Certain business vertical need considerable commercial physical space to carry on business. Post outbreak of Covid 19, certiain business verticals can consider working remotely retaining minimal physical space to operate business. The fixed costs spent by businesses in commercial lease premises as one time improvement expenditures and monthly rent are critical and precious during present times. Managers and leaders in organizations would prefer to restrict unforseen termination before expiry of the Lease Deed by negotiating 'lock in clauses' to prevent Landlords from terminating lease after the economic situation improves and monthly rental benefits increase in the years to come. 

Entities seeking commercial lease to carry on business either enter into an Agreement to enter into a Lease or actually enter into a Lease Deed. Sometimes to avoid paying stamp duty and registration charges or for ther business reasons, Entities enter into 'Agreement to enter into Lease'and relying on the such Agreement such entities take possession to commence its interior work spending substantial monies to make the space available for occupation. There is clear distinction between the two. The former is a prequel to the actual lease agreement. The latter - the Lease Deed  is actually a conveyance. 

The distinction has been emphasized by Indian Courts in several decision.

Read Woodfall in Law of Landlord and Tenant (Volume I) 28th Edition, 1978, page 127

“A contract for lease is an agreement enforceable in law whereby one party agrees to grant another to take a lease. The expression contract for lease’ and ‘agreement for lease’ is considered to more definite and contains one of the many stipulations in a contract. But it is not really or actually a conveyance. It is a merely an agreement that a conveyance of lease shall be entered into at a future date."

Thus, the intensity and binding effect and interpretation of lock in clauses would vary depending on if it appears actually in a Lease Deed or an Agreement to enter into a Lease Deed.
 

There is standard practice to insert lock-in clauses in a Lease Deed. A clause will state that Lessor cannot terminate the lease agreement for a period of two years or three years. The economic logic is to protect lessee’s right to use the premises for a reasonable period of time after making lakhs of investment on the commercial premises tailoring it for a particular commercial or business use. The lock in clauses offers comfortable assurances but if any party breaches the clause and it is before the Courts to interpret such clauses the outcomes are culmination of several factors.

Situation “A”

Assume Entity A is taking a big franchise of an international brand, Entity “A” may pay Rs.20,00,000/- as security deposit but spend another Rs.20,00,000/- (26750 USD)  in carrying out internal structural improvements, changing the flooring, walls painting and carrying out electrical fittings and fixture to align with the business format, brand protocols and customer perception and experience. However after spending such a massive amount on internal improvement of the premises, if such Lessee is called upon to vacate the premises within the lock in period – one can assess the loss, cost of re-location and resources computed in terms of time and manpower deployment to set up the store to be an absolute waste.

The Indian Courts have taken a view on interpreting such a lock in clause. If the lock in clause binds the lessee/licensee to abide by the lock in period strictly, Courts have held they cannot be strictly enforced and lessees/licensee cannot be strictly compelled to continue in the premises well before the lock in period expires.
 

Situation “B”

Lessee pay a monthly rent of Rs.2,00,000/- to Lessor for a premises admeasuring 2000 square feet and there is a lock in period of three (3) years wherein both Parties cannot terminate the Lease Agreement. The Lessee decides to terminate the lease agreement after one (1) year.

The Courts have held ‘Lessor can possibly claim damages – from Lessee based on actual injury suffered by Lessor.’ Lessor (Owner of the Premise) cannot compel Lessee to pay rent for the entire duration of the lock in period which will be about 2 years at the rate of Rs.2,00,000/- which means Rs.24,00,000/- (Twenty Four Lakh Only).

Considerations if Landlord/lessor has spent a lot of capital and resources to modify / alter the premises fit to be used by Lessee at the time of handing over of the premises are also looked into. If Lessor/Owner of the Premises has spent Rs.10,00,000/- (Ten Lakhs) in modifying the premises to suit the needs of the Lessee and then Lessee decides to vacate before the lock in period this initial capital cost will be considered in computing damages that Lessee has to pay. Instances wherein Landlord may have installed a high capacity generator in the premises just to suit the enhanced electricity requirement and offer a backup just to support the Lessee’s business. However once the Lessee vacates the Lessor may not find a Lessee who can use the entire premises admeasuring 2000 square feet and who is in need of enhanced electric supply and back up. The investment made on the generator will not yield value and thus may be one of the considerations in computing damages. There may similar infrastructure cost that Lessor may have spent solely to make the premises available to Lessee which may be added while computing damages.  Such costs put together may not exceed Rs.14,00,000/- when compared to the rent payable for the remaining lock in period which is 24,00,000/-.

Situation C

Consider a Lease Agreement wherein the lock in period is for one year or 18 months applicable for both parties

Such shorter duration of one year or 18 months lock in period may seem reasonable as if there is termination before that Lessor may have to again spend on making the premises ready for the next lessees/tenants, spend on brokerage and carry out minimum expenditures on internal fittings and fixtures to make it available to the next tenants. Such shorter lock-in period was treated as reasonable period to avoid duplication of such expenditure, etc
However rigorous lock in clauses have been held to unenforceable and no injunctive relief can be sought to enforce such clauses.

