England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
MR JUSTICE LEWISON

[2006] EWHC 1008 (Ch)

		Royal Courts of Justice Strand, London, WC2A 2LL
		24th January 2007

Lord Justice Lloyd:

1. This is an appeal against an order of Lewison J made on 28 April 2006 declaring that two leases had come to an end pursuant to the exercise of a break clause at the option of the Defendant tenant. The judge's decision was based on the effect of a separate written agreement between the parties and involved construing that agreement as including an implied term going beyond the effect of its express terms.
2. There are two leases of separate and adjacent premises at the Heathrow International Trading Estate, Green Lane, Hounslow, between the Claimant as landlord and the Defendant as tenant, but it is common ground that they were in materially identical terms and we have seen only one of them. The leases were dated 18 January 2001 and granted terms of ten years from that date at a rent, after an initial rent free period, of some £345,000 in aggregate between the two leases. The lease contained normal tenant's covenants, including provision for repair and redecoration, in clauses 3.3 and 3.4, and provision for the landlord to be able to enter the premises and give notice requiring the tenant to do repairs, and if they were not done then to do them at its expense, in clause 3.24. Clause 3.9 dealt with alterations and additions and precluded the tenant from making certain kinds of addition or alteration to the premises. Clause 3.9.5 entitled the landlord to require the tenant at the expiration of the tenancy to reinstate and make good the demised premises if there had been any addition or alteration to the premises not prohibited by clause 3.9.1, so as to reverse the effect of that addition or alteration. Clause 3.39 was a covenant by the tenant to yield up the premises (but not with trade and other tenant's fixtures) with vacant possession at the end of the term in good and substantial repair and condition and in accordance with the covenants in that respect.
3. The break clause is clause 6.10, as follows:-

"6.10 Tenant's option to determine

6.10.1 The Tenant may determine this Lease on 30 December 2004 by giving to the Landlord not less than six months' prior written notice to that effect, if:

6.10.1.1 the Tenant has paid the yearly rent reserved by this Lease and substantially performed and observed the Tenant's material covenants up to the date of expiry of the notice; and

6.10.1.2 on the expiry of the notice the Tenant delivers up to the Landlord the whole of the Premises with vacant possession.

6.10.2 On the expiry of the notice and subject to the observance and performance of the conditions in clause 6.10.1, the Term will cease and terminate, but without prejudice to the rights and remedies of one party against the other in respect of any antecedent breach of covenant.

6.10.3 Time is of the essence as to all the dates and periods referred to in this clause 6.10."

The lease was excluded from the protection of Part II of the Landlord and Tenant Act 1954. It is not necessary to refer to any other provision in the lease.

4. The tenant served break notices under each lease under clause 6.10 on 12 June 2003, eighteen months or so ahead of the break date. The landlord responded by giving attention to the state and condition of the premises. On 17 December 2003, the landlord's solicitors sent a letter to the tenant enclosing schedules of dilapidations and wants of repair and reinstatement in respect of each lease. The items set out in the respective schedules included both matters covered by the repairing obligations, under clauses 3.3 and 3.4 of the lease, and also matters which would arise only under clause 3.9.5 by way of the reinstatement at the end of the lease of alterations or additions done by the tenant and not prohibited by the lease. In the letter enclosing the schedules, the landlord's solicitors asserted that the works of reinstatement and repair needed to be actioned by the tenant and that if they were not, the landlord reserved the right to make a claim for damages or, under clause 3.24 of the lease, to execute the works and reclaim the cost of those works. Those were points that the landlord was entitled to make, except in so far as works of reinstatement were concerned which the tenant was required to do before the end of the tenancy; clause 3.24 of the lease did not apply to those works.
5. The parties' respective surveyors entered into negotiations about the extent of the dilapidations and the monetary value to be assigned to the respective items. The landlord's original claim had been for a sum just over £178,000. It included substantial sums referable to reinstatement work under clause 3.9.5, and to six weeks' loss of rent. The basis of this latter item was that, if the tenant did not do the reinstatement work before the end of the term, the landlord would have to do it afterwards (because it could not require it to be done, or do it, under clause 3.24 of the lease) and time would be required for that which would delay the moment when the premises could be let to another tenant.
6. By the end of July 2004, the parties had agreed in principle on the sum of £172,000 as being the figure for settlement of the landlord's claim as set out in the schedules to which I have referred. The parties agreed that it would be sensible to record the then condition of the premises in a photographic schedule of condition which would define the state of the premises which the tenant would thereafter be obliged to maintain. The tenant's surveyors prepared such a schedule at an inspection on 24 August 2004 and it was signed on behalf of those surveyors and, by 9 September, on behalf of the landlord's surveyors. It is preceded by a brief narrative of which it is necessary to quote only paragraph 1.1, as follows:

"1.1 Our instructions were to prepare a Photographic Schedule of Condition on Unit 15, Units 16 and 17 Heathrow International Trading Estate, Green Lane, Hounslow. The schedule has been prepared as part of the full and final settlement of the Dilapidations Claims and Lease Breaks under the terms of the Leases for the respective Units as agreed under correspondence between the Landlord Legal and General Assurance Society Limited and the Tenant Expeditors International (UK) Limited."

7. The matter was then referred to the parties' solicitors who prepared an agreement which was in due course executed and dated 21 October 2004. It is called the Settlement Agreement and I will refer to it under that name. It has four recitals as follows:-

"BACKGROUND

A. This deed is supplemental to the Lease.

B. The Landlord has inspected the Premises.

C. The inspection has revealed that the Tenant is in breach of the covenants in the Lease relating to repair.

D. The parties have agreed to resolve this dispute on the terms set out in this Deed."

8. It has six operative clauses of which only two matter for present purposes, namely clauses 2 and 4. These were as follows:

"2. In consideration of £172,000 (exclusive of value added tax) paid by the Tenant to the Landlord and the Tenant's covenant in clause 4 the Landlord releases the Tenant absolutely from its liabilities, covenants and obligations past and present under the Lease so far as the same relate to the state and condition of the Premises."

"4. The Tenant covenants with the Landlord that it will keep the Premises in no worse a state and condition than they were in as at 24 August 2004 as evidenced by the schedule of condition prepared by Telling Associates and annexed to this Deed."

