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Relief from forfeiture: Can the landlord gather a windfall?

Published April 2016

Written by John Furber QC

Two recent decisions of the Court of Appeal provide guidance as to the approach to be adopted in cases where a long lease having substantial value is forfeited, following a serious breach of covenant, and the lessee seeks relief from forfeiture. In each of these cases, more than one application for relief was necessary and in each case the Court of Appeal granted relief, which had been refused by the court below, thereby depriving the lessor of what was described as a “windfall”.

Magnic

In Magnic Limited v Ul-Hassan [2015] EWCA 224 the premises were used for a number of years as a “take-away pizza restaurant”, without planning permission or without compliance with a condition attached to a planning permission relating to the installation of a fume extraction system, in breach of covenant. The lease was therefore forfeited and the first order for relief from forfeiture was made by consent on 5 January 2010, providing, amongst other matters, that relief would be granted if planning permission was obtained before 1 March 2010 and any conditions thereby imposed were complied with within 3 months of the grant of planning permission.

The lessees did not comply with these terms (although a planning permission subject to conditions was obtained on 16 December 2010), but the use of the premises continued. On 14 January 2011, the District Judge, hearing an application for possession following the forfeiture, was not minded to extend the time limits or otherwise vary the terms for relief from forfeiture agreed in January 2010, but instead followed a suggestion made by the claimant lessor: an order for possession was granted but there would be relief from forfeiture if the use ceased completely by 11 February 2011.

The lessees applied for permission to appeal against this order of the District Judge and for a stay of execution. A Circuit Judge granted permission to appeal and an interim stay of execution and the use continued until 31 May 2011 when another Circuit Judge lifted the stay and dismissed the appeal. There was then correspondence between the solicitors to the parties as to whether the lessor was entitled to possession because the condition imposed on the grant of relief had not been complied with or whether the stay of execution had been in itself sufficient to extend the 11 February 2011 deadline. Further proceedings were then commenced, in which the claimant sought a declaration that it was entitled to possession by virtue of the failure to cease the use by 11 February 2011. In these proceedings a further application for relief from forfeiture was made which was dismissed by a District Judge, whose decision was upheld on appeal by a Circuit Judge. The application in effect sought an extension for the time given to cease the offending use from 11 February until 31 May 2011.

The District Judge first decided that the interim stay of execution merely prevented the enforcement of the order for possession and did not extend the time for compliance with the order for relief from forfeiture. He recognised that he had jurisdiction to make another order for relief from forfeiture, but decided not to exercise this in favour of the lessee. This refusal to grant further relief was upheld by a Circuit Judge, but was overturned by the Court of Appeal, which held that the District Judge had gone wrong in considering how to exercise his discretionary jurisdiction and, in the exercise of its own discretion, made an order for relief from forfeiture on terms as to payment of costs and the reimbursement of other expenditure by the lessor.

In short, the District Judge was held to have erred because he found that the lessee had made a “deliberate decision” to continue its use after 11 February 2011, whereas the Court of Appeal considered that, although the interim stay which had been granted was inadequate for the lessees’ intended purpose, the continuation of the use until the appeal was dismissed on 31 May 2011 should not in the circumstances be treated as “deliberate in the sense of a conscious disregard of the terms upon which relief was granted” (Patten LJ at para.38). In taking this view of the lessees’ conduct, the District Judge had also erred in giving the value of the “windfall” that the lessor would gather if relief was refused “little weight” in the circumstances and in failing to take proper account of the fact that the use had immediately ceased following the dismissal of the appeal on 31 May 2011.

It is notable that the Court of Appeal did not attach much importance to the fact that it was considering the third application for relief made by the lessees (see Patten LJ at para.42). Rather, it concentrated on the effect, if any, of the continuation of the use from 11 February 2011 to 31 May 2011 (see Patten LJ at para.52), thereby taking a narrow rather than a broad view of the history of the case. The lessees had acted on legal advice relating to the effect of the stay, and this was not unreasonable; in the circumstances, “it would be disproportionate and, to put it bluntly, unjust for the defendants to be deprived of their property for a legal error of this kind” (Patten LJ at para.52).

This decision obviously depends on the unusual facts, but it suggests that, notwithstanding a lengthy history of breach of covenant, relief may be granted if eventually the breach is remedied and ceases (see Patten LJ at para.51). However, the decision should not be interpreted as meaning that history can always be ignored, so that in other circumstances the District Judge might have been justified in refusing the third application for relief, notwithstanding the windfall effect (see Patten LJ at para. 41):

“What the District Judge is, I think, saying… is that the weight to be given to the windfall factor is diminished by the fact that this is the third attempt by the defendants to vary the terms upon which relief from forfeiture has been granted. As a standalone proposition it is obviously right that considerations which would normally weigh quite heavily in the balance in favour of the grant of relief may be given much less weight when considered in relation to persistent failures by a tenant to satisfy the conditions which the court has imposed…If therefore the defendants’ conduct in this case had amounted to a conscious disregard of the terms for relief which the court imposed then it would be much more difficult to argue that the refusal of further relief was wrong in principle even though it would produce a windfall for the landlord. The balance to be struck will obviously depend on the relevant circumstances.”

Patten LJ also made some important general observations relating to the grant of relief from forfeiture at para.50:

“The starting point for the exercise of our discretion has to be to remind ourselves that the purpose of the reservation of a right of re-entry in the event of unpaid rent or a breach of covenant is to provide the landlord with some security for the performance of the tenant’s covenants. The risk of forfeiture is not intended to operate as an additional penalty for breach. It is an ultimate sanction designed to protect the landlord’s reversion from continuing breaches of covenant which remain unremedied and to secure performance of the covenants: see Shiloh Spinners Ltd v. Harding [1973] AC 691 at p.723. There may, of course, be breaches which are so serious and irremediable as to justify the refusal of relief: for example, an unlawful sub-letting. But in most cases relief will be granted on the breach being remedied and on terms as to costs.”

