In Zinc Cobham 1 Limited and others v. Adda Hotels and others1, the court has issued welcome guidance that an assignment by a tenant in breach of the terms of its lease can validly be reversed by a direct re-assignment to the tenant, with its obligations guaranteed by the tenant’s original guarantor.
What were the issues at stake?
The tenants in this case held several hotel leases. The tenants’ obligations in each lease were guaranteed by the parent company, Hilton Worldwide Inc. The tenants assigned the leases to £1 subsidiary companies within the same group as part of a group restructuring. Those assignments were unlawful as the landlords’ consent had not been obtained as required by the terms of the leases. The landlords and tenants wished to restore the original position, so that the leases would again be vested in the original tenants with guarantees from the original guarantors. The question was: how could this be achieved?
The stumbling block was the Landlord and Tenant (Covenants) Act 1995 (the 1995 Act). This:
- Provides that tenants and guarantors are released from liability under a lease on a lawful assignment of the lease to a new tenant, although the assignor can be asked to give a limited guarantee in the form of an “authorised guarantee agreement” (AGA) of the assignee’s liabilities in certain circumstances;
- Has broad anti-avoidance provisions which invalidate any term in a lease or related agreement that frustrates the aims of the 1995 Act, for example by limiting the release from liability.
The Court of Appeal’s decision in K/S Victoria Street v House of Fraser (Stores Management) Limited  caused consternation by stating that the anti-avoidance provisions invalidated any obligation in a lease that an outgoing tenant’s guarantor must re-assume liability by directly guaranteeing the assignee’s liability. It went on to say that the guarantee itself, if actually given, would also be invalid whether it was given pursuant to an obligation or freely offered. This was particularly bad news on intragroup assignments, as it was common practice for the parent company willingly to guarantee the liability of both the outgoing tenant and the assignee. However the Court did indicate that the guarantor could guarantee any AGA given by the outgoing tenant.
Against this background, the court was asked in Zinc Cobham whether lease obligations could be re-imposed on the original tenants and their guarantors by a re-assignment of the leases particularly given that, as the original assignments were unlawful for being in breach of the terms of the leases, the initial release from liability would not occur until the re-assignments took place.
- The landlords favoured a direct assignment back to the original tenants, with the original guarantors giving new guarantees of the tenants’ obligations.
- The tenants considered that that would not work under the 1995 Act and that a more indirect route would have to be adopted. This involved an initial assignment to another company, Newco, who would then assign back to the original tenants, again with a fresh guarantee given by the original guarantors. If this route were to be used the landlords required a formal commitment in advance from each party to ensure that all these steps were completed.
In a helpful and commercial judgment, Mr Justice Morgan decided that the straightforward approach of the landlords would succeed. He held that:
- A direct re-assignment to the original tenants would be valid. The release of the tenants under one provision of the 1995 Act did not preclude a re-assignment whereby they again became bound by the tenant covenants under another provision.
- A new guarantee given by the original guarantors would also be valid. The release of the guarantors followed by a new guarantee on the re-assignment to the tenants resulted in the guarantors being released “to the same extent” as the tenants - which is what the 1995 Act requires.
However Mr Justice Morgan was not persuaded by the tenants’ solution. In his view the proposed agreement requiring the tenants’ guarantors to commit themselves to giving another guarantee on a future assignment would not be valid.
Where are we now?
- There are numerous commercial situations where the parties to a lease may want to assign back to the previous tenant. It is now clear that this is a valid course of action from the perspective of the 1995 Act even where the initial assignment is in breach of the terms of the lease.
- A fresh guarantee given on that re-assignment by the original guarantor of the previous tenant is also valid.
- But a contractual agreement in advance by a tenant’s guarantor to guarantee an assignee’s obligations is invalid, whether it relates to the immediate or a later assignee.
- This supplements the guidance in Victoria Street that a tenant’s guarantor cannot give a valid guarantee of the liabilities the immediate assignee even if the guarantee is spontaneously and freely given.
- But it indicated that the guarantor can guarantee an AGA given by the outgoing tenant.
- A tenant’s guarantor can also guarantee the liabilities of a later assignee if that guarantee is freely given at the time of the later assignment.
The judge’s pragmatic approach in Zinc Cobham is a definite step in the right direction. But it is a shame that he could not go further. In Victoria Street, a tentative comment was made that it would “appear” that a tenant could not assign its lease to its guarantor because of the anti-avoidance provisions. Mr Justice Morgan questioned this, but was not required to determine the issue.
It is also to be hoped that it will not be too long before a court is in a position to take the next logical step and declare that a guarantee freely offered for commercial reasons by a guarantor in relation to both a tenant and an immediate assignee - as on an intragroup transfer - would be valid. That would be a big step indeed.