As indicated in clause 4, the agreed schedule of condition dated 24 August 2004 was annexed to the deed. The other clauses dealt with confidentiality, and what one might call lawyers' points about jurisdiction, choice of law and third parties.

9. The sum of £172,000 referred to in clause 2 was duly paid. The judge recorded, and it is not in dispute, that the basis on which that sum was calculated and agreed included provision for the reinstatement of alterations and the removal of fixtures and fittings which would be liabilities of the tenant only at the expiration of the lease under clause 3.9.5, and loss of rent which would arise only at that time.
10. The tenant started the process of vacating the premises in December 2004 but, as the judge held, had not completed that process by 30 December. If clause 6.10 of the lease had stood unaltered, the judge would have held that the break options had not been exercised effectively, because they were conditional on, among other things, vacant possession being given by 30 December 2004 and on the facts it was not. There is no challenge to that.
11. However, the judge decided the case in favour of the tenant on the basis that the effect of clause 6.10 had been modified by the operation of the Settlement Agreement. As it originally stood, clause 6.10 made the effect of the break notice conditional upon (a) payment of all rent falling due before 30 December 2004, (b) substantial performance and observance of the tenant's material covenants up to that date, and (c) delivery up of vacant possession on 30 December 2004. Time is of the essence under clause 6.10.3 and the conditional nature of the break exercise is clear from clause 6.10.1 and is underlined by clause 6.10.2.
12. It is common ground that, in general, conditions attached to a break clause, as with any other option provision, must be strictly complied with, so that even a day's delay in giving vacant possession or a shortfall in the payment of rent of a few pounds would be fatal. The use of a phrase such as "substantial performance" is designed to mitigate the strictness of that position: see Fitzroy House Hepworth Street (No 1) Limited v Financial Times Limited [2006] EWCA Civ 329. The justification for that is shown by Bairstow Eves (Securities) Limited v Ripley [1992] 2 EGLR 47, where the tenant had repainted premises recently but not, as required by the covenant, during the year up to the break date and this was held to be fatal.
13. Against the context of clause 6.10 as it stood, and the landlord's contention that the tenant was in substantial breach of its repairing obligations, it was plainly sensible for the parties to endeavour to agree both to what extent the tenant was in breach and what the consequences of that were, in financial terms. That process was undertaken by the parties' surveyors and then put into the form of the binding Settlement Agreement through solicitors.
14. The express terms of the Settlement Agreement achieve two things. First, they quantify the tenant's liabilities in respect of its obligations as regards the state and condition of the premises as at the date of the agreement and provide for the payment of £172,000 to be accepted in full settlement of those obligations. Secondly, for the future they replace the obligations in the leases as regards the state and condition of the premises with a more limited covenant in clause 4 to keep the premises in no worse a condition than that in which they were on 24 August 2004 as recorded in the schedule of condition.
15. If that were all that the Settlement Agreement did, clause 6.10 of the leases would still have required substantial compliance with all the material covenants in the lease up to 30 December and strict compliance with the obligation to give vacant possession by that date. Of course, the obligations in the lease as regards the state and condition of the premises had been released so no question could arise as regards compliance with those. I am inclined to agree with the judge that substantial compliance with the substituted obligation in clause 4 of the Settlement Agreement would not in any event have been a condition under clause 6.10, but that did not arise on the facts. There were, however, other continuing covenants which the tenant was required to go on performing. All rent due before 30 December 2004 had been paid by the date of the Settlement Agreement so no further question arose as to that aspect of clause 6.10.1.1. In practice no further sum fell due thereafter under the extended definition of rent such as insurance premiums or service charges.
16. The tenant contended however that the Settlement Agreement had a greater effect. It did not merely replace the obligations under the leases as regards the state and condition of the premises with a more limited obligation, together with the payment of the substantial sum of money, but it modified clause 6.10 so that the effect of the notices already served was no longer conditional on anything yet to be done by the tenant. In effect, the tenant argued, the Settlement Agreement removed from clause 6.10.1 all of the words after "to that effect" and it removed from clause 6.10.2 the words "and subject to the observance and performance of the conditions in clause 6.10.1", consequentially on the elimination of those conditions themselves. On that basis failure to give vacant possession on 30 December 2004 would still be a breach of covenant under clause 3.39, and remaining in possession thereafter would be a trespass giving rise to financial claims, but it would not prevent the break notices having effect to terminate the leases. Similarly, had there been a substantial breach of some other material covenant, for example the covenant not to assign or underlet, it would give rise to a claim for damages, preserved by the last words of clause 6.10.2, but would not prevent the leases from coming to an end.
17. The Settlement Agreement says nothing to this effect. It is strikingly concise and focussed on the obligations as regards the state and condition of the premises. On that basis the argument at trial that the agreement had a greater effect than that for which it provides expressly was placed, in the end, on implication from the terms of the agreement in the context of the admissible extrinsic material.
18. It seems to me that it was unfortunate that the course of the pleadings was such that the tenant's case on this had not been identified in those pleadings. The landlord sued for rent for 2005 on the footing that the leases were still subsisting. The tenant defended by reference to the break notices. In reply the landlord admitted the service of the notices and compliance with clause 6.10.1.1 in the light of the Settlement Agreement but denied that the tenant had complied with clause 6.10.1.2. In a rejoinder the tenant contended that "so far as it related to the state or condition of the premises the requirement of vacant possession imposed by clause 6.10 has been exonerated or waived by the claimant" by virtue of clauses 2 and 4 of the Settlement Agreement. That therefore appears to be an argument that the obligation to give vacant possession is an obligation under the lease which related to the state or condition of the premises and is released by clause 2 of the Settlement Agreement. The tenant's skeleton argument at trial confirmed this at paragraph 22(b)(iii)(2) where it is said that the release extended to clause 3.39 as well as to clauses 3.20 and 3.21. That is not the basis on which the judge decided the case and it seems to me an impossible contention. To argue that a compromise of the tenant's past and present obligations as regard the state and condition of the premises could affect its future obligation to yield up vacant possession of the premises on the expiration of the lease simply does not follow. Of course the reference in clause 3.39 to the state or condition of the premises had to be read in the light of the modification achieved by the settlement agreement, but the essential obligation to give vacant possession still stood. Clause 3.39 is not (save to that limited extent) an obligation as to the state or condition of the premises.
19. In the tenant's written note of its closing submissions at trial the point was put differently. It was said that the Settlement Agreement contained a term that the break notices were to take effect as being implicit in the settlement sum of £172,000 calculated on the basis that I have described, and as incorporated by reference to paragraph 1.1 of the schedule of condition with its reference to the scope of the settlement as extending to the break clauses.
20. In the light of that the judge referred to the tenant's argument at paragraph 24 of his judgment as being that, as an implied term of the Settlement Agreement, the landlord waived compliance with the remaining conditions as conditions of the exercise of the break option, so that the parties were to be taken to have agreed that the notices already served would bring the leases to an end without further action on the part of the tenant.
21. The judge said it was common ground between Counsel that the Settlement Agreement did modify the conditions attached to the break clause. Mr Fetherstonhaugh QC for the landlord before us would not accept that and clearly Mr Wood QC who appeared before the judge for the landlord was certainly not at first willing to accept that proposition. Since the question is one of construction, it seems to me that what matters is whether the break clause was affected by the Settlement Agreement, not whether Counsel accepted that it was, to any extent.
22. Going back to the judgment, at paragraph 27 the judge referred to the schedule of condition and its preamble as making clear that the agreement was intended to be a full and final settlement of the lease breaks and he posed the officious bystander test by reference to two features of the Settlement Agreement. One was the replacement of the tenant's repairing obligations by the limited obligation in clause 4 of the Settlement Agreement. He asked whether it could be supposed that this limited obligation could have been intended to endure potentially for some six years up to the contractual end of the term rather than only for a couple of months up to the break date. The second point was the proposition that the £172,000 included six weeks' loss of rent on the basis of the time that would be required for reinstatement and the question posed was whether the landlord could have been intended, if vacant possession was not given on the 30 December 2004, to have both that and the continuing rent. Both of those questions the judge answered in the negative, and he concluded at paragraph 29 as follows:

