Tenant insolvency is increasingly common in the current climate. The disclaimer of a lease by the tenant's liquidator causes a particular headache for the landlord. Where the property is underlet, the effect of the disclaimer on the undertenant is not straightforward following the decision in Hindcastle Ltd v Barbara Attenborough Associates Ltd. For this reason, some landlords include a provision in the licence to underlet which requires the undertenant to take a new lease from the landlord in the event of a disclaimer of the headlease.

In BNY Trust & Depositary Co Ltd v Bourne End One Ltd, the relevant clause in the licence to underlet said:

"If, following an Event of Default, the Underlease ceases to subsist and the Landlord serves a Landlord's Notice, the Undertenant ... shall accept a new lease..."

An "Event of Default" included the disclaimer of the headlease by the tenant's liquidator. On 13 October 2008 the tenant's liquidator disclaimed the headlease. The landlord sought to enforce the clause in the licence to underlet against the undertenant. However, unknown to the landlord, the undertenant had surrendered the underlease to the tenant on 29 September 2008. The undertenant had paid a reverse premium of £100,000 to the tenant for the surrender.

Since the underlease had ceased to subsist prior to the disclaimer of the headlease by the tenant's liquidator, the clause in the licence to underlet was not engaged.

The landlord therefore argued that the surrender was a breach of the alienation provision in the underlease. This was in a fairly standard form, and provided that the undertenant was not to assign, underlet, part with possession or share occupation of the whole or any part of the premises, or hold the premises on trust, save as provided by the remainder of the clause. The landlord argued that, by virtue of the surrender, the undertenant had given up possession of the premises to the tenant, and that this was therefore a breach of the alienation clause. Since the undertenant had given a direct covenant to the landlord in the licence to underlet to comply with the terms of the underlease, the landlord was able to enforce the underlease covenants against the undertenant.

The High Court rejected this argument. It held that it was not the case that the surrender was a technical breach of the alienation covenant by the undertenant (albeit one which the tenant, by accepting the surrender, had waived). A surrender was not a breach of the alienation covenant at all. Surrender is, after all, a consensual matter between the landlord and tenant under a lease. It was simply not a transaction at which the covenant against alienation was aimed.

The licence to underlet also contained a covenant by the tenant not to waive any of the covenants in the underlease without the landlord's consent. The landlord argued that, since the surrender contained a release of the undertenant's obligations in the underlease, this constituted a breach of this covenant in the licence to underlet.

The court was equally unimpressed by this argument. Reviewing the terms of the underlease, it noted that it contained a clause regulating sub-underlettings. In addition to prohibiting the undertenant from waiving any of the provisions in a sub-underlease, the underlease also expressly prohibited the undertenant from accepting a surrender of a sub-underlease without the consent of the tenant. No similar covenant in relation to a surrender of the underlease had been included in the headlease, or in the licence to underlet.

In addition, the underlease contained a right of re-entry, which would have allowed the tenant to forfeit the underlease. The covenant by the tenant in the licence to underlet not to waive any of the covenants in the underlease would not have prevented forfeiture of the underlease. Since this clause would not have enabled the landlord to prevent forfeiture, nor should it be taken as preventing a surrender.

A second issue arose in the case. When the tenant failed to pay the rent due in December 2007, the landlord served a notice on the undertenant under section 6 of the Law of Distress (Amendment) Act 1908. Under this section, a superior landlord can direct an undertenant to make all future payments of rent under the underlease directly to the superior landlord until the arrears outstanding under the headlease have been paid. The notice must specify the amount of arrears. The question was whether such a direction operates only until the amount of arrears specified in the notice has been paid, or whether it continues to operate until all outstanding arrears under the headlease have been cleared.

In this case, the rents payable under the lease and the underlease were identical. The undertenant had already paid its December 2007 rent to the tenant. However, in accordance with the notice, the undertenant paid its March 2008 rent directly to the landlord. This was enough to clear the arrears specified in the landlord's notice. However, the tenant did not pay the March 2008 instalment of rent due under the lease. The landlord invoiced the undertenant directly in respect of the June instalment of rent, and the undertenant paid it to the landlord. The undertenant had therefore paid all rent which was owing under the underlease.

However, the landlord argued that the effect of the section 6 notice was that all subsequent quarterly payments which would have been due under the underlease if it had not been surrendered were payable by the undertenant to the landlord. Section 3 of the 1908 Act deems the undertenant to be the immediate tenant of the landlord for the purpose of recovering any rent payable under a section 6 notice. The landlord argued that the tenant was therefore not in a position to release the undertenant from its liability to pay future instalments of rent to the landlord. Since the disclaimer of the lease only operated to terminate the tenant's liabilities under the lease and not the lease itself (Hindcastle), rent under the lease remained due and payable so far as the undertenant was concerned.

The court rejected this argument. It held that a section 6 direction operates only until the amount of arrears specified in the landlord's notice has been paid. A landlord must therefore serve a further section 6 notice if it wishes to operate the section 6 procedure in respect of any further arrears under the headlease. Otherwise, there would be no point in the section requiring the notice to state the amount of arrears. In any event, the court thought that if no rent is payable under the underlease (e.g. because it has been surrendered), then there is nothing on which a section 6 notice can operate.

Things to consider

On the first issue in the case, the court did not draw a clear distinction between the automatic release of future liabilities under a lease which occurs on a surrender, and the release of any breach of covenant which may have occurred prior to the date of the surrender. It is arguable that, while the automatic release of future liabilities may not constitute a waiver of the tenant's covenants (the liabilities simply never arise, because the lease has come to an end), the express release of any past breaches may do. However, there was no suggestion that the undertenant was in breach of covenant, which may explain why it was not considered in the case.

In relation to section 6 notices, the message for landlords is that they should serve a new section 6 notice each time additional arrears become outstanding under the headlease. The case does however also highlight how an undertenant in receipt of a notice can be in a difficult position to know to whom it should pay its rent. In this case, the undertenant would have known that once it had paid the March instalment of rent to the landlord, it had cleared the amount of arrears specified in the notice. However, it is easy to envisage instances where this may not be the case. For example, where there are several underlettings of part, one undertenant would not necessarily know whether the other undertenants had received section 6 notices, or had paid the superior landlord in accordance with those notices, and therefore whether there were any arrears still outstanding.