Patten LJ’s reference to unlawful sub-letting in this context is interesting and perhaps also surprising. A breach of covenant by unlawful sub-letting is indeed in law correctly categorised as an “irremediable” breach but it may or may not be serious in its context; in any event it can potentially be put right for practical purposes by bringing the sub-letting to an end. As it happened, the second case which came before the Court of Appeal (in which reference was made to Magnic) concerned relief from forfeiture in the case of a deliberate unlawful sub-letting.

Freifeld

In Freifeld v West Kensington Court Limited [2015] EWCA Civ. 806, there was a lease of a number of commercial units, subject to a covenant not to sub-let any part without the lessor’s consent (not to be unreasonably withheld). One of the units was sub-let and used as a Chinese restaurant which was the subject of complaints by the lessor about nuisance and annoyance caused by its operation to its residential lessees. In breach of covenant, the lessees granted a further sub-lease of the relevant unit to the sub-lessee (referred to as “the Future Lease”) without seeking or obtaining consent and this was found by the trial judge to be a deliberate breach. Relief from forfeiture was refused by the judge.

Shortly after judgment had been given, the lessees procured the surrender of the Future Lease and sought relief from forfeiture on a new basis, namely on condition that they should be given six months within which to complete the sale and assignment of the lease, failing which it would be surrendered. It was submitted that the order for forfeiture was unjust, in that the lessor thereby gained a windfall worth £1 million or more. The judge again refused relief; he was concerned about the windfall, but held that it was very difficult to find any injustice when a party had acted as the lessees had done. He observed that following the forfeiture, the lease only had a “hope value”, based on the hope that relief would be granted.

The Court of Appeal found that the judge had misdirected himself and, exercising its own discretion, granted relief from forfeiture on terms enabling an assignment of the lease within six months, subject to payment of sums due to the lessor out of the proceeds of sale. Arden LJ made the following points:

(i) Relief can still be granted even though a breach of covenant is deliberate. There is no need to show special or exceptional circumstances in order to justify the grant of relief (paras.40-41).

(ii) The value of the leasehold interest is a relevant consideration: “the exercise of the court’s wide discretion should not enable the landlord to take advantage of a breach by which he is not irreparably damaged” (para.43). Reference was here made to the judgment of Patten LJ in Magnic at para.50, quoted above, although this was followed by reference to his judgment at para.41, quoted above, to show that the windfall effect is not conclusive (para.44).

(iii) In the circumstances, the judge had been right to refuse the first application for relief from forfeiture. He was right to make findings about the wilfulness of the breach and to take these into account. “It would not without some security that the future would be different be fair to grant relief and restore the parties to their previous contractual relationship. There can be no such guarantee here since the [lessees] may lapse back into their old ways” (para.45).

(iv) However, the judge had failed to consider the second application properly, without weighing the value of the windfall against the lessees’ conduct, and had been wrong to treat the lease as a “flawed asset” because of the forfeiture, because it was not flawed if relief was granted:

“He did not consider the possibility that there should be no forfeiture if the leasehold could be sold on suitable conditions. If he had done this, he would
have seen that there was a way of squaring the circle between the lessor’s right to enforce its right of re-entry and the lessees’ right not to be required to give the lessor some uncovenanted benefit” (para.48 and also paras. 49-50).

Briggs LJ agreed that the judge had erred and concluded as follows (paras.67-68):

“Relief on the terms proposed [by Arden LJ] fully serves the dual purposes of ensuring that [the lessor] will no longer be prejudiced by [the lessees’] misconduct as tenants, and that the value of the leasehold interest will not unnecessarily be transferred to [the lessor]. The right of re-entry will therefore provide effective security without excessively penal consequences.

This conclusion should not be misinterpreted as conferring carte blanche on tenants to disregard their covenants, wherever there is value in their leasehold  interest which would be lost by an unrelieved forfeiture. In every case a balance will have to be struck, and there may well be cases where even substantial value has to be passed to the landlord if no other way of securing the performance of the tenants’ covenants can be found”.

Conclusion

These decisions of the Court of Appeal do not purport to change the law nor to lay down rigid guidelines. However, their application should lead to some alteration in the practice of the lower courts in dealing with applications for relief from forfeiture, particularly in “windfall” cases, in accordance with the following propositions.

(1) Forfeiture clauses in leases should not be treated as penal in nature. A bad lessee who has acted in deliberate breach of covenant is not to be punished by the loss of the lease if continuing damage to the lessor can be prevented by the grant of relief on appropriate terms.

(2) There is no objection in principle to multiple applications for relief from forfeiture, even in cases where there has been non-compliance with a consent order (as in Magnic). Decisions such as that of the Court of Appeal in Starside Properties v Mustapha [1974] 2 All ER 567, considered in Magnic, in which it was stated that “the court will scrutinise with particular care an application for further relief and will be more reluctant to grant it than in the case of a first application” (p.574) need to be applied having regard to the approach adopted in these recent decisions.

(3) Freifeld shows that relief can be obtained even in the case of a deliberate and serious  breach of covenant by an unlawful subletting, following an initial refusal of relief. The lessee could retain the value of the lease provided it was realised promptly.

(4) The value of any “windfall” to the lessor must always be taken into account and weighed properly in the balance. Following these recent decisions, it is unlikely that a lessor will be allowed to gather the windfall, unless the lessee is for some reason unable or unwilling to provide a method for effectively securing the performance of his covenants in the future. The purpose of the forfeiture clause is to provide security rather than an “uncovenanted benefit” or windfall.

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