Can a tenant assign leases to their guarantors?
Napthens - June 8th 2016
A recent High Court decision has clarified an important point of landlord and tenant law relating to ‘new leases’ (created after 1 January 1996).
The decision in EMI Group Ltd v O & H Q1 Ltd makes clear that a tenant cannot assign its lease to its guarantor. Any attempt to do so will be void and will result in the lease remaining vested in the tenant, and the guarantor continuing to be subject to their responsibilities as guarantor.
While the clarity is welcome, the decision does restrict the options open to tenants when restructuring a portfolio.
What does this mean for landlords and tenants?
- Tenants could consider the possibility of underletting to a guarantor (if the lease permits).
- Both landlords and tenants are advised to reviewtheir portfolios to identify any void assignment in light of this decision.
- Any new investments should be carefully investigated in order to identify any void assignments.
Background to the decision
The Landlord and Tenant (Covenants) Act 1995 (LTCA 1995) came into force on 1 January 1996 and significantly changed the law regarding landlord and tenant liability following an assignment of the tenancy.
The LTCA 1995 provides that where a tenant assigns (or transfers) a “new” lease:
- The binding tenant covenants of the tenancy pass to the assignee on assignment
- The assigning tenant is released from future liability under all the tenant convents of the tenancy from the assignment (except where the assignment is an excluded assignment)
- Where the assigning tenant is released from a tenant covenant by virtue of the LTCA 1995, then as from that release any guarantor of the tenant is released to the same extent
The LTCA 1995 also contains a general anti-avoidance provision.
There have been a number of significant, high profile cases that have considered these provisions of the LTCA 1995. These cases have clarified certain points but left uncertainty in some areas.
In K/S Victoria Street v House of Fraser (Stores Management) Ltd and others  EWCA Civ 904, the Court of Appeal considered whether a requirement for an assigning tenant’s guarantor to act as guarantor of the assignee was void under section 25(1) of the LTCA 1995. The court held that the requirement that an assigning tenant’s guarantor act as the assignee’s guarantor was void.
The court went on to consider some related issues, one of which was whether a tenant’s guarantor could take an assignment of the lease from the tenant, or whether this would be void because the effect was that the guarantor was not released to the same extent as the tenant. It was not necessary for the court to decide the issues, but it noted that the release of a guarantor under section 24 and the re-imposition of liability on the former guarantor as assignee created a possible conflict.
Facts of EMI Group Ltd v O&H Q1 Ltd
By a lease dated 26 September 1996, HMV UK Ltd (HMV) was granted a tenancy of premises in Worcester. The lease was a “new” tenancy under the LTCA 1995. By a deed of guarantee, also dated 26 September 1996, EMI Group Ltd (EMI) guaranteed HMV’s obligations under the lease.
On 15 January 2013, HMV went into administration.
On 28 November 2014, the landlord, O & H Q1 Ltd (OH), granted HMV licence to assign the lease to EMI. In the licence EMI covenanted with OH that after the assignment it would perform and observe the lease covenants for the remainder of the term. On the same day, HMV assigned the lease to EMI by a deed of assignment.
On 18 December 2014, EMI’s solicitors wrote to OH’s solicitors stating that although the lease assignment was valid, the tenant’s covenants in the lease were unenforceable against EMI. Reliance was place on Lord Neuberger’s obiter comment in paragraph 37 of the judgment in K/S Victoria Street.
EMI sought a declaration that the assignment operated to vest the lease in it and that by operation of law the tenant covenants in the lease were void and could not be enforced against it.
OH counterclaimed that notwithstanding that the lease was vested in EMI, the tenant covenants were enforceable, or in the alternative, that the purported assignment was void and of no effect so that the lease remained vested in HMV with EMI bound as guarantor.
Decision in EMI Group Ltd v O&H Ltd
The High Court held that under the LTCA 1995 a tenant may not assign its lease to its guarantor and any agreement that sought to give effect to such an arrangement was void under section 25(1) of the LTCA 1995 because it frustrated the purpose of the LTCA 1995.
The court accepted that the purpose of the LTCA 1995 was to ensure that there should be no resumption or renewal of liabilities by either tenant or guarantor. It means that where a tenant and the tenant’s guarantor are equally liable for the tenant’s covenants in the tenancy, then the guarantor could not reassume those same liabilities by the tenant assigning the lease to the guarantor.
