Lease Guarantee: When can you not rely on them?
The Landlord and Tenant (Covenants) Act 1995 (the “1995 Act”) provides in relation to leases made after 31 December 1995 for tenants and guarantors to be released from liability on assignment of the lease. Section 25 of the 1995 Act is an anti avoidance provision which seeks to prevent landlords defeating the intention of the 1995 Act by keeping tenants and guarantors on the hook following a lawful assignment.
In a judgement handed down on the 27 July 2011 by the Master of the Rolls, Lord Neuberger, in K/S Victoria Street v House of Fraser (Stores Management) Limited and Others (the “Victoria Case”) the Court of Appeal has confirmed and clarified the judgement in Good Harvest Partnership LLP v Centaur Services Limited in relation to the termination or avoidance of lease guarantees. The conclusions are well summarised by Lord Neuberger at paragraph 53 of his judgement:
“Reverting to the general effect of the 1995 Act on existing guarantors, our conclusion, as explained above, is that the effect of Sections 24 and 25 is that:
(i) An exisiting or contracting guarantor of a tenant cannot be validly required to commit himself in advance to guarantee the liability of a future assignee
(ii) Subject to (iii) and (iv) a guarantor of an assignor cannot validly guarantee the liability of the assignor’s assignee
(iii) Such a guarantor can validly do so by being a party to an AGA (an authorised guarantee agreement) which otherwise complies with Section 16 [of the 1995 Act] and
(iv) Such a guarantor can in any event validly guarantee the liability of an assignee on a further assignment”
What is the effect of the judgment
Generally, the Courts only interpret the law, they do not make new law. This means that existing lease and guarantee arrangements will be judged by reference to the Victoria case.
This decision, albeit that some of it is obiter dicta, has important consequences in the following circumstances:
1. in relation to the reliance that can be placed upon existing guarantees and, therefore, the value of some investment properties;
2. in considering the structuring of assignments of leases where guarantees are involved; and
3. in relation to the drafting of the alienation provisions of leases
What is not affected
1. Old Leases: i.e. in broad terms, leases made before the 1 January 1996.
2. Any lease which either is not supported by a guarantee or where the guarantor has not guaranteed any previous tenant of the lease (which will cover the majority of situations).
The value of existing guarantees
The capital value of investment property will normally depend on the strength of the covenant of the occupational tenants. The strength of that covenant will be evaluated by reference to the financial strength of the tenant and of any supporting guarantor, among other factors. If the supporting guarantee is void, then the value of the investment will be reduced.
There is no problem with a guarantee of the original tenant or where the assignee’s guarantor has not guaranteed the assignor. There will only be a problem where the current tenant has acquired his interest in the lease by assignment or transfer and where the guarantor of the assignor is also the guarantor of the assignee current tenant.
Where there is an investment property with post 1995 leases and tenants whose obligations are guaranteed, the landlord needs to establish whether the lease remains vested in the original tenant and, if it does not, whether the guarantor of a current tenant had also guaranteed the person who assigned the lease to the current tenant.
There are two situations where there will be a significant risk that this situation could have arisen.
First, where there have been intergroup assignments of the lease, it is common for the same group company to guarantee both the assignor and assignee companies. This is exactly what was intended to happen in the Victoria case.
In this case the guarantee of the assignee will be void even if the guarantor voluntarily agreed to guarantee the assignee.
Second where a guarantee has been provided by a bank for the assignor and is also to provide a guarantee for the assignee the guarantee of the assignee will be void..
Structuring assignments of post 1995 leases
The important thing is to remember that, where the tenant has a guarantor, then the same person or company cannot validly also stand as guarantor to the assignee.
If the alienation provisions of the lease so provide, and assuming that the landlord is entitled to require the assignor gives an AGA, the landlord may also be entitled to require that the assignor’s guarantor stands guarantor to the assignor’s obligations under the AGA so that it effectively guarantees the obligations of the assignee. Note that on a further assignment, the original assignor tenant and his guarantor will be automatically released but it is Lord Neuberger’s opinion (obiter) that there is nothing to prevent the assignor’s guarantor guaranteeing an assignee of the original assignee (see (iv) of paragraph 53 of Lord Neuberger’s judgment quoted above)
Note also that Lord Neuberger in his judgment (paragraph 50) very specifically left open the question of whether an absolute obligation in a lease on an assignor tenant to enter into an AGA was enforceable or whether, regardless of what the lease says, the obligation to enter into the AGA is always subject to the test of reasonableness.
Drafting the Leases
Which brings us to the lease drafting. The alienation provisions need to reflect the guidance on the operation of the 1995 Act provided by Lord Neuberger in his judgement. The provisions should now:
- Provide a requirement that the landlord’s consent to an assignment is required even where the assignment is between companies within the same group. Where no consent to an assignment is required, the landlord cannot require an AGA.
- Require that, on any proposed assignment an AGA is required from the assignor as a precondition to consent to the assignment.
- There should be an obligation on any guarantor in the guarantee to be a party to any AGA given by the guaranteed tenant on an assignment in order that the guarantor guarantees the assignor’s obligations under the AGA.