05 Dec Can we keep things on the side? A Review of the Side Letter and its use in Commercial Leases
The vagaries of these pandemic times have caused commercial tenants and landlords to renegotiate the terms of their leases. Landlords have been forced to weigh the loss of income and terminating the leases of tenants in arrears, against the uncertainty of locating a new tenant and the attendant costs. Some landlords are willing to make temporary concessions by varying the terms of their leases to reduce or suspend the rent. A side letter is a simple way to document the agreed changes to the lease, rather than a Deed of Variation. A Deed of Variation must be prepared by an Attorney-at-Law and is required to be stamped and registered at the land registry, which makes the side letter a more attractive option.
It is tempting to pursue the ease afforded by keeping things ‘on the side’. However, parties to side letters should exercise caution, as the letter may not be legally binding, or may expose them to risks that were not present in the lease.
Advantages of a side letter
A side letter is an agreement that is supplemental to the main contract. It is often used in real estate transactions to clarify, add to, or vary the terms of a lease. It is convenient to a landlord who wishes to tailor certain terms to meet the circumstances of each tenant, while preserving identical terms in the lease. In this way, a landlord may also have the benefit of confidentiality, as a side letter is not required to be registered and disclosed to the public, which may not always be the case with the lease.
Variations to a lease (at the time when the parties have already finalised the document) may result in the redrafting of several clauses, which can delay the completion and increase the costs of the transaction. Therefore, it may be easier, efficient and cost-effective to set out the changes in a side letter. Side letters are useful in real estate matters, as certain aspects of the negotiated terms between the original parties to the lease may not be intended for the successors/ subsequent owners of the property. These temporary arrangements may be appropriately recorded in a side letter.
Issues to keep in mind when pursuing a side letter:
Undoubtedly, there are significant benefits to keeping matters on the side. However, there are certain dangers with proceeding with a side letter.
- If you want a side letter to be enforceable you should ensure that it contains the basic elements of a contract. There must be an (i) offer which has been accepted, (ii) consideration (payment/benefit), (iii) certainty in the terms expressed and (iv) a clear intention to create legal obligations between the parties. In contracts for the sale of land, (v) the side letter must also be in writing and (vi) signed by or on behalf of all the parties to the contract. Although most of the criteria is straightforward, the elements of consideration and certainty can pose challenges to the enforceability of the letter.
- Consideration is not required to be a monetary payment. It will suffice if a benefit is exchanged, or a party has acted to his/ her detriment in reliance on the terms of the letter. Where the letter is used to amplify terms that are mutually beneficial to the parties, consideration may be established. In the absence of a benefit/ payment, the parties may opt to execute the letter as a deed. The letter must be signed in the presence of a witness and state that it is executed as a deed. In the case of a company, it is effectively signed by one director and a secretary, or two directors of the company in accordance with its by-laws.
- There must be a ‘sufficiently complete and certain agreement on all essential terms’ so that a court may interpret and give effect to them in the event of a dispute. In instances where the parties are unable to finalise all the terms, it may be appealing to agree to negotiate in good faith at a later stage. However, it should be noted that an agreement to negotiate is not enforceable where the parties fail to outline the machinery to resolve the dispute. Ambiguous terms may also result in an unenforceable contract.
- Care must be taken in the drafting of the letter, as legal obligations may be created where none were intended. Additionally, where the letter proposes to vary the lease, careful consideration is also required to ensure that parties do not unwittingly release obligations that are intended to survive for the duration of the lease.
- Most side letters are intended to create temporary obligations on the part of the tenant. However, tenants should review the letter to ensure that it is binding on the landlord’s successors-in-title, if the landlord sells the property.
- It has been determined by the court that in certain circumstances, a side letter may amount to an unenforceable penalty. This has occurred where a landlord stipulated that the concession to reduce the rent reserved in the lease would end if the tenant breached the terms of the side letter, or the lease. In this case, the tenant was late in making a payment of the instalment of the reduced rent. The landlord sought to terminate the concession and demanded payment of the higher rent reserved in the lease. In arriving at this decision, the court considered whether the sum demanded by the landlord as compensation for the tenant’s breach was exorbitant and unconscionable in the circumstances of the case.
Practical suggestions to consider:
- If the side letter is being exchanged at the same time with the lease, the lease should contain a reference to the side letter. If the side letter is finalised after the lease, it should be expressed to be supplemental to the lease.
- The issue of whether a side letter exists should be raised when purchasing an assignment (from a tenant) or a reversion (from a landlord) of a lease. The purchaser may request that the seller provide a warranty that no side letter exists.
- Permanent amendments to the lease should be finalised in a Deed of Variation.
- The duly authorised signatories of both parties should execute the letter to avoid questions regarding the authority of the person binding the landlord or the tenant to the agreement.
- Review both documents to determine whether there is consistency in the terms.
Notwithstanding the potential pitfalls associated with relying on a side letter, it is arguably a useful tool for landlords and tenants who wish to vary their leases on a strict deadline and can be worth the risk.
Disclaimer: This Document Provides General Guidance Only And Nothing In This Document Constitutes Legal Advice. Should You Require Specific Assistance, Please Contact Your Attorney-At-Law.
This Article was authored by Candice Jones-Simmons, Partner at M. Hamel-Smith & Co. Candice can be reached at firstname.lastname@example.org.