Lease assignments to guarantors have been confirmed to be void
Back in the days of 25 year tenancies of commercial property, it was very difficult for former tenants to escape liability for the lessee’s obligations in the lease. Even if they assigned their leases to new tenants the original tenant would remain liability under a legal doctrine known as “privity of contract”, which would continue to exist between the original parties to the contractual lease. This led to chains of guarantees being formed as leases changed hands to protect former tenants but sometimes businesses would find themselves facing huge bills in relation to premises they vacated decades before.
The Landlord and Tenant (Covenants) Act 1995 (LT(C)A) was intended to address this perceived injustice. The LT(C)A effectively removed the harsher consequences of privity of contract with regards to leases entered into after 1 January 1996. Upon an assignment of such a tenancy, which complies with the terms of lease and is, therefore, a lawful assignment, the outgoing tenant is to be released from liability, with one major exception. As a compromise to appease property investors, landlords were allowed to require an outgoing tenant to guarantee the performance of the lease by its direct assignee and only that first assignee. These guarantees are called authorised guarantee agreements or AGAs.
Landlords concerned about the financial strength of a corporate tenant often require that another party, such as a more established parent company, guarantee the tenant’s obligations. The release of liability on assignment under the LT(C)A extended to cover the guarantors of leases entered into after 1 January 1996. When a tenant assigns such a tenancy, the LT(C)A requires that the liability of its guarantor should terminate no later than the termination of the tenant’s liability.
Section 25(1) of the LT(C)A says that any agreement relating to a tenancy that would “exclude, modify or otherwise frustrate” the operation of any of its provisions is void.
An AGA from a weak assigning tenant is of little value to a landlord so the practice developed of asking any guarantor of the tenant to also enter into the AGA to extend its guarantee to cover the incoming assignee. Guarantors were often content to do this, particularly when leases were being transferred within a group of companies.
It, therefore, came as a surprise to many in the real estate market when the High Court cast doubt on this practice in the case of Good Harvest Partnership LLP v Centaur Services Limited. That decision was approved five years ago in K/S Victoria Street v House of Fraser (Stores Management) Ltd, in which the Court of Appeal confirmed that the guarantor of a tenant is released on a lawful assignment of a lease and cannot act as guarantor for the assignee either by way of an AGA or by entering into a new contractual guarantee, even if the guarantor is happy to do so.
The new decision
The High Court has now approved a suggestion made by Lord Neuberger in K/S Victoria Street that a tenant cannot assign a lease entered into after 1 January 1996 to its guarantor.
In EMI Group Limited v O&H Q1 Limited, a tenant had taken a commercial lease of premises at a market rent. Another company agreed to guarantee the tenant’s covenants. The tenant eventually got into financial difficulties and entered a formal administration procedure. The administrators of the tenant wished to assign the lease to the guarantor, which would help the guarantor deal with its continuing liabilities under the lease guarantee.
The landlord had given its consent to the assignment but that made no difference to the outcome of the case. This matter came before the Court because, the following the assignment, the guarantor said to the landlord that the lessee’s covenants in the lease could not be enforced against it. The guarantor cited K/S Victoria Street, in which the Court commented that because an assignment to a guarantor would result in that guarantor being liable for longer than the tenant such an assignment would be void under the LT(C)A.
The tenant argued that this meant that the lease was still assigned to the guarantor but the guarantor’s covenants were void. Mr Justice Morgan had made comments supporting this argument in a speech he gave to the Property Bar Association about one of his decisions in November 2015.
For the first time, the Court in EMI Group confirmed that the tenant could not assign to its guarantor. The judge rejected the tenant’s argument, holding that the lease remained with the tenant and the guarantor was still bound by the guarantee. As a result, the landlord could serve a notice on the guarantor under the terms of the guarantee requiring it to take up a new lease.
The new decision might clarify the law but on a practical level it is going to make moving assets around within a group of companies even harder.
Lord Neuberger’s comments appeared to close off one approach to sidestepping the effect of Good Harvest that had not been conclusively prohibited by the judgment – assigning a lease first to the tenant’s guarantor and then on to the third party assignee with an AGA from the guarantor. EMI Group has definitively barred that option.
Landlords also need to bear it in mind when considering applications for consent to assign leases – would any landlord still consent to the assignment of a lease to a tenant’s guarantor? The judgment also leaves uncertainty in relation to past transactions of this kind, which once were once quite common.
K/S Victoria Street was unpopular with many businesses and its application of the LT(C)A has been criticised as lacking commerciality and rationality. What is notable from this run of cases is the disregard of the intentions of commercial and professionally advised parties operating at arm’s length.
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