"I accept therefore Mr Dutton's primary submission that it was an implied term of the Settlement Agreement that the landlord waived the right to rely on the remaining conditions of the break clause in order to defeat the notices already served."

23. In the course of Counsel's submissions to us, reference was made to a number of letters and emails passing between the parties and their representatives from May 2004 onwards. Those letters do not constitute the actual agreement reached between the parties, which is the formal Settlement Agreement to which I have referred. They are part of the process of negotiation which led ultimately to the Settlement Agreement. Accordingly it seems to me that they are inadmissible, on well established principles, in considering the true construction and effect of the Settlement Agreement. Above all this is because they are irrelevant. They cannot help in the task of determining the effect of what eventually was agreed.
24. It is legitimate to consider the terms of paragraph 1.1 of the preamble to the schedule of condition itself since that forms part of the Settlement Agreement, at least physically. Mr Dutton based an elaborate submission on that paragraph, together with the preceding correspondence, in order to show that the eventual Settlement Agreement, incorporating this document, was intended to relate not only to the dilapidations claims but also to the lease breaks, that is to say to the effect of the notices given under clause 6.10. For my part it seems to me that that paragraph is of no assistance in seeking to determine the effect of the Settlement Agreement. The purpose of reference to the schedule of condition, as is apparent from clause 4 of the Settlement Agreement, was as a record of the condition of the premises on the 24 August 2004. By the date of the schedule, 24 August 2004, and even by the date in September when it was signed on behalf of the landlord's surveyors, the Settlement Agreement had not been come to and probably had not been even drafted. Accordingly, whatever the surveyors may have thought, at that date, would be agreed between the parties, what they said about it cannot cast any light on the meaning and effect of what eventually was agreed. The paragraph shows that it was or may have been contemplated in August 2004 that there would be an agreement by way of full and final settlement of the dilapidations claims and of the lease breaks under the terms of the leases but it does not show that any eventual agreement did have that effect. Moreover the reference "as agreed under correspondence" may well refer to no more than an agreement that the schedule should be prepared rather than that a full and final settlement had already been agreed. It is plain that no settlement had yet been agreed on a binding basis by that time. Nor does it seem to me that the incorporation of the document into the Settlement Agreement, for the purpose of identifying the state of the premises, has the effect that, by virtue of the terms of paragraph 1.1, the operative terms of the Settlement Agreement mean something other that they would if paragraph 1.1 were not physically part of the document. For those reasons it seems to me that that paragraph is of no assistance.
25. One thing that is admissible in construing the effect of the Settlement Agreement is the fact that the work for which the landlord claimed in its schedule of dilapidations, and for which substantial sums were allowed in the agreed sum, included not only ordinary dilapidations but also works of reinstatement under clauses 3.9.5, the liability to do which only arose on the termination of the lease. On that basis Mr Dutton submitted that the calculation itself assumed that the leases would come to an end and that the landlord cannot go back on that. Mr Fetherstonhaugh for the landlord accepted, contrary to the reference made in the landlord's solicitors' letter in December 2003, that the landlord could not require such reinstatement work to be done under clause 3.24 though it could require much of the subject matter of the schedule to be done under that clause.
26. The tenant's contention therefore, is that in the circumstances existing in October 2004 at the time when the Settlement Agreement was reached, the agreed sum, calculated as it had been, showed that the parties were proceeding on the basis that the landlord would recover possession so that the obligation under clause 3.9.5 would arise for performance and a future loss of rent would arise if the landlord chose to do the reinstatement, because of a delay before the landlord could re-let the premises.
27. It is clear that the parties were proceeding on the assumption that the break clause would have effect. It might have done in any event if the tenant had succeeded in giving vacant possession by 30 December. The question is whether the parties went further and, by the effect of their express agreement, agreed that the leases should come to an end leaving the consequences of, for example, failure to give vacant possession as merely a question of damages for the delay rather than as preventing the break notice having effect.
28. If the compensation sum had been limited to sums arising from the ordinary running obligations under the lease it seems to me that it would be impossible to say that the agreed provision for financial settlement showed that the leases were to come to an end in any event. However, I can see that, from the landlord's point of view, that would have been unsatisfactory, if the agreement had been phrased as it is, because the release would have put an end to the reinstatement obligations under clause 3.9.5 as well as to the obligations current during the term. That could have been avoided by a different technique, for example a twofold approach whereby there was an agreement on one sum payable in advance to settle the liability for ordinary dilapidations and as to another sum payable at the break date to settle liabilities which would only arise on termination, for example under clause 3.9.5. Together with appropriate express provisions, that could have made it clear that the second payment, and presumably also the giving of vacant possession, were still to be conditions of the effectiveness of the break clause.
29. Since no such elaborate and explicit formula was adopted, the question is as to the implicit effect of an agreement to settle liabilities as to the state and condition of the premises which included liabilities which would only arise on the termination of the lease. Mr Fetherstonhaugh's submission is that it had no effect on the conditionality of clause 6.10. He submits, rightly, that any question of the implication of terms into the Settlement Agreement, just as any question as to its true construction, has to be considered at the date of the agreement. At that date, he submitted, it remained to be seen whether vacant possession would be given, but there was no particular reason to suppose that the giving of vacant possession would be problematical, it being something entirely within the control of the tenant. Thus while the parties could and no doubt did contemplate and accept, and perhaps assumed, that the break clause would have effect, that would have been the result of the tenant complying with the requirements of clause 6.10. He submitted that nothing in the terms or the context of the agreement calls for a construction under which the landlord is to be taken as having given up the potential advantage of the conditionality of clause 6.10. The tenant was bound by the lease for the remaining six years or so of its term and could only avoid that effect by going through the hoops set up by clause 6.10.
