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.