Relief from forfeiture: Court of Appeal considers impact of a windfall on court's discretion

When a landlord discovers that its tenant has deliberately breached its lease covenants, it may consider that it has no option but to forfeit the lease. Given the draconian nature of the remedy, forfeiture is often contested by the tenant applying to the court for relief from forfeiture. A recent case has clarified how the court should balance the interests of both parties in seeking a fair outcome for all concerned.

The Court of Appeal in Freifeld v West Kensington Court Ltd [2015] EWCA Civ 806 considered whether a landlord should be allowed to gain a windfall from forfeiting a lease where it has significant value. The appellant court looked at how much weight a court should give such a factor when exercising its discretion on an application by a tenant for relief.

Facts of the case

The dispute concerned a mixed use block owned by West Kensington Court Ltd, which was subject to a headlease of the commercial units located on the ground floor (the “Head Lease”). No passing rent was payable under the Head Lease but rent was payable by the commercial under tenants to the head lessees, the Freifelds, meaning that the Head Lease had a significant value.

A dispute arose over the letting of one of the commercial units to a Chinese restaurant, which was the subject of numerous complaints about its practices by residential leaseholders (many of whom were also shareholders of West Kensington).

The alienation provision in the Head Lease allowed for underletting of part only, with the landlord’s consent (not to be unreasonably withheld). Although the landlord had given its consent to previous underleases, the Freifelds then granted a future underlease to the Chinese restaurant without the consent of the landlord.

When the landlord discovered this, it served a section 146 notice on the Freifelds. The landlord forfeited the Head Lease by counterclaim in the proceedings (as they were commenced by the Freifelds in respect of another commercial unit in the block) and in turn, the Freifelds applied for relief from forfeiture. The Freifelds argued that they should be entitled to relief; as otherwise, the landlord would get a windfall from the significant value in the Head Lease due to the commercial rents. When the court refused this initial application, the Freifelds brought a separate application seeking relief, this time on the condition that they be given six months to complete a sale and assignment of the Head Lease.

First instance decision

The Freifelds’ second application for relief was also refused at first instance. The judge considered the Freifelds’ breach to be wilful, finding that they were aware at the time of granting the future underlease that the landlord’s consent was required. The judge criticised their behaviour towards the landlord during the term of the Head Lease (and conduct during the course of the proceedings). Although accepting that the Court still had discretion to award relief even where the breach had been deliberate, in all the circumstances, the judge declined to exercise this discretion in the Freifelds’ favour.

The Court of Appeal decision

The Court of Appeal unanimously overturned the first instance decision and granted the relief sought, on the condition that the Head Lease must be assigned to a third party within 6 months of the date of the order (as initially proposed by the Freifelds in their second application for relief). The appellant court was essentially exercising the court’s discretion afresh and so was entitled to consider the further evidence of a surrender of the future lease and conditions proposed by the Freifelds. The appellant court considered that this result balanced the injustice of the landlord gaining a windfall against the need to protect its rights of re-entry and prevent the Freifelds from disregarding their covenants further.

The key points raised in the Court of Appeal’s judgment were as follows:

• The Court of Appeal held that the first instance judge was right to take into account the deliberateness of the Freifelds’ breach as part of his exercise of discretion. This did not, however, mean that the Freifelds needed to show special circumstances in order to convince the court to exercise its discretion (a task that the first instance judge described as ‘vertiginous’). Arden LJ found that the first instance judge should have also thrown into the balance the substantial value of the Head Lease, which he did not do.
• The fact the landlord would receive a windfall was a relevant consideration, but certainly should not have been regarded as a factor that would guarantee relief. There may well be instances where the value has to be passed to the landlord where there is no other way of securing the performance of the tenant’s covenants. Indeed, the fact a lease has value should incentivise the tenant to comply with its obligations.
• In this case, relief without conditions would not have been granted even though the breach had been remedied (as the Chinese restaurant agreed a surrender of the future lease prior to the final hearing), because of other, persistent breaches by the Freifelds.
• The Court of Appeal was conscious that granting relief from forfeiture was a matter for the court’s discretion and so did not want to curtail its ability to exercise its right in each case by setting out rules and guidelines to be followed.

Interestingly, the decision did not mention the impact on the other commercial sub-tenants, if relief from forfeiture was not granted. Usually, this will be another relevant factor for the court to consider when exercising its discretion, and will be looked at on a case by case basis.

Finding a middle ground

The Court of Appeal’s decision shows a willingness to be flexible when considering remedies for a breach of covenant, and should encourage parties to be more creative in their approach. Tenants should not presume that just because their lease has value, they will be protected from forfeiture. But, equally, landlords should be aware that a court may be reluctant to refuse relief if this would give them a significant windfall. This is particularly so if the breach complained of can be rectified (for example by an underlease being surrendered).

Forfeiture proceedings can become protracted and costly, particularly where fresh applications are made for relief, new conditions are proposed, or decisions appealed. Often, by taking a more cooperative approach at the outset, the parties may be able to find a middle ground themselves, avoiding the time, cost and risk of protracted litigation. Nevertheless, as in this case, litigation may ultimately be the only tool available to a landlord to bring an unruly tenant to the table.