The minefield of surrenders and assignments

A lease can often be the most financially draining contract a company has hanging around its neck, which can be particularly burdensome when the tenant company is already facing financial distress. Administrators are regularly faced with the task of relieving the administration estate of an onerous, costly lease and often look either to surrender the lease, which requires the co-operation of the landlord, or assign the lease to a new, incoming tenant. An assignment could require the landlord’s consent and can often be riddled with a number of conditions.  The law on surrenders and assignments of leases has recently been clarified by the cases Padwick Properties Limited v Punj Lloyd Ltd andEMI Group Limited v O & H Q1 Limited, respectively.

These cases will be of interest to landlords, tenant companies and restructuring professionals alike, particularly when requiring clarity on the determination of a lease and, more importantly, the liabilities that accrue under the terms of such lease.

Padwick Properties Ltd v Punj Lloyd Ltd

A surrender of a lease cannot be achieved unilaterally and if a landlord chooses not to co-operate, this can leave tenant companies in a difficult position. For as long as the lease continues, the tenant company will be responsible for liabilities that continue to accrue under the lease. In such circumstances, the tenant company may seek to surrender the lease by operation of law. It is well-established at common law that a surrender by operation of law will occur when the unequivocal conduct of the parties to a lease is inconsistent with its continuation. As well as returning keys to the premises, it is clear that there must be some other act that demonstrates the landlord’s intention to resume possession. These principles were recently applied in Padwick Properties Limited v Punj Lloyd Ltd where the tenant went into administration. Two months into the administration, the administrators vacated the premises stating that the tenant ceased to have responsibility for the premises. A month later the administrators returned the keys saying that the premises were not being used and offering surrender for no payment.

The landlord took steps to secure the premises. A year on, the landlord marketed the premises through agents whose marketing particulars offered a long leasehold with vacant possession. After 6 weeks, the premises were removed from the market on legal advice.

It was held that the landlord’s actions did not amount to an acceptance that the lease was at an end. It will be of particular interest to insolvency practitioners to note that acceptance of the keys by the landlord did not indicate a surrender. The court held that one party has to hold the keys to prevent the absurd passing of the keys back and forth as the parties seek to avoid making any admissions. The court examined the behaviour of the administrators and the landlord and decided that the lease was not surrendered; the landlord was protecting its interests in the property and had told the administrators what action it was taking.

The case highlights the need for unequivocal conduct on the part of both parties for a surrender by operation of law to occur. A tenant cannot simply divest itself of a lease by walking away from the premises.

EMI Group Limited v O & H Q1 Limited

This is the latest case to be decided under the Landlord and Tenant (Covenants) Act 1995 (“the Act”). The facts were that HMV UK Ltd (“HMV”) was granted a new tenancy in September 1996 and by a simultaneous deed of guarantee EMI Group Ltd (“EMI”) guaranteed HMV’s obligations under the lease. In January 2013, HMV went into administration. In November 2014, the landlord, O & H Q1 Ltd (“OH”), granted HMV a 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. HMV then assigned the lease to EMI by deed. Also on that day an underlease was granted by EMI to a new company, HMV Retail Ltd, who took occupation of the premises.

EMI sought a declaration, in reliance on Lord Neuberger’s obiter comment in the judgment in K/S Victoria Street v House of Fraser (Stores Management) Limited [2011], that the assignment vested the lease in it but that by operation of law the tenant covenants in the lease were void and could not be enforced against it.

The K/S Victoria Street reasoning was applied and it was held that a tenant cannot assign to its guarantor as such assignment is void for breaching the anti-avoidance provisions of the Act. The effect of this is that the assignor remains the tenant and the guarantor continues to guarantee the tenant’s obligations – both HMV and EMI remaining on the hook in this case.

The case will make already wary landlords particularly sceptical of corporate restructurings and highlights the need for outgoing tenants seeking to bring their liabilities to an end properly to consider a suitable assignee. Further, any incoming tenant will need to satisfy itself that they are not walking into a new tenancy that has previously been assigned to a party which previously guaranteed the assigning tenant, making the validity of their subsequent occupation uncertain.