  1 WLR 1988. That decision explained that the implication of terms was simply one aspect of construction of a contract. As Lord Hoffman said: “There is only one question: Is that what the instrument, read as a whole against the relevant background, would reasonably be understood to mean?”
This was the test applied by the court at first instance and this approach was criticised by the Court of Appeal.
Arden LJ emphasised that to imply a term the court is still required to pass a high test. This test was put in a number of ways:
In short, the Court of Appeal considered that the implication of a term in favour of the tenant in Marks & Spencer Plc v PNB Paribas was a product of focusing too much on what was reasonable rather than whether the high bar necessary for implying a term had been reached.
As the court said: “In my judgment, when all the circumstances are considered, the correct influence to draw is that the parties proceeded on the basis that the loss from a payment of rent for the broken period should lie where it fell. Thus no term for repayment is implied.”
In general terms therefore it is now clear that:
In its analysis of the tenant’s payment obligations, the court at first instance considered what happened when a lease expires by effluxion of time part way through a quarter.
Both at first instance and on appeal it was accepted that words such as 'proportionally for any part of a year' in relation to rent meant that at the end of the contractual term rent only had to be paid for a period up to the last day of the lease. Morgan J considered that the same result was achieved even if these express words were not used (see York v Casey  2 EGLR 25).
He also held that if on the last quarter day preceding the break date, it was by then clear that the lease was bound to end on the break date, only a payment of rent apportioned up to the break date, would be due.
This could apply in two circumstances:
The Court of Appeal did not hear full argument on this point but was of the view this, 'would seem to be correct'.
In practical terms: