This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.
Most leases will contain a forfeiture provision. The rules around forfeiture are complex but, broadly speaking, the forfeiture right essentially allows a landlord to end the lease if the tenant is in breach of its obligations in the lease. The forfeiting of the lease also ends the interest of any mortgagee. This is clearly of concern to a lender where the lease is the valuable asset which has been charged (this will usually be where the lease is for a long term) as the mortgagee will not want to lose the security it has for the loan. There are a number of points a lender needs to consider if a lease they are charging contains a forfeiture right.
Claiming Relief from Forfeiture
If the landlord has exercised its right to forfeit the lease, the mortgagee still has a right to claim relief from forfeiture pursuant to section 146(4) of the Law of Property Act 1925. Where a court grants relief from forfeiture, the court will grant a new lease on terms which are to be decided by the court. There are a number of issues a mortgagee faces if it must rely on a right to relief from forfeiture under this provision:
a. any inferior interests which have been created by the borrower (likely to be income producing lettings) fall away and are not automatically reinstated (subject to statutory rights. The mortgagee may therefore have a situation where there may be no income until new lettings are completed which may not be on terms as favourable as the previous leases. This is likely to have an impact on the value of the asset;
b. there is no certainty that the court will grant relief; and
c. the mortgagee cannot be certain as to the terms of the new lease to be granted following a successful application for relief from forfeiture, although in practice the courts do tend to follow the same terms as the forfeited lease.
Although subject to the judge's discretion, a mortgagee may be able to obtain relief for breach of covenant (not being non-payment of rent) under section 146(2) of the Law of Property Act 1925 (instead of 146(4)). In these circumstances, the mortgagee takes the old lease (rather than being granted a new one) meaning that the inferior interests are reinstated. This is still not ideal from the mortgagee's perspective as it is relying on the judge's discretion.
Where the forfeiture trigger is non-payment of rent, the mortgagee is able to seek relief under section 138(2 or 9A and 9B) of the County Courts Act 1984 or section 38 of the Senior Courts Act 1981. If relief is obtained no new lease is granted meaning any inferior interests are reinstated.
The uncertainty around making a relief claim and the potential loss of income is therefore a big concern to lenders when assessing the risk around lending against a property.
Mortgagee Protection Clause
In order to mitigate the impact of the "standard" forfeiture clause, a mortgagee will want to see a mortgagee protection clause in any forfeiture provisions in the lease. Such a provision gives a mortgagee some comfort that the lease cannot simply be forfeited in the usual way without the opportunity for the mortgagee to remedy the breach to prevent the forfeiture.
A mortgagee protection clause will typically require the landlord to give notice to the mortgagee telling the mortgagee the landlord is intending to exercise its right to forfeit the lease due to a breach of the tenant's covenant and giving the mortgagee opportunity to remedy the breach. Usually the clause will be caveated so that the landlord need only comply with such obligations if it has been notified of the mortgagee's interest. It is therefore crucial that the mortgagee ensures the borrower tenant notifies the landlord of the mortgagee's interest once the charge has been created.
A well advised tenant will have negotiated a mortgagee protection clause into the lease with an eye on the future that the tenant (or its successors in title) may wish to charge the lease. Landlords do not generally offer mortgagee protection drafting when issuing the draft lease for negotiation. A tenant should also resist a right for the landlord to forfeit in the event of tenant insolvency as banks will usually not lend against a lease which contains this right.
Many leases, particularly older ones do not contain mortgagee protection clauses. A mortgagee may therefore require the borrower to agree a variation of the terms of the lease with the landlord to insert a mortgagee protection clause. This may have a cost implication if the landlord requires a fee to agree to the variation and will certainly have an impact on the timings of completing the charge.
If the lease does not contain a mortgagee protection clause and the landlord will not agree to vary the lease, the mortgagee will need to rely on its rights to claim relief from forfeiture.
Conclusion
The uncertainty around whether a mortgagee's claim for relief from forfeiture would be successful and the possible loss of any income yielding inferior interests makes forfeiture provisions in leases a very real problem for banks and in turn is likely to have a negative impact on any valuation carried out over the lease asset. At worst, it may mean that the leasehold interest held by the borrower cannot be lent against.
It is therefore crucial that tenants, when negotiating leases (particularly longer leases with a capital value), seek to include a mortgagee protection clause in the lease or, if taking an assignment of the lease, approach the landlord at that time in order to vary the lease.
