Penal contractual terms that seek to impose exorbitant or unconscionable obligations are generally not worth the paper they are written on. The High Court found one such term unenforceable in the context of a side letter to a retail lease.

A tenant had taken a 15-year lease of shop premises at an initial rent of £110,000 a year, subject to upwards only rent reviews every five years. On the same day as the lease was executed, a side letter was signed whereby the landlord agreed to accept a reduced rent of £90,000 in the first year, rising to £100,000 in year five.

The letter also provided that the rent would be capped at £125,000 a year in the succeeding five years. The letter stated that the agreement was terminable by the landlord with immediate effect if the tenant breached any of its terms or conditions. In the event of termination, a term of the letter provided that rent would be payable in accordance with the lease as if the side agreement had never existed.

Following the first rent review, the landlord sought to increase the rent payable to £232,500 a year on the ground that rent had been paid late, which was a breach of the conditions in the side letter. The tenant launched proceedings in order to hold the landlord to the rent cap agreed in the side letter. In upholding the tenant’s arguments, the Court found that the term relating to termination of the agreement contained therein was unenforceable as a contractual penalty.

The term sought to impose a greater obligation on the tenant than that which was contained within the lease. Termination of the agreement at any time within the first ten years of the lease would have the effect that the tenant would be obliged to pay additional rent for all the preceding years as well as in the future.

The obligation to pay increased rent on termination was a blunt instrument that could give rise to the tenant suffering substantial and disproportionate financial detriment for a minor breach of covenant that caused no harm to the landlord’s interests. Notwithstanding the equality of bargaining power between the landlord and the tenant, the term was exorbitant and unconscionable in its potential effects. In the circumstances, the term was of no effect and the rent was capped in line with the other provisions of the side letter.