Ever since the Landlord and Tenant (Covenants) Act 1995 came into force, there has been an unresolved question as to whether an outgoing tenant's guarantor could be a party to an Authorised Guarantee Agreement entered into by the outgoing tenant. In some respects it is surprising that it has taken quite so long for the point to reach the courts. Perhaps however it was inevitable that it would do so in the current economic climate.
The Act provides for tenants and guarantors of "new leases" (broadly, leases granted on or after 1 January 1996) to be released from liability on a lawful assignment of the lease by the tenant. Section 25 of the Act contains anti-avoidance provisions. It states that an agreement is void to the extent that it would (apart from that section) "exclude, modify or otherwise frustrate" the operation of the Act (including the provisions for the automatic release of tenants and guarantors). There is an exception for Authorised Guarantee Agreements (AGAs), but these must comply with the strict criteria laid down in section 16 of the Act.
Section 16 provides that an agreement is an AGA if, under it, the outgoing tenant agrees to guarantee the performance of the tenant covenants of the lease by the assignee. The agreement must not guarantee performance by any person other than the assignee, or impose on the outgoing tenant any liability in relation to a period after the assignee has lawfully assigned the lease.
In Good Harvest Partnership LLP v Centaur Services Limited, Chiron CS Limited (Chiron) was the original tenant under a lease dated 5 October 2001. The lease was guaranteed by Centaur Services Limited (Centaur). Chiron assigned its lease in September 2004. Chiron and Centaur entered into an agreement (described as an AGA) with the landlord under which they each agreed to guarantee the performance of the tenant covenants in the lease by the assignee until the next lawful assignment of the lease.
The assignee company was acquired by the Woolworths Group, and failed to pay the rent under the lease. Chiron was dissolved in May 2008 and so the landlord sought to enforce the AGA against Centaur. Centaur claimed that the AGA was unenforceable against it by virtue of section 25 of the Act.
The High Court agreed. It ruled that:
- The anti-avoidance provisions in section 25 of the Act are to be interpreted generously, in order that the operation of the Act is not frustrated, either directly or indirectly.
- The Act provides for guarantors' liabilities to end on assignment. If a guarantor could be required to enter into a further guarantee when the lease was assigned, then this would frustrate the operation of the Act, since it would impose on the guarantor equivalent obligations to those from which it was released.
- The fact that the obligations undertaken by the guarantor were "new" obligations, rather than a continuation of its existing guarantee, made no difference. The tenant's obligations in the AGA were also new obligations, but it was clear that Parliament had intended to restrict any such obligations to those permitted under section 16 of the Act.
- Section 16 sets out the circumstances in which an outgoing tenant can give a guarantee for an assignee. Had Parliament intended an outgoing tenant's guarantor also to be able to guarantee obligations of an assignee, it would have said so explicitly. This was particularly the case given that guarantors are mentioned elsewhere in the Act.
- There was no indication in section 16 that an AGA could include a guarantee from anyone other than the outgoing tenant.
- If an outgoing tenant's guarantor could be required to give a guarantee for the outgoing tenant's assignee, there would be nothing to prevent that guarantee from extending to future assignees as well. This would drive a coach and horses through the legislation.
Things to consider
In Good Harvest, the guarantor had agreed in the AGA to guarantee the performance of the tenant covenants by the assignee. However, some guarantors' obligations are drafted so that the guarantor instead guarantees the outgoing tenant's obligations under the AGA (a form of "sub-guarantee").
The court did not think it was clear that this was permitted by the Act, but did not conclusively decide the point. Sections 17 and 18 of the Act do provide for landlords to serve notices on former tenants' guarantors before recovering arrears from them. This might be taken to suggest that guarantors can continue to be liable after an assignment. However, the court thought that in this regard these sections were "more obviously applicable" to old tenancies, under which such ongoing liability is permitted.
The court acknowledged that its decision meant that the Act was capable of operating in ways which could appear arbitrary. It gave as an illustration a parent company guaranteeing a subsidiary's obligations under a lease. Many would find it difficult to see why, if the lease was to be transferred intra-group, the parent company should not be able to continue to act as guarantor. However, the court noted that even if it were possible for the parent company to give a sub-guarantee, this would cease to apply in the event that there was a further intra-group assignment (as the AGA itself would fall away at this point). On that basis, this would still produce an arbitrary result from a commercial point of view.
Implications for landlords
The issue decided in this case has been debated ever since the Act was passed. Landlords have often attempted to make guarantors a party to an AGA on the basis that, although the position was not clear, until the point was firmly decided they wished to protect themselves in the strongest way possible. As a result of this case, such covenants entered into by outgoing tenants' guarantors will be void (although the guarantee given by the outgoing tenant itself should be unaffected). Landlords should ensure that where a current tenant is in default, prompt action is taken to enforce an AGA given by an outgoing tenant, since they may not be able to pursue the former tenant's guarantor. However, the result in Good Harvest may mean that parent company guarantors have less incentive to ensure that their subsidiaries pay up.
The court did not decide whether a guarantor could lawfully guarantee the outgoing tenant's obligations under the AGA (i.e. a sub-guarantee, as opposed to a direct guarantee of the assignee). It remains to be seen whether a subsequent court would use the court's reasoning in this case to strike down this sort of arrangement too. In the absence of a binding decision on the point, landlords may continue to draft guarantors' obligations in this way in order to attempt to bolster what could otherwise be a weak covenant under the AGA.
Implications for tenants
Although on the face of it this case represents a win for tenants and their guarantors, this may well be tempered with a less flexible approach by landlords on the grant of new leases. Landlords may in some circumstances refuse to grant leases to anyone other than the main parent company. It remains to be seen to what extent the current state of the market will affect the parties' bargaining power in this respect.
The position is less straightforward on assignment, where the landlord is usually required to act reasonably. This will ordinarily involve reviewing the covenant strength of a prospective assignee and its guarantor together in the round. However, once the lease is assigned on again, the covenant of the guarantor may now be lost, leaving the landlord with only a potentially weak covenant under the AGA.
We understand that permission to appeal the decision has been granted, and so it seems that the "AGA saga" may not be quite over yet.