EMI Group Limited v. O&H Q1 Limited

Like a Scandinavian drama, the AGA GAGA SAGA is compelling, dark, protracted and engaging. With each new episode there is an exciting twist as new characters contribute to the plot and the viewers try and work out what it all means.

In box set terms, the AGA GAGA SAGA has been running for five seasons – Good Harvest v. Centaur appearing in season 1 way back in 2010, K/S Victoria v. House of Fraser following in the Court of Appeal in 2012, Tindall Cobham v. Adda Hotels in the Court of Appeal in 2014 and UK Leasing Brighton v. Topland Neptune in the High Court in 2015.

The latest instalment of the popular drama is EMI Group Limited v. O&H Q1 Limited [2016] EWHC 529. In this episode the heroine of the story (Miss Amanda Tipples QC) has to make a difficult choice to determine whether the Landlord and Tenant Covenants Act 1995 (the Act) prevents an assignor's guarantor becoming the assignee of the lease.

She then has a further dilemma to grapple, if the arrangement is prevented by the Act, whether the assignment is void or just the tenant covenants in the lease.

Is the assignment precluded by the Act?

Section 25 of the Act contains a wide anti-avoidance provision. We know it is wide as the then House of Lords said as much on the London Diocesan Fund and others v. Avonridge Property Company Limited (Avonridge) case in 2005. The Act voids any arrangement that frustrates the purpose of the Act – namely the release of a tenant from its obligations upon assignment (section 5) and the release of the tenant's guarantor from its obligations upon assignment (section 24).

The Act allows for the assigning tenant to provide an Authorised Guarantee Agreement (AGA – section 16). However, the guarantor cannot provide an AGA (a GAGA). Instead, it can only provide a sub-guarantee (a SAGA). This is where the guarantor guarantees the assignor's performance of its AGA and does not guarantee the assignee's performance of the lease covenants (Good Harvest).

A tenant assignor with a guarantor cannot assign to another tenant who is then guaranteed by the same guarantor entity (K/S Victoria).

What Miss Tipples QC had to determine was whether or not a tenant can assign directly to its guarantor.

The guarantor raised a novel argument based on the guarantor being released in its status as guarantor, and then sequentially being bound to the tenant covenants in its status as assignee. The distinction is therefore drawn between the two different hats worn by the guarantor/assignee.

Miss Tipples didn't accept this "sequential" argument – "in practical terms … there is no release at all for [the guarantor] in respect of its liabilities under tenant covenants". In reality, the guarantor is bound to the same extent upon assignment as it was before assignment, the consequence being that the assignment is caught by section 25 as the assignment frustrates the purpose of section 24 – the release of the guarantor upon assignment.

Therefore the obiter commentary from Lord Neuberger in K/S Victoria has been applied. He had stated that "the whole thrust of section 24(2), indeed of the 1995 Act itself, is that a person should not remain liable under a tenancy after the tenant whose liability he is associated with has been released from his liability". In coming to this conclusion, Miss Tipples rejected the view of Paul Morgan J, the leading actor in UK Leasing Brighton, who had considered the possibility of the arrangement being valid in a seminar delivered in November 2015. Her firm view was based on the "policy of the Act that a tenant or guarantor cannot, as the result of an assignment, re-assume the very same, or essentially the same, liabilities in respect of the tenancy".

Miss Tipples re-emphasised the absurdity of the situation that arose despite the willingness of the parties to effect the arrangement – "the fact such a conclusion is unattractively limiting and commercially unrealistic is neither here nor there".

What is void – the assignment or the lease covenants?

The basic principle arising from Tindall Cobham is that the court has to take "a balanced approach to invalidation which, whilst neutralising the offending parts of the contract, does not leave it emasculated and unworkable". The court is entitled to look at "the structure of the agreement in an objective and common sense way".

The plot-line advanced by the guarantor was not for fooling Miss Tipples. Indeed she held that "[Counsel's] submissions as to what happens to the lease on an assignment to the claimant do not make any sense at all".

The guarantor's argument was that the tenant covenants in the lease were void as against the guarantor, but that the lease itself still existed and was vested in the guarantor. The guarantor claimed that the lease was vested in the guarantor; the guarantor was not under any obligation to pay rent and the tenant covenant was void; but the landlord could then forfeit the lease (the forfeiture provision not being a tenant covenant) if the tenant did not pay rent.

Miss Tipples could not reconcile tenant covenants being void with the concept of the landlord being able to then forfeit for the tenant's failure to comply with the void covenants. This would "on any footing … be enforcing by the 'back door' covenants rendered void by the Act". How could a landlord forfeit for non-payment of rent if the covenant to pay rent was void? In the judge's view, this could not work as a matter of law. In conclusion, Miss Tipples determined that the guarantor's position was "unbalanced as well as 'emasculated and unworkable'".

At the denouement, it was evident that the assignment itself was void. This avoided any unpleasantness in dealing with a shell lease. The assignment from tenant to guarantor frustrated section 24 of the Act and therefore was void. The consequence of this is that the assignment does not take effect to vest the lease in the guarantor as assignee. This is clear from K/S Victoria – "the lease could not be assigned to the guarantor, even where both the tenant and guarantor wanted it".

The lease therefore remains vested in the original tenant and the guarantor remains bound as guarantor of the original tenant's obligations.

A cliff-hanger ending?

It is helpful to have further judicial consideration of the Act. However, the fact that judicial time is being taken up with cases arising from the operation of the Act emphasises its fundamental flaws and lack of commercial and at times rational application.

A common thread throughout the cases is the fact that it is irrelevant what arm's length professional parties, independently advised, actually want – this is "neither here nor there". Well, for many parties it is a big issue. Tenant groups want to be able to restructure their arrangements. There may not be an adequate alternative guarantor. The Act frustrates this for no sensible reason. Why should a tenant not be able to assign to its guarantor if they both want this to happen? Similarly, why shouldn't a guarantor of a tenant not be able to guarantee that tenant's assignee?

It is clear that, as another gripping instalment of the AGA GAGA SAGA draws to a thrilling season finale, there is likely to be another season commissioned. However, what might be better would be for the authors of the Act to rewrite parts of the script of the Act to avoid series fatigue.