The hungry caterpillar: a cautionary tale for commercial landlords

A recent judgment handed down by the Court of Appeal in Caterpillar Property Limited and Anor v Park Cakes Limited should serve as a cautionary tale for commercial landlords hoping to rely on favourable renewal rents in cases where tenants have an option to renew their lease.

The lease dispute

The case concerned Caterpillar Property Limited (the “Landlord”) who in 2007 granted two 20-year leases of factory premises to Park Cakes Limited (the “Tenant”) a company in the business of making cakes. Each lease contained an option for the Tenant to renew the respective leases for a further 10 years provided that the Tenant served at least 12 months’ notice of their intention to exercise the option and all rent had been paid up to the end of the term.

Under the terms of the option, the renewal rent would be index-linked which as it happened led to a rent that was higher than the prevailing market rent.  In the hopes of avoiding being saddled with the higher renewal rent the Tenant, instead of exercising their options in the leases, sought a new tenancy with a market rent to be determined by the court under Part II of the Landlord and Tenant Act 1954 (the “1954 Act”). The Landlord resisted, arguing that the existence of the option triggered section 28 of the 1954 Act, which would operate to exclude the Tenant’s ability to renew the lease under the 1954 Act.

1954 Act protection

Business tenants have the right under the 1954 Act to ‘security of tenure’, providing that the tenancy is not excluded from the provisions of the 1954 Act. In effect this means a tenant can stay in occupation of the property and apply to the court for a new tenancy even where the contractual term of their lease has ended. Unless a landlord can prove certain statutory grounds to oppose any new tenancy, a tenant will generally be granted a new tenancy by the court on certain terms, unless otherwise agreed by the parties.

However, section 28 of the 1954 Act provides that:

“Where the landlord and tenant agree for the grant to the tenant of a future tenancy of the holding, or of the holding with other land, on terms and from a date specified in the agreement, the current tenancy shall continue until that date but no longer, and shall not be a tenancy to which this Part of this Act applies.”

So, where there is an agreement for a future tenancy, the lease will not benefit from security of tenure.

Consequently, the question before the court in the present case was whether the option to renew constituted an agreement for a future tenancy for the purposes of section 28. The Landlord argued that it did.

Court of Appeal ruling

The case was an appeal of an earlier decision from the County Court, where the Landlord had lost and was now appealing that decision. The Court of Appeal dismissed the Landlord’s appeal and upheld all of the County Court’s judgment.

The Court of Appeal held that the grant of an option in favour of a tenant imposes no obligation on that tenant to exercise that option. Similarly, although the landlord has a continuing obligation to ensure that it will be able to grant the new tenancy, before the option is exercised the landlord has no obligation to grant the tenancy.

Further, the exercise of the option is often contingent on compliance with strict requirements. In this case, 12 months’ notice was needed together with the prior payment of the yearly rent up to the end of the term. Other options discussed in the judgment by way of example included strict compliance with all covenants in a lease. Any slight failure of the Tenant to meet these requirements would mean the exercise of the option fails. The court therefore held that it is wrong to characterise all options to renew as amounting to effective entitlement to the grant of a new lease on this basis.

The court found that the proper way by which to analyse the legal nature of an option in this context is from the perspective of the tenant (as Part II of the 1954 Act is designed to give protection to business tenants) and from this perspective the option is best regarded as analogous to an ‘irrevocable offer’ rather than a conditional contract. Unless and until the tenant has successfully exercised the option, there is nothing that the tenant can enforce.

Section 28 of the 1954 Act did not therefore apply.

What does this mean for landlords and tenants?

Put simply, for the purposes of section 28 of the 1954 Act, an option to renew is not an agreement for a future tenancy. Tenants therefore, assuming Part II of the 1954 Act applies, still benefit from the right to a new tenancy and any favourable rental implications that follow.

As far as we can tell, if the rental position was more favourable to the tenant under the option, for example was less than the prevailing market rent, the tenant could still exercise their option rather than going down the lease renewal route in the 1954 Act.

Landlords should be conscious when entering into a new lease that they have properly considered the impact of the 1954 Act on the future tenant-landlord relationship.