Tindall Cobham 1 Limited & Others v. Adda Hotels and Others [2014] EWCA Civ 1215

There has been a lot of talk about the Landlord and Tenant Covenants Act 1995 (LTCA 1995) following the decisions in Good Harvest v. Centaur and K/S Victoria v. House of Fraser. However, there have been no significant determinations in respect of the issues arising from those cases and in particular in respect of the important issue of repeat guarantees.

In summary, it is not uncommon for tenants to want the ability to assign intra-group. This is usually between entities of limited covenant strength. The original tenant is normally guaranteed by a parent of substance. There should be no issue with this pre-assignment.

However, upon intra-group assignment a major problem arises if the guarantor of the original tenant is to guarantee the assignee intra-group tenant. Why? The effect of section 25 of the LTCA 1995 is to render void any provision that seeks to avoid the purpose of the LTCA 1995 – namely, the release of parties from on-going liability upon assignment. Upon assignment the tenant is released by virtue of section 5 and the guarantor by virtue of section 24. The tenant can be obliged to guarantee the assignee's performance of the lease covenants pursuant to section 16 if the landlord requires the tenant to provide an authorised guarantee agreement (AGA). However, there is no equivalent provision in respect of guarantors.

Good Harvest held (and K/S Victoria confirmed) that guarantor AGAs (where the guarantor guarantees the assignee's performance of the lease covenants) are void. However, it seems clear from Lord Neuberger's obiter comments in K/S Victoria that sub-guarantees (where the guarantor guarantees the performance of the original tenant's AGA) are valid.

The substantive determination in K/S Victoria concerned repeat guarantees. Was an obligation requiring the House of Fraser parent to guarantee an intra-group House of Fraser SPV assignee enforceable? In short, no – the provision was void, regardless of how much either party desired the assignment to take place and regardless of how much commercial sense there might have been in effecting the assignment.

What made matters worse was that the assignment between the intra-group assignees was valid but the guarantee was void. Consequently, the landlord was left with an SPV entity as tenant without the support of a parent guarantee. This is very likely to have had a significant adverse impact on the value of the landlord's property.

The impact of repeat guarantees being void has caused a considerable amount of discussion within the industry and has created problems for both landlords and tenants. Landlords want covenant strength and tenants want flexibility – a repeat guarantee being void (regardless of the wishes of the parties) does not facilitate this where otherwise it would.

The first big post-K/S Victoria decision is therefore important. In Adda, leases were granted to hotel companies. The leases were guaranteed by a substantial parent entity. The leases allowed the hotel tenants to assign intra-group without the landlord being able to refuse consent if a) the tenant gave notice of assignment and b) the tenant procured that the guarantor and any other guarantor of the tenant provided a guarantee.

The tenant's position was that it could assign intra-group with the assignee being guaranteed by the same guarantor. Whilst the tenant conceded that it required consent from the landlord, the tenant's position was that the landlord had to consent in accordance with the provision, even if the tenant offered the same guarantor. The advantage to the tenant of doing this would be that the repeat guarantee would be void and the parent entity would be off the hook. The disadvantage to the landlord was that it would be left with an SPV entity as tenant and with no covenant strength in the lease package.

In order to give effect to the lease, the Court of Appeal considered whether to sever the relevant intra-group assignment provision and how much of it to sever. The general view is that only so much of an offending void provision should be severed so as to make the provision operative. On this basis, the offending provision concerning the guarantee would be severed, leaving the tenant free to assign to an intra-group entity with no guarantor without the landlord being obliged to consent. This would make the provision operative, but would still deny the landlord the benefit of an entity of substance guaranteeing the assignee.

This was regarded as 'wholly uncommercial' and a 'radical variation of the lease' at first instance.

The Court of Appeal agreed with the outcome intended by the first instance court, albeit that it reached its conclusion in a different way. The Court held that the whole proviso allowing intra-group assignment upon providing notice and providing a guarantor was void for falling foul of section 25 of the LTCA 1995. This left the clause as a qualified covenant – i.e. the tenant required landlord's consent to assign intra-group. In the event that the tenant failed to offer an assignee of sufficient covenant strength or an alternative guarantor, the landlord could likely reasonably refuse consent.

Therefore, the Court reached a conclusion that it considered was equitable between the parties and which continued to give commercial effect to the lease. The tenant was free to assign, but consent could be refused in the event that the assignee package was insufficient. The tenant had a degree of flexibility, the landlord, security.

This decision may be a product of pre-K/S Victoria leases. However, the outcome still does leave tenants who only have one parent of sufficient strength in a difficult position and highlights difficulties in the effect of the LTCA 1995 itself. If they are unable to find alternative security, intra-group restructuring becomes very difficult if a landlord can essentially veto assignment due to ineffective security being offered. Therefore, whilst we do now have reasonable clarity on the operation of the LTCA 1995, the consequences of the LTCA 1995 are such that there is a strong case for reform. The Law Commission decided not to put reform on the agenda in its recent programme of reform, but it is likely that calls from all sides of the commercial lettings industry will continue.