The court held that the assignment was void and therefore did not take effect to vest the lease in the guarantor. The lease remained vested in the tenant and the guarantor remains bound as guarantor. The court firmly rejected the suggestion by the tenant that the assignment operated to vest the lease in the guarantor, but that the tenant covenants in the lease were void against the guarantor.
The High Court has ruled that it is unlawful for a landlord to require an assignee’s obligations to be guaranteed not only by the outgoing tenant under an authorised guarantee agreement, but also by the outgoing tenant’s guarantor. Any such guarantee is void and unenforceable.
Tenant Release on Assignment
The decision relates to the Landlord and Tenant (Covenants) Act 1995, which abolished the old rule that a tenant remained liable to pay the rent and comply with the tenant’s other lease obligations throughout the whole term of the lease, even after the lease has been assigned. The Act provides that for leases granted after 1995 the tenant is automatically released from liability once the lease is assigned. It also ensures that any guarantee of the tenant’s obligations will fall away when the tenant is released.
Authorised Guarantee Agreements
There is one exception to the blanket release of liability on assignment: the landlord may require the outgoing tenant to give an “authorised guarantee agreement” (commonly called an AGA) guaranteeing the liability of the assignee. The contents and extent of the AGA are strictly prescribed by the Act. They may not extend to the liability of anyone other than the first assignee or to any time after that assignee is released from the lease obligations.
The Outgoing Tenant’s Guarantor
However, the Act does not make clear whether the landlord may require the outgoing tenant’s guarantor also to back the obligations of the assignee. Commercially it is important that the landlord should be able to call on the guarantor to stand behind the AGA. The tenant could be a single purpose vehicle with no assets other than the lease, or a company which will cease trading once the lease is disposed of. The landlord might not have accepted the tenant unless a parent company or a couple of directors stood behind it.
The Form of the Guarantee
There are two ways in which the guarantee can be given. The first is a direct guarantee, where the guarantor joins in the AGA to guarantee the assignee’s obligations. That is what happened in the recent case. However it is more usual for the guarantor not to guarantee the assignee’s obligations directly, but instead to guarantee the assignor’s obligations under the AGA. This is sometimes described as a sub-guarantee and it is the way Dechert’s leases are drafted.
The High Court decided that a direct guarantee is not permitted and is unenforceable. The reason for the ruling is that the Act contains a wide anti-avoidance provision which declares an agreement void to the extent that it would frustrate the operation of any provision of the Act. The court decided that allowing a guarantor to guarantee the assignee’s obligations would frustrate the operation of the requirement that a guarantor’s obligations must end on an assignment.
The ruling does not affect sub-guarantees so they remain enforceable, however the judge commented that it is not by any means clear that they are permitted by the Act. Nevertheless it is believed that sub-guarantees are permitted because the provision which requires the guarantor to be released relates only to guarantees of obligations to be complied with by the current tenant, whereas a sub-guarantee relates to the obligations of the former tenant under the AGA. It can also be said that a sub-guarantee is not inconsistent with the policy behind the Act. It does not extend the guarantor’s liability beyond the date on which the tenant is released or make the guarantor responsible for the obligations of future tenants.
Implications of the Decision
It is likely that the landlord will appeal against the ruling but in the meantime the judgment has serious implications for landlords. The decision is not restricted to future transactions but applies also to existing arrangements. The outgoing tenant’s obligations under the AGA remain enforceable, but the guarantor’s liability under a direct guarantee cannot now be enforced. This is likely to have an adverse effect on the value of property where such a guarantee has been given. The decision may not be entirely good news for tenants either. If landlords become more wary of accepting weak tenants backed by substantial guarantors it may become harder for tenants to dispose of their leases.
One possibility is for the landlord to take an alternative form of security, such as a large rent deposit or a bank guarantee. But these will inevitably be limited in amount and so will not provide the same level of security as a parent company or personal guarantee. They will also be unattractive to tenants as they will require large amounts of capital to be tied up.
Another option is for the guarantee given on the assignment to be by a different party from the one that joined in the lease. This would not fall foul of the antiavoidance provision in the Act because the guarantor would not be covered by the wording which requires the lease guarantor to be released on assignment. A large organisation is likely to include more than one substantial company which could provide a guarantee but this route would probably not be possible for smaller tenants.
If the case is not quickly overturned on appeal, landlords may consider including in new leases a tenant’s obligation not only to enter into an AGA, but also to procure a guarantee of the AGA obligations by an entity acceptable to the landlord which has not also guaranteed the tenant’s lease obligations.