30. The evidence was that the rental market in the area was weak so that the rent payable under the lease was higher than was available in the open market. Thus, both parties would have known that it was to the tenant's substantial advantage, and to the landlord's corresponding disadvantage, that the break clause should be brought into effect. In those circumstances, Mr Fetherstonhaugh submitted, it is by no means obvious nor even reasonable from the landlord's point of view to construe an agreement which relates to the state and condition of the premises as having an additional effect, without any further consideration, of binding the parties to the leases coming to an end on 30 December 2004, to the substantial disadvantage of the landlord if the tenant were not able to comply otherwise with the condition as to vacant possession.
31. Mr Fetherstonhaugh further submitted that the landlord could not be supposed to be willing to agree to waive the condition imposed by 6.10.1.1. To take two examples, he postulated that the premises might have been vandalised shortly before the break date or that the tenant might have sublet the premises after the 21 October and before the break date. In either of those cases, he submitted, to have waived the condition in 6.10.1.1 would put the landlord at a substantial disadvantage because it would be left with a financial claim for damages against the tenant which would need to be quantified, rather than being able to say that the tenant simply had to carry on paying rent under the lease, not having complied with the conditions required to operate the break clause. So far as the possibility of third party malicious damage to the premises is concerned it seems to me that that is a point which is in effect covered by the Settlement Agreement in any event because if the premises were in a substantially worse condition on 30 December 2004 than they had been on 24 August of that year, the tenant would be in breach of clause 4 of the Settlement Agreement but it would be difficult to say that clause 6.10.1.1 required material compliance with that new obligation, not being an obligation contained in the lease.
32. Leaving that aside, the point as to underletting is of a different character. As Mr Dutton pointed out, the underletting would have to be for a short term, whether fixed or periodic, because any underletting which necessarily lasted beyond 30 December 2004 would amount to an assignment and the subtenant, in effect an assignee, would have no greater security than the tenant itself and accordingly failure to give vacant possession on 30 December would be a breach of the obligations under the lease. The position on underletting is more complicated. The effect of the authorities is that the contractual subtenancy would cease to exist on the head tenancy coming to an end under the break clause, but that, assuming that the premises comprised in the subletting were occupied by the subtenant for the purposes of a business carried on by it, it would have the protection of Part II of the Landlord and Tenant Act 1954 and could therefore only be removed by following the procedures under that Act: PW & Co v. Milton Gate Investments Ltd (BT Property Ltd Part 20 Defendant) [2003] EWHC 1994 (Ch). In theory that could be a serious problem for the landlord in a situation of this kind. In practice, as it seems to me, it is somewhat fanciful to suggest that between 21 October 2004 and 30 December 2004 the tenant would do anything other than try to give vacant possession and to ensure that on 30 December the landlord would have vacant possession of the premises. Accordingly it seems to me that the judge was justified in not giving much weight to the point, to which he referred at paragraph 25 of his judgment, that a breach of the covenant not to underlet might cause the landlord a serious problem such that the landlord would have wanted to retain the conditionality of clause 6.10.1.1 in order to protect itself. In practice this was not a serious risk.
33. Mr Fetherstonhaugh's most cogent point seems to me to be, first, that the Settlement Agreement is short, to the point, professionally drafted and says nothing about clause 6.10 of the lease. Going on from there he says that, while at the date of the Settlement Agreement the parties no doubt expected that the break notices would have effect because the tenant would give vacant possession by the relevant date, that situation would be to the disadvantage of the landlord, for reasons already mentioned, and accordingly there is no good reason to suppose that the landlord would have been willing to convert that contemplation or expectation into a contractual provision to the effect that the leases would in any event come to an end on that date, regardless of whether vacant possession was given on time or not. As to the inclusion in the £172,000 of sums attributable to a liability under clause 3.9.5 of the lease, including loss of rent, he submitted that there is no reason why that should not have taken effect once and for all in any event even if the lease continued, contrary to expectation, beyond the end of the year. The effect of the Settlement Agreement was to release the reinstatement obligation, although he had a point which I confess I find less than convincing on the effect of the words in brackets in clause 3.39. In any event, the obligation being released for the future, if the break clause did not have effect and the lease therefore terminated in 2011, the effect of the Settlement Agreement was that the landlord would have had the consideration for the previous breaches of the ordinary repairing covenants and would have had consideration for the release of the reinstatement obligation. Thus in effect payments due from the tenant would have been crystallised and accelerated, including payment for loss of rent. It was not, he submitted, a case of duplication of payment or the receipt of a payment to which the landlord would not be entitled.
34. Mr Fetherstonhaugh pointed out that the judge had not, in the course of giving judgment, tested the implied terms contended for by reference to the well-known criteria for such implication. Although the judge was of course very familiar with such criteria, not least as author, he submitted that it could not be assumed that he had applied the approach set down in the relevant authorities. Moreover he contended that the judge had not offered any reasoned explanation for the answers he gave to the questions posed. In particular he had not in terms considered the position as at the date of the settlement agreement, nor from the landlord's point of view as a party at risk of being deprived of a valuable asset, namely the continuance of the tenant's covenants for the rest of the term. He pointed out that, when addressing the factual question whether the tenant had succeeded in giving vacant possession, the judge commented on the landlord's position, in paragraph 43, as follows:

"The landlord's stance is, I infer, based simply on a desire to defeat the exercise of a break and to continue to receive a rent of £344,000 a year in a weak market."