Read Hon’ble Court’s decision in Silvermoon Construction Pvt. Ltd. v. South Asian Hospitality Services Pvt. Ltd.,

MANU/DE/4958/2012.

Situation D

The Lessor / Owner of Premises to pressurize the Lessee inserts a clause stating if there is breach of lock in clauses, the Lessee has to pay a penalty of Rs.25,00,000/- (33,400 USD) to Lessor. Are such pre-quantified damages enforceable?

Courts has in several decisions considered the different between ‘penalty’ and ‘genuine pre-estimate of damages’. Without going into legal technical discussions, Courts have held any amount which looks excessive and well over and above the actual loss the Lessor/Owner of Premise may suffer cannot be enforced by pre-quantifying the same in a lock in clause. The Claimant must produce genuine documents and evidence to prove that Claimant has indeed suffered losses to the tune of Rs.25,00,000/-. If the documentary evidence along with other standard practices and communications leads to the conclusion the Lessor /Owner of Premises has only suffered losses to the tune of Rs.10,00,000/- (13,000 USD) however an amount of Rs.25,00,000/- (33,400 USD) is mentioned in the lock in clauses of the lease agreement, then such clauses are not binding. Additionally, Lessor should not spend amounts which are not necessary.  Lessor further cannot claim from Lessees rent for the remaining lock in period. It is hard to believe that a premise admeasuring 2000 square feet in a good commercial building cannot be rented for the next 2 years because Lessee left the premises prematurely. There is a legal principle called ‘doctrine of unavoidable circumstance’ and ‘mitigation of damages’ based on which above statements are made.

Read Section 73 explanation of the Indian Contract Act 1878;

In the decision of Delhi High Court in the case of Manju Bagai vs M/S. Magpie Retail Ltd (2011) 105 SCL 55(Delhi) held that a person must take reasonable steps to minimize the loss and refrain from taking unreasonable steps which would increase the loss. Defence cannot be held liable to pay a loss which the claimant could have avoided or which arises due to the neglect and failure of the claimant to take such reasonable steps.

Damages is compensation for the wrong suffered by the claimant and the loss incurred by him but this is subject to the rule that the claimant must take reasonable steps to avoid their avoidable accumulation. It is difficult to accept that arguments that Lessor was unable to rent out the premises for the remaining months of lock-in-period which is three years despite the highly commercially viable location of the premises.

Further in lease disputes averments that losses were suffered due to decline in the rate of rent had to be specifically pleaded. The burden to furnish evidence and material rests on the Entity seeking to enforce the lock in clause.  There must be clear documents to prove that there was difficulty in such commercial premise to be rented out for the remaining duration of the lock in period. 

While answering the question whether to treat the amount of unpaid rent for unexpired lock-in period as debt or liquidated damage in the case of Tower Vision India Pvt. Ltd. vs Procall Private Limited, the court held that the following factors influenced the Court not to treat the amount of unexpired lock-in period as debt or liquidated damages:

1. Whether a particular clause about pre-determined liquidated damages represents genuine pre-estimate of damages or it is in the nature of penalty has to be judged in the facts of each case and in the background of relevant factors which are case specific.
2. To prove the amount mentioned is payable for the lock-in period is a genuine pre-estimate of damages, proper evidence is required of specific nature, namely, the landlord had altered the the premises to make it available to the Tenant depending on its own requirement, incurred expenditure on infrastructure specifically requested by Tenant, incurred certain other expenditure on painting, fixtures and fittings and the landlord was forced to incur such expenditure again before giving the premises to new tenant and, therefore, lock-in period was treated as reasonable period to avoid duplication of such expenditure, etc.
3. The doctrine of mitigation of damages may also apply in such cases and even if the tenant had committed breach by leaving the premises before the expiry of lock-in period, it was for the landlord to prove that he had taken reasonable steps to minimize the loss, but could not award the loss to the extent mentioned in the clause and, therefore, the same is to be treated as genuine pre-estimation of the loss.

Additionally amounts due by either Party assuming an amount is due and payable in breach of lock in clauses cannot be construed to be an ‘admitted debt’ while seeking action under Section 433 ( e) of the Companies Act, 1956. The matters require detailed appreciation of evidence which is possible to be undertaken by Trial Courts. Thus, approaching Courts as a creditor through a winding up action may not be best remedy to seek recovery of such amounts.

The parameters to enforce lock in clauses in a lease agreement are well laid down by Courts in India. However in a Commercial Complex of an A grade builder wherein most of facilities and infrastructure is inbuilt and in a commercial space owned by a an Individual or a business family wherein investments are being made to make the premises ready to be occupied by the Lessee - the way such clauses are enforced would vary. It would also vary from sector to sector and industry to industry.