Sometimes, the law really is an ass

Recent developments in landlord and tenant law concerning the position of the outgoing tenant’s guarantor on the assignment of the lease can only be described as ‘bonkers’.  A few years ago, the Good Harvest and House of Fraser cases confirmed that a parent company could not guarantee both of its subsidiaries on an intra-group assignment.  Last month, in the EMI case, the High Court has confirmed that the assignment of a lease to the tenant’s guarantor is similarly void.

Happy anniversary

Twenty years ago, the law on landlord and tenant liability was fundamentally changed.  Before the Landlord and Tenant (Covenants) Act 1995 was enacted, the original tenant was liable throughout the term of the lease, no matter how many times the lease was subsequently assigned.  Every assignee similarly covenanted for the residue of the term remaining at the date of assignment, and guarantors were on the hook to the same extent as the tenant whom they guaranteed.

The net effect of this was that if the current tenant defaulted, the landlord could usually pursue anyone who had ever been involved with the lease as tenant and guarantor, even if they had parted with all interest in the lease many years before.

To remove the perceived unfairness to tenants and guarantors, for leases granted since 1 January 1996 each tenant is released from its liabilities under the lease when it parts with its interest by assigning the lease. Its guarantor receives an equivalent release.

To give the landlord some additional protection, the outgoing tenant may enter into an ‘authorised guarantee agreement’ (commonly known as an AGA) with the landlord, guaranteeing the performance of the next tenant.  However, the outgoing tenant can only guarantee their immediate assignee and so will drop out of the picture when the lease is next assigned.  Since this next assignment may not take place for many years (if at all), the risk of a long-forgotten lease coming back to haunt a former tenant many years later has not been completely eradicated.

So, what’s the problem?

The 1995 Act contains in section 25 an extremely wide anti-avoidance provision that renders void any attempt to circumvent the operation of the Act.

The courts have interpreted this as meaning that an outgoing tenant and its guarantor can have no liability under the lease following the assignment, since that would frustrate the complete release required by the Act.  The outgoing tenant’s liability under an AGA is acceptable, since this is expressly permitted by the Act, although the courts have been keen to stress that this is an isolated exception from an otherwise absolute prohibition.

In the House of Fraser case, Lord Neuberger suggested that it is also permissible for the outgoing tenant’s guarantor to guarantee the outgoing tenant’s liability under the AGA, thereby creating the mythical ‘guaranteed authorised guarantee agreement’, or GAGA.  This is eminently sensible, otherwise the landlord would be deprived of the guarantor’s covenant during the AGA period.  However, because this point was not critical to the decision in House of Fraser, his lordship’s comments are not strictly binding in future cases.

The law of unintended consequences

The concept that an outgoing tenant and its guarantor are owed a complete release and cannot have any liability under the lease following assignment does not sound obviously preposterous, but the implications of an overly-rigid interpretation of the 1995 Act can be quite alarming:

Repeat guarantees

While it is obviously right that a landlord should not be entitled to drive the proverbial coach and horses through the statutory scheme by compelling the outgoing tenant or its guarantor to directly guarantee an assignee with whom it has no connection (other than by way of AGA), the position is less clear-cut where the parties are related.

What is the objection to a parent company guaranteeing both assignor and assignee on the assignment of a lease between group companies, perhaps as part of a restructuring exercise? For years, tenants have told their landlords that they shouldn’t really care which particular subsidiary held the lease so long as successive tenants were all guaranteed by the parent company, but tenants may now struggle to restructure once they have played the ace card of the parent company guarantee.

Lord Neuberger acknowledged the harshness of this rule in House of Fraser, but was attracted by the certainty of an absolute prohibition on repeat guarantees.

Void assignments

The ruthless pursuit of the absolute release also means that the outgoing tenant and its guarantor cannot be the tenant after the assignment.  While this would not be a common situation (and if permitted could theoretically be used to circumvent the release mechanism of the Act), there are many scenarios where such an assignment may be desirable for genuine commercial reasons.

In the recent EMI case, the tenant of premises in Worcester was the well-known music retailer HMV, who became insolvent and went into administration in January 2013.  It was therefore perfectly sensible for the lease to be assigned to HMV’s guarantor, EMI.  A licence to assign was duly entered into in November 2014 and the assignment was completed on the same day.

EMI perhaps tried to be too clever.  Their solicitors wrote to the landlord’s solicitors three weeks after the assignment, alleging that the assignment of the lease to EMI was valid, but that the effect of the 1995 Act was that – as former guarantor – the landlord could not enforce the tenant covenants against them.  The landlord quite rightly dismissed EMI’s argument as the piffle it clearly was.  When EMI subsequently applied to court for a declaration, the landlord counterclaimed that EMI were either a fully-fledged tenant and therefore subject to the covenants in the lease, or alternatively that the assignment to EMI was a nullity.

Unfortunately, Miss Amanda Tipples QC (sitting as Deputy High Court Judge) adopted the approach that the assignment to EMI was void, leaving the lease vested in HMV and with EMI remaining liable as guarantor.  It is however important to appreciate that she felt constrained to follow Lord Neuberger’s dictum in House of Fraser, where his lordship had opined that this was the logical and inevitable outcome of the obsession for an absolute release.  So, while in such situations we would normally hope for an appeal to restore sanity, we already know the view of the most important judge in the country on this particular point.

It is a shame that the case did not instead come before Mr Justice Morgan, who has publicly expressed his contrary opinion that the assignment of a lease by a tenant to its guarantor does not necessarily offend the 1995 Act, taking the view that the guarantor is released from its liability as guarantor under the lease before assuming a fresh liability as tenant.

The implications of declaring an assignment void are even more extreme than declaring a repeat guarantee void, especially if the ineffectual assignment is only spotted many years after the event.  By this time, the lease may have been assigned several more times, subleases and mortgages may have been granted by subsequent ‘tenants’, alterations may have been made and monies paid.

If a previous assignment is declared void at that point, who is now the tenant?  Who has the right to occupation of the premises?  What about any alterations made or monies paid by those who later discover that they never held an interest in the property?  It is easy to imagine how difficulties will arise.

And it may not just be assignments to guarantors that are affected.  The same logic would presumably also invalidate the assignment from a sole tenant into joint names (and vice versa) and the assignment of partnership property to reflect changes in the partnership.

Shutting the stable door

Cases such as House of Fraser illustrate the problems that can be caused by lease clauses and other contractual arrangements that conflict with the court’s strict interpretation of the 1995 Act.  Those responsible for drafting new leases should obviously ensure that alienation clauses avoid, for example, relaxed group assignment regimes based around repeat parent company guarantees, but what about all those leases that are already in place?

Even in the vast majority of cases, where the lease itself is not at fault, it is incumbent upon landlords and tenants – and their professional advisers – to realise when an existing or a proposed assignment or guarantee is potentially void.  Cases such as Good Harvest and EMI demonstrate that these issues are not always spotted at the time of the assignment, but often at some later date when the landlord seeks to enforce and a clever or well-advised tenant or guarantor seeks to escape liability on a technicality.

It is impossible to know how many repeat guarantees have already been willingly given and accepted, nor how many void assignments have already taken place.  I wonder how many of these time bombs are patiently ticking away and how much havoc they will wreak when they ultimately explode.

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