35. No doubt that was the landlord's position but, Mr Fetherstonhaugh argued, why should it not take that position? The tenant had a valuable advantage under the lease, being able to escape from its obligations early, and there is no particular reason why the exercise of that option should be made any easier than the terms of the lease have made it. There was no argument based on estoppel, by convention or otherwise, and therefore no contention that the landlord had led the tenant to believe that giving vacant possession was not still a condition of the operation of the break clause.
36. During submissions on the appeal there was some debate as to whether the tenant's case was really one of the implication of a contractual term or rather one of the construction of the settlement agreement. In Chapter 6 of his book, The Interpretation of Contracts (3^rd ed. 2004), the judge discusses implied terms and at pages 154-6 discusses to what extent the implication of terms is a process of interpretation, citing substantial support for that view in the cases. The fact remains that the express terms of the agreement do not do anything to clause 6.10 of the leases, so that to find that the agreement did go further and affect that clause of the leases involves the addition of a contractual term by implication from the express terms and the relevant surrounding circumstances.
37. The judge's approach, based on the officious bystander test (see Shirlaw v. Southern Foundries (1926) Ltd [1939] 2 KB 206, 227), was that the implied term as to waiver of the conditions represented the obvious but unexpressed intention of both parties. An alternative approach could have been that the implication was necessary to give business efficacy to the transaction. Mr Fetherstonhaugh reminded us that any case for implication has to be based on the implication being not just reasonable but necessary and, if it is said to be obvious, it must be clear that both parties would have agreed that it was obvious. Another factor on which he relied is the caution to be adopted before implying a term into a professionally drawn agreement which is apparently self-sufficient. In some of the cases this point is made in relation to a long and full agreement, but it seems to me that the point can be made just as forcefully in relation to a short agreement such as the settlement agreement in the present case, where the express terms seem to be complete in themselves, and the implication would give the agreement a further and wider effect. The judge, at page 158 of his textbook, recognises that there is a presumption against adding terms, which is the stronger where the contract is in writing and represents an apparently complete bargain between the parties. As authority for that, the decision of this court in Philips Electronique Grand Public SA v British Sky Broadcasting Ltd [1995] EMLR 472 is mentioned, which was also cited to us.
38. One essential part of the starting point is the effect of the express terms of the agreement. As mentioned, clause 2 contains a release of the tenant's "liabilities, covenants and obligations past and present under the Lease so far as the same relate to the state and condition of the Premises". That is replaced by the limited obligation in clause 4, to keep the premises in no worse a state than they were in on 24 August 2004. The release is not merely of past or present liabilities for breach of covenant. It had to operate for the future as well, since otherwise the tenant would have been in breach of the lease by not delivering the premises up in a better state than the position as recorded on 24 August. Evidently, clauses 3.3 and 3.4 were released. There was some debate before us as to whether clause 3.9, or any part of it, was also released. It seems to me that, especially taken with the knowledge that the agreed sum included payment in compromise of matters which could only have arisen under clause 3.9.5, the release must have extended to clause 3.9 as a whole. There was also some debate as to whether clause 3.24 survived the release. Mr Fetherstonhaugh submitted that, like clause 3.39, it remained in effect, but by reference only to the modified standard to which the premises had to be maintained. I see force in that submission, just as in the point that, had the lease continued and a rent review been called for, the assumption under clause 4.3.8 would have to be that the premises had been maintained to the modified standard in accordance with the settlement agreement. Mr Dutton submitted that clause 3.24 was released, along with all of clause 3.9 and part of clause 3.39.
39. More generally, he relied on the fact that the landlord's original claim in the schedule of dilapidations included matters which would only arise on termination of the lease (and which, therefore, might not arise in fact at the time of the schedule) and submitted that, given the basis of the sum agreed to be paid, it would be inconsistent with the whole basis of the agreement for clause 6.10.1.2 to remain as a condition of the exercise of the break clause. He suggested that the price agreed for the compromise was on the basis of certainty that the leases would come to an end, and that if that had remained uncertain there should have been a discount for the tenant. Conversely Mr Fetherstonhaugh submitted that if certainty was to be assured for the benefit of the tenant, in addition to the compromise of the tenant's liabilities, the landlord would have expected to receive a premium, rather than to allow a discount. These equal and opposite arguments as to the price seem to me to be of no assistance in themselves.
40. I prefer to assess the rival contentions by reference to the well-established criteria for the implication of contractual terms, considering the position as at 21 October 2004. The relevant surrounding circumstances were, first, the terms of the lease and the approach of the break date, secondly the fact that, if the tenant's obligations as regards the state and condition of the premises were settled as proposed, there would be no more for the tenant to do (in substance) in order to comply with the terms of the break clause other than to ensure that vacant possession was given by 30 December, a process entirely within the tenant's control, thirdly that the terms of the landlord's claim as regards the state of the premises, as agreed in substance by the tenant, included the proposition that additions and alterations had been made to the premises by the tenant which the landlord was entitled to require be removed at the end of the term (but not before), and that compensation was to be paid to the landlord in respect of those items as well as for ordinary breaches of the repairing obligations, including loss of rent to reflect the fact that the landlord could not require that work of removal to be done before the end of the lease. More generally, it was known that the tenant wanted to escape from the lease and that if the tenant was able to do so by using the break clause, the landlord would suffer a loss on reletting.
41. The express terms of the agreement do not themselves vary the lease, but they do change the tenant's obligations in respect of the state of the premises. It can certainly be said that the terms of clause 4 of the agreement are not such as one would expect to find as a long-term maintenance obligation in a lease. On the other hand it cannot be said that they could not be applied as the basis of such an obligation.
42. There is force in Mr Fetherstonhaugh's point that, though the agreement is short, it is internally consistent and free-standing, and appears deliberately to be limited to the single question of the tenant's obligations as regards the state and condition of the premises. It would have been easy to add a clause providing for clause 6.10 to be modified in the way that the judge has held it was modified. The implied addition of such a clause has to be justified on the basis of obviousness or of its inclusion being required to give the contract business efficacy. It might be thought odd to find an implied substantive contractual term, going beyond the effect of clauses 2 and 4, when all the other express terms of the agreement were incidental points most of which would only have been thought relevant by lawyers. On the basis on which the judge proceeded, it should have occurred to someone, as a much higher priority, to spell out the implied term which he regarded as obvious.
43. As it seems to me, both the argument from business efficacy and that from obviousness would be based on the same factors in the present case. Mr Dutton's best point is that, the financial settlement having dealt with obligations under clause 3.9.5, if the lease could continue after 30 December (because 6.10.1.2 remained a condition) then the relationship between the parties would be a rather odd one. The tenant's obligations as to the state of the premises would be defined by clause 4 of the agreement, not by the lease. The landlord would have had a financial settlement for work of reinstatement under clause 3.9.5 for work which it could not require to be done until the end of the lease in 2011, including loss of rent which would only be applicable if the reinstatement had not been done by 2011, and calculated at rates relevant in 2004 which would almost certainly be too low by 2011, though of course the acceleration was a benefit for the landlord.
44. Nevertheless, it does not seem to me that these odd features of the relationship after the break date, if the break clause was not validly operated, are such that the contract could not be said to have business efficacy without the proposed implication. The landlord would have been delighted, no doubt, to find that the leases had not been terminated, and that the rent remained payable. If the maintenance obligations were to survive after that date in a somewhat modified form, the landlord might well, it seems to me, have regarded with relative equanimity the limitation of its ability to claim for further dilapidations, and the elimination of further reinstatement, in 2011, by the 2004 agreement, taken with the advance payment of £172,000.
45. I therefore question whether the landlord, if asked by the officious bystander on 21 October 2004 what would happen if the tenant was unable to give vacant possession by 30 December 2004, would without hesitation have said that the break clause would nevertheless have had effect, leaving it to claim financial compensation alone for any delay in giving possession. That was not the question which the judge imagined as being put by the bystander. The cases on this point have recognised that much may depend on how the hypothetical question is formulated (see Lewison, Interpretation of Contracts, pages 166-7). As to the questions which he did postulate, the first is somewhat oddly phrased in referring to the possibility that the tenant might choose not to vacate. No-one would have thought it likely that the tenant would make that choice, but if it did, or if the contingency was put neutrally by reference to the lease continuing after 30 December 2004, whether by the tenant's choice or not, there seems to me to be no reason to suppose that the landlord would not have accepted it, with the advantage of a good rent outweighing any possible problems from the modified maintenance obligation. As to the second, about the duplication of the rent, it seems to me that the landlord's answer would have been that the rent was not to be paid twice, but rather that the tenant's obligation to pay not only for the reinstatement work but for the time that it would take to do that work was merely accelerated, if the break clause did not have effect.
46. For those reasons, therefore, it seems to me, with respect, that the judge was wrong to accept that clause 6.10 had been modified implicitly by the settlement agreement so as to cease to be conditional in any respect. In my judgment, if the proverbial bystander had asked, just before the agreement was to be signed, whether this meant that the break notices would have effect in any event, regardless of whether vacant possession was given by the break date, the tenant might have said yes, but there is no reason to suppose that the landlord would have done so. The landlord's position could well have been that the agreement affected nothing other than that which it dealt with expressly, and it remained necessary for the tenant to satisfy the remaining condition, as to vacant possession, there being no particular reason to suppose that it would not be able to satisfy it. In those circumstances, it seems to me that, while the parties no doubt assumed that the leases would come to an end, they did not by the settlement agreement contract that they should in any event. I would therefore allow the appeal.

