A judgment on virtual assignments has been passed in the High Court which, if upheld, may provide some relief to landlords and some concern to corporate tenants who may be looking to incorporate a virtual assignment into a corporate sale transaction or group arrangement in the future.

The case, Clarence House Limited -v- National Westminster Bank PLC [2009] EWHC 77(Ch) held that entry by a tenant into a virtual assignment was a breach of the covenant contained in the lease for the tenant not to share or part with possession of the premises.

WHAT IS A VIRTUAL ASSIGNMENT?

Virtual assignments are commonly seen in a large real estate ownership transaction where an assignment or parting with possession of occupational leases requires landlord's consent and which the parties believe will not readily be forthcoming (possibly due to the financial covenant of the assignee (often an insolvency remote SPV)) or other perceived differences between the current tenant and the assignee.

A virtual assignment occurs where a tenant agrees to pass the economic benefit and burden of a lease and the performance of other responsibilities under the lease (e.g. management responsibilities) to a third party without actually effecting an assignment of the lease or changing the occupancy of the premises. Usually the virtual assignee is appointed to act as the agent of the assignor and agrees to indemnify the assignor against any costs it may incur.

THE CASE

National Westminster Bank PLC (Natwest) were the tenant of a lease and Clarence House Limited (CHL) was the landlord. Natwest was no longer the occupier of the premises and had underlet the whole of the premises to William M Mercer Ltd. Natwest entered into a virtual assignment (as part of a larger transaction) with New Liberty Property Holdings Limited (New Liberty). Natwest did not seek CHL's consent to the assignment.

CHL claimed that Natwest was in breach of its alienation covenants in the lease and in particular, those not to underlet, assign, make a declaration of trust or share or part with possession or occupation of the property without the landlord's consent. Natwest argued that it was not in breach of any of the covenants because the virtual assignment only related to the transfer of economic benefits and burdens of the interest in real property and separated them from the underlying real property interest (which remained unassigned). They argued that the virtual assignment did not provide New Liberty with occupation of the property and only facilitated New Liberty acting as Natwest's agent. Accordingly, the relationship between the landlord and Natwest did not change.

The court held that the virtual assignment was a breach of the covenant not to share or part with possession. This was because the court considered that 'possession' denoted a degree of control of the premises and because Natwest had transferred some of the control over the lease (and the underlease) to New Liberty, it could be seen to have at least shared possession (by sharing control) of the premises.

The court however rejected the arguments that the virtual assignment was a breach of the covenants not to underlet or assign without consent (in the latter case because no legal assignment had occurred) nor was there any breach of the prohibition against holding on trust (because New Liberty was not entitled to enjoy the property nor direct the disposal of the property).

WHAT IS THE POTENTIAL IMPACT OF THIS DECISION?

The effect of this decision, if upheld on appeal, is that virtual assignments could be held to be a breach of the covenant not to part with or share possession. There is a real sense that in finding as it did, the Court was trying to avoid the need for landlords to specifically seek to prohibit virtual assignments, but as each case will turn on its facts and the construction of the relevant documents, it may still be the case that a cautious landlord may consider a specific prohibition of these.

For corporate tenants who would look to use a virtual assignment, as the potential breach occasioned by a virtual assignment is in effect "available", it will be a commercial decision as to whether to continue to use such devices or seek the landlord's consent either to an actual or virtual assignment.