A recent Court of Appeal case has highlighted the importance for tenants to comply with subletting covenants when granting underleases, even when tenants believe that the covenants don’t make commercial sense.
In Warborough Investments Limited v Lunar Office S.A.R.L  EWCA Civ 427, Warborough was the freehold owner of a property in Wokingham. The property consisted of shops and office blocks and was subject to a head lease owned by Lunar Office. One of Lunar Office’s tenants had granted an underlease for part of the property for a term of just under 10 years.
The head lease included four subclauses containing covenants describing the circumstances in which underleases may be granted. The subclauses did not contain any express links to each other.
Two of the covenants were at issue in this case. First, the covenant in clause 4(21)(b) stated that an underlease must be in respect of complete floors or complete shop units and for a term of not less than 10 years. Second, the covenant in clause 4(21)(c) stated that any underlease must be at the best rent reasonably obtainable for the premises as between a willing lessor and a willing lessee.
Given that the underlease granted by one of the tenants was for only part of the premises and for less than 10 years, Warborough served notice on Lunar Office, stating that there was a breach of the covenant in clause 4(21)(b).
Covenants – Cumulative or Alternative?
At issue in this case was how these covenants should be interpreted. Warborough argued that the covenants should be read as separate obligations. Given that the underlease was for only part of the property and was for a period of less than 10 years, the covenant in 4(21)(b) had clearly been breached.
Lunar Office argued that the covenants relating to granting underleases should read together, such that if one is complied with, then the others need not be. Consequently, Lunar argued that while the underlease did not comply with one of the covenants, it did comply with another covenant (clause 4(21)(b)). Lunar concluded this meant that the covenant relating to underleases as a whole had not been breached. Lunar further argued that this was the most commercially sensible construction of the covenants because otherwise the tenants could not grant underleases in the final 10 years of their tenancies; a commercially damaging outcome for both parties.
Literal Construction of Covenants
The Court disagreed with Lunar. The judge stated that one must assume that the parties intended to give the words they chose in drafting their natural meaning rather than what the parties, acting commercially, are likely to have intended. Consequently, each covenant must be read as a separate obligation despite the fact that compliance might result in a non-commercial outcome for both parties.
Jumping through the Subletting Hoops
This case is a lesson for tenants wishing to grant an underlease. If the terms of a lease are expressed as a series of covenants, unless there is clear drafting to the contrary, those covenants should be read as separate, individual obligations on the tenant regardless of commercial outcome. Conversely, for the lessor of a head lease, investing in professional advice at an early stage to ensure clear, unambiguous drafting can save a huge amount of time and money by avoiding costly court disputes.
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