Lord Justice Sedley

47. I am not at all sure, despite the way it has been argued, that this case is about an implied term in the material agreement. I think it is about the meaning and effect of its express terms. The distinction between the two things is in many respects chimaeral – see Lewison The Interpretation of Contracts (3^rd ed.), ch.6 – but not in all respects. The implication of a term sets a series of hurdles – obviousness, business efficacy, reasonableness, necessity – which are absent from the ordinary process of interpretation.
48. For example, the requirement found by the House of Lords to be part of the tenancy agreement in Liverpool City Council v Irwin [1977] AC 239 - that the lessor was to be responsible for repairing and lighting the common parts - could only be an implied term. It had to be spelt out and written in by the court. It was additional to, not part of, the express terms. In the phrase of Mason J in Codelfa Construction v State Rail Authority of NSW (1982) 149 CLR 337, 346, a term which should have been included had been omitted. None of this seems to me to describe what the judge found here. What he found, albeit describing it as an implied term, was that the meaning and effect of the express terms of the agreement were that the break notices were to take effect irrespective of the provisions of clause 6.10.1.2.
49. In this, with deference to the contrary view of Lord Justice Lloyd, I consider the judge was right.  The self-evident purpose of the Settlement Agreement was to draw a line under the parties' mutual rights and obligations at 30 December 2004 when the break notices were to take effect. To this end the agreement, anticipating the break, crystallised the tenant's outstanding liabilities and the landlord's entitlements. Its intrinsic assumption was that the right of possession was irrevocably set to expire on 30 December, so that any consequences of a failure to yield possession on that date would sound in damages for trespass but could not, as they otherwise would, constitute a breach of the condition in clause 6.10.1.2. This seems to me to have been the manifest intention of the parties – manifest in the sense that without it the principal purpose of the agreement would not be achieved. In the events which have happened the lessor's construction serves its interests; but on the same construction the agreement would have left it open to the lessee, for instance in a sharply rising market, to change its mind and simply stay put, rendering the break notices ineffective and frustrating any new letting the lessor might have agreed upon. Both sides, in my judgment, recognised and intended that the leases would come to an end on 30 December and were settling their intervening liabilities and rights. That the compromise might have turned out to have overlooked one party's material interests, for example if the premises were vandalised, is only one of many illustrations of the fallibility of prediction, without which contract lawyers would have very little work.

