We look at a recent High Court decision confirming that an assignment of a lease to an existing guarantor is void.
A recent High Court decision found that the assignment of a lease between a tenant and its guarantor was void as it fell foul of the anti-avoidance provisions in the Landlord and Tenant (Covenants) Act 1995. This applies even where all parties are in agreement on the assignment and has a retrospective effect in respect of assignments which have already taken place.
THE LANDLORD AND TENANT (COVENANTS) ACT 1995
The Act was introduced following a Law Commission Report to address the perceived unfairness of the common law position that the original tenant under a lease remained liable for its obligations until the end of the term. There was nothing to prevent an original tenant being required to make good a current tenant's default where the lease had been assigned several times over, even in cases where the obligations had become more onerous, for example where a higher rent had been agreed to. This put landlords in a position of considerable strength and tenants at a significant disadvantage.
The Act addressed this by providing an automatic release of liability for tenants, as well as any third parties to the lease such as guarantors, on assignment. The Act also includes an express anti-avoidance provision which renders void any agreement which has the effect of excluding, modifying or otherwise frustrating any provisions of the Act. Previous authorities have shown the restrictiveness of these provisions and a judge in one of the leading Court of Appeal cases in this area made a non-binding observation that these provisions would mean that a "...lease could not be assigned to the guarantor, even where both the tenant and guarantor wanted it." The implication was that because it would remain liable for the lease obligations after an assignment contrary to the Act, a guarantor of an original tenant would be prevented from guaranteeing its assignee, even in group company arrangements where this would be a simple and desirable step. This comment caused a great deal of uncertainty and debate amongst landlords and tenants.
THE VOID ASSIGNMENT
Five years later, EMI Group v O & H Q1 Ltd  arrived to test this proposition. The defendant landlord had consented to the assignment of a lease from the original tenant to its guarantor, after the original tenant went into administration. In a rather calculating move, the guarantor then sought to rely on the anti-avoidance provisions in the Act to argue that the effect of the assignment was that the lease term vested in it, but the tenant covenants (such as payment of rent) were void. The Court dismissed this position as making "no sense at all", but instead found that the effect of section 25 was to render the entire assignment to the guarantor void, concluding "the guarantor is absolutely precluded from becoming the assignee, on an assignment by the tenant whose tenant covenants he is guaranteeing". This meant that the lease remained vested in the original tenant and the guarantor remained liable for the obligations under the lease.
The Court felt that this conclusion leads to a clear, simple and certain position and safeguarded the objectives of the Act. However, this generous interpretation of the anti-avoidance provisions in the Act seriously restricts the ability of parties to freely assign leases, particularly in cases of portfolio restructuring. Further, this decision makes it clear that the Act does not simply prevent such transactions happening in the first place, but renders void those which have already been effected. This raises concerns regarding the extent to which this could undermine the investment value of commercial reversions and highlights the importance of future due diligence to ensure that there has been no previous assignment between a tenant and its guarantor.
Given the continuing uncertainties which have arisen as a result of the Act and the recent cases, there is no doubt that battles between landlords and tenants will continue in relation to these issues.