Sir Anthony Clarke, MR

50. I have read the judgments of Lloyd LJ and Sedley LJ in draft. Like Sedley LJ, I prefer the conclusion of the judge to that of Lloyd LJ, although I am not sure that I have reached that conclusion by quite the same route as Sedley LJ. It is not necessary for me to set out the facts in any detail because they are fully described by Lloyd LJ. The question is whether, on the true construction of the Settlement Agreement dated 21 October 2004 ("the Agreement") or by a term to be implied into it, the parties agreed that the Lease would come to an end on the expiry of the break notice served by the tenant on 12 June 2003; that is on 30 December 2004.
51. The answer to that question, whether as a matter of construction or implication, depends upon a consideration of the terms of the Agreement set in their factual matrix or surrounding circumstances. There is scope for debate as to what circumstances may legitimately be taken into account. I take a somewhat broader view of the circumstances to which it is permissible to have regard than Lloyd LJ. The conclusion that I have reached is that the judge was correct to hold that a term is to be implied into the Agreement that the Lease would come to an end on 30 December 2004, regardless of whether the tenant gave vacant possession to the landlord on or before that date. I am not persuaded by Mr Fetherstonhaugh's submission that the judge misapplied the principles applicable to the implication of terms into a contract.
52. The aspects of the correspondence between the parties which seem to me to be admissible and of assistance in determining the relevant question are these. On 17 December 2003 the landlord's solicitors wrote to the tenant enclosing a "Schedule of Dilapidations and Wants of Repair and Reinstatement in respect of the Property". Paragraph 2 of the letter stated:

"The works of reinstatement and repair now need to be actioned by you as tenant of the Property. If these works are not actioned our client reserves the right to make a claim for damages or (under clause 3.24 of the Lease) to execute such works and reclaim the costs of these works."

It is right to say, as Mr Fetherstonhaugh observed in his reply, that clause 3.24 does not give the landlord a right of entry in respect of works of reinstatement. The Schedule was entitled "Schedule of Dilapidations – Reinstatement".

53. On 28 May Mr Mullis, of the landlord's surveyors, wrote to Mr Telling, of the tenant's surveyors, in reply to Mr Telling's response to the Schedule of Dilapidations. Mr Mullis drew attention to the two conditions in clauses 6.10.1.1 and 6.10.1.2 of the Lease and added:

"Should a financial settlement be reached then the works will need to be undertaken by [the landlord] and they will be unable to market the property during this period. I have, therefore, included as part of the claim a contribution towards the rent during this period."

He concluded by saying that he was therefore willing to recommend the landlords to accept a total sum of £178,502.18 in lieu of the tenant undertaking the works.

54. In the passage just quoted Mr Mullis was explaining the figures for "loss of rent" in the Schedule, which amounted to a total of £39,826 in respect of six weeks' rent for the properties. That is about 22 per cent of the total claimed of £178,502.18. As can be seen from the letter, and as is apparent from the Schedule, the basis of the claim was that, if the parties were to reach a financial settlement of the landlord's claims it would follow that the tenant would not be discharging its obligations under the Lease but would simply be paying the landlord a lump sum. The landlord would then be left to carry out such work as it thought appropriate and would not be able to earn rent at the same time. It therefore argued that the settlement sum should include a figure for notional rent during the time it was estimated that it would take it to carry out the works.
55. It follows that the underlying basis of the landlord's claim was that the Lease would in fact come to an end on 30 December 2004 because there would be no sensible basis upon which the tenant could be expected to pay a sum agreed on the footing that a significant proportion of the amount paid would include notional rent after the Lease came to an end unless it did in fact come to an end. It is suggested that such an agreement makes sense, or can make sense, on the footing that, if the tenant did not give vacant possession on or before 30 December 2004, the settlement satisfied the landlord's claim for notional rent, not in January 2005, but at the end of the full term of the lease in January 2011. That does not seem to me to make any commercial sense at all and there is nothing in any of the materials which we have seen which supports it.
56. The Schedule also included the estimated cost of reinstatement, which, under clause 3.9.5, was only required of the tenant "at the expiration or sooner determination of the lease". In these circumstances, neither party could to my mind have supposed that the tenant would agree to pay a lump sum in the autumn of 2004 which included the estimated cost of reinstatement, unless the Lease was to come to an end in December. Again, it makes no sense for the parties to have agreed a lump sum in respect of the cost of reinstatement which might not be incurred until January 2011.
57. In any event, there followed negotiations between the parties and a settlement figure of £172,000 was agreed in principle. As can be seen, that was only slightly less than the landlord was claiming, so that there can be no doubt that it included both a significant (albeit notional) figure for the notional rent and something for the cost of reinstatement as well as the cost of repair. It was also agreed that the surveyors would agree what was called a "Photographic Schedule of Condition" of the properties. Accordingly, by agreement, Mr Telling carried out an inspection on 24 August 2004 and the Schedule was signed by both Mr Telling and Mr Mullis. The Schedule was in due course attached to and forms part of the Agreement.
58. The Agreement was drafted by the landlord's solicitors. Its express terms have been set out by Lloyd LJ. It is a short document. It contains four recitals, of which recital C states that the inspection has revealed that the tenant is in breach of the covenants in the Lease relating to repair and recital D states that the parties have agreed to resolve "this dispute". The Agreement does not expressly vary any of the terms of the Lease but, by Recital A, is said to be supplemental to it. The key express terms are clauses 2 and 4, which provide, so far as relevant:

"2. In consideration of £172,000 … paid by the Tenant to the Landlord and the Tenant's covenant in clause 4 the Landlord hereby releases the Tenant absolutely from its liabilities, covenants and obligations past and present under the Lease so far as the same relate to state and condition of the premises.

4. The Tenant covenants with the Landlord that it will keep the premises in no worse a state and condition than they were in as at 24 August 2004 as evidenced by the schedule of condition prepared by Telling Associates and annexed to this Deed."

59. The schedule referred to in clause 4 was of course the Schedule of Condition referred to above. Paragraph 1.1 has been quoted in full by Lloyd LJ. It includes this important statement:

"The Schedule has been prepared as part of the full and final settlement of the Dilapidations Claims and Lease Breaks under the terms of the Leases for the respective Units as agreed under correspondence between the Landlord … and the Tenant …"

This Schedule forms part of the Agreement and is thus a relevant and admissible document in any exercise of construction of the Agreement or in a determination of the question whether any and, if so what, term should be implied into the Agreement.

60. I do not share the view expressed by Lloyd LJ that the sentence just quoted from paragraph 1.1 of the Schedule is of no assistance in seeking to determine the effect of the Agreement. On the contrary, it seems to me that it underlines the fact that the parties were settling "the Dilapidations Claims and the Lease Breaks". The effect of the settlement was thus to be, firstly, that the agreed sum would be paid in settlement of all the claims which had been put forward, namely the claims for dilapidations and reinstatement, including the claim for notional rent, and, secondly, that the leases would come to an end; that is that there would in fact be a lease break on 30 December 2004. That, to my mind, is what was meant by a "settlement of the Dilapidation Claims and Lease Breaks" (my emphasis).
61. I appreciate that there was no final written agreement in the correspondence at the time that the Schedule came into existence but the paragraph was included in the Schedule attached to the Agreement and thus underlines the essence of the settlement, namely a lump sum payment in respect of the Landlord's claims and a determination of the lease. This is I think an important consideration in determining the question whether the judge was correct to imply a term into the contract.
62. The judge applied the officious bystander test. It is common ground that the test is to be applied when the relevant agreement is made. The judge posed two questions for the parties to answer. The first was: is it the case that the tenant can choose not to vacate but to remain in occupation for a further seven years without any obligation about the state and condition of the premises apart from the obligation to keep them in no worse condition than that in which they were in August 2004? The second was: do you realise that, although the landlord has been paid six weeks rent for all three units as part of the settlement agreement, if the tenant fails to give possession until the day after the break notice [expires] but gives possession on, say 31st December 2004, the landlord could have those six weeks rent twice?
63. The judge held that the parties would have answered "of course not" to both questions. He held that the parties would have said this. "We have agreed that the leases have come to an end as a result of the notices. That is why the tenant has agreed to pay the landlord a sum which has been calculated on that basis and which would not have been payable in any other circumstances."
64. There are of course a number of ways in which the test for the implication of a term into a contract can be put. In each case the test is one of necessity not reasonableness. Apart from the officious bystander test, the tests which have been posed include the following. The term must be necessary to give business efficacy to the contract: The Moorcock (1889) 14 PD 64; and the term must be necessary to make the contract work: Liverpool City Council v Irwin [1977] AC 239. It is in my opinion inconceivable that the judge did not have these various formulations in mind. Equally, there is in my opinion no reason to think that he did not have in mind the principle that there is a presumption against adding terms to a written agreement, which (as Lloyd LJ observes) is the stronger where the agreement is in writing and represents the apparently complete bargain between the parties.
65. The term implied by the judge does not in my opinion fail any of these tests. In order to give business efficacy to the Agreement or, to put it another way, to make the Agreement work, it is necessary to imply a term into the Agreement to the effect that the payment of the £172,000, which was made by the tenant, was made in settlement of the landlord's claims for repair, reinstatement and notional rent and of the parties' agreement that the Lease would come to an end on 30 December 2004.
66. This is not, to my mind, an example of the kind of case in which the whole Agreement is contained in the written contract. The landlord's case itself involves both unspoken variations of the Lease and the non-application of one of the conditions in clause 6.10. The Agreement does not expressly specify which clauses of the Lease were no longer to have effect in the future. Yet, for example, clauses 3.3 and 3.9.3 of the Lease cannot stand with clauses 2 and 4 of the Agreement. Clause 2 of the Agreement refers only to a release of past and present liabilities, covenants and obligations under the Lease. It does not expressly refer to the future. To my mind that is because it is obvious that the purpose of the Agreement was to reach a once and for all agreement and that the purpose of clause 4 was not to compare the state of the premises for the next seven years with their state on 24 August 2004 but to compare the state of the premises on that date with their state when the tenant gave them up on 30 December 2004.
67. More importantly for present purposes, there is no reference in the agreement to clause 6.10.1.1, which is not a liability, covenant or obligation of the tenant under the Lease. Yet clause 6.10.1.1 could surely not have had effect to defeat the operation of the break clause if there were a breach of the obligation in clause 3.39 to yield up the premises in good and substantial repair in accordance with clause 3.3, because clause 3.3 must (on any view) have been replaced by clauses 2 and 4 of the Agreement. Equally, to my mind, if there had been a deterioration of the premises between 21 October and 30 December 2004, caused by, say, vandals, clause 6.10.1.1 could not sensibly have had effect to defeat the break clause.
68. I see the force of the landlord's argument that it would have wished to retain the benefit of clause 6.10.1.2 because of the state of the market. However, the question is one of construction of or implication into, not the Lease, but the Agreement. That Agreement entitled to the landlord to receive money to which it would not have been entitled for some years if the Lease did not come to an end in December 2004. The landlord made its claim on the express basis that the Lease would in fact come to an end because it included the notional rent. The settlement was reached on that same basis, as the agreed figure and paragraph 1 of the Schedule which was incorporated into the Agreement make clear. The amount of £172,000 was thus expressly paid on that basis two months or so before 30 December 2004. In these circumstances, in order to give business efficacy to the Agreement, it is necessary to imply a term to the effect that the Lease would come to an end whether or not the tenant succeeded in giving vacant possession on or before 30 December. Any failure to do so would be a breach of clause 3.39 and entitle the landlord to appropriate compensation. Equally, if for any reason, the premises were in a worse state when handed over than they had been on 24 August 2004, the landlord could not rely upon clause 6.10.1.1 of the Lease to defeat the break clause but would be entitled to appropriate compensation for breach of the covenant in clause 4 of the Agreement.
69. For these reasons I would hold that the judge was right to imply an appropriate term and would dismiss the appeal. I have approached the appeal on the basis of implied term because that was what the judge did. Sedley LJ has reached the same conclusion by a process of construction, noting that the difference between the process of construction and that of implication is often (as he puts it) chimaeral. This may indeed be such a case.