As the impact of the COVID-19 pandemic continues to reverberate throughout Australia and worldwide, it is worth considering the implications for tenants and guarantors who have previously assigned their lease to an occupier that may now be facing financial difficulties. Importantly, outgoing tenants and guarantors not released upon assignment may find themselves caught out in the event of default by their assignee.
Assignments - the typical scenarios
Often a tenant will sell their business and transfer the associated premises lease to the buyer as part of that sale, or the tenant might no longer need their space and assign their lease to a third party to occupy as tenant. The outgoing tenant (and any guarantor) may walk away from the premises thinking that their involvement in the lease of the premises is over. After all, they have assigned the lease to a third party whom they believe has the financial standing to comply with the lease (with the landlord’s consent), their bank guarantee or cash security has been returned and in states where leases are registered their name is no longer registered on the title as the lessee.
Protection for retail leases
It is true that in some jurisdictions, including New South Wales, Victoria and Queensland, the retail leasing legislation specifically provides that outgoing tenants (known as 'assignors') and their guarantors are released from their obligations under the lease in relation to any default by the incoming tenant (known as the 'assignee'), so long as the required disclosures are given to the assignee (although in New South Wales this relief is limited to obligations regarding money, rather than all lease obligations). This is intended to protect the parties who no longer control the use and occupation of the premises or performance of lease obligations from the consequences of acts or omissions of the incoming tenant/assignee.
No protection for non-retail leases
However, the same protection is not available to non-retail tenants and guarantors. They must consider both the terms of the lease and any deed of consent to assignment documenting landlord’s consent to the assignment, to determine whether any ongoing liability applies to them and their guarantors.
Typically office leases provide that the tenant and any guarantor are not released from their obligations on an assignment of the lease, and landlords often refuse to change this position, and are within their rights to do so, when the tenant seeks to assign the lease. If this is the case, then the assignor and their guarantor are at risk of being required to perform the lease obligations if the current tenant is no longer able to do so, even if this assignee has subsequently transferred the lease to a further assignee. That is, the outgoing tenant and guarantor may have no control at all over who is the current tenant in occupation, but nevertheless be responsible for their acts or omissions. Importantly, the landlord is not required to pursue the current tenant first, before pursuing the outgoing tenant and guarantor.
Where the current tenant has the benefit of COVID-19 rent relief
Therefore if the current tenant fails to pay rent or outgoings or is otherwise in default under the lease in circumstances where the tenant does not have the benefit of rent relief under COVID-19 State rent relief regulations (COVID-19 Regulations), the COVID-19 Regulations restrictions on landlords taking action under leases may not apply, and the original tenant and their guarantor could be pursued by the landlord. A landlord would typically choose to do so where the prospects of success against a current tenant in financial difficulties are low, or where the original tenant or guarantor are seen to have 'deeper pockets'.
Where the current tenant doesn't fall within the COVID-19 Regulations
If the current tenant does not fall within the scope of the Regulations, and it fails to pay rent or outgoings or is otherwise in default, the landlord can choose to pursue the original tenant and their guarantor, without being constrained by the COVID-19 Regulations.
What options does an outgoing tenant or guarantor have if pursued by the landlord for the breaches of the current tenant?
The outgoing tenant or guarantor should seek legal advice whether they can resist a claim from the landlord in the particular circumstances that apply to the lease and the parties. Attention should be paid in particular to whether there may be any limitation on the liability of an outgoing tenant or guarantor – for example, it may terminate at the end of an initial term and not extend into any option term.
If approached by a landlord, the tenant and guarantor will need to seek all required information to assess any claim, including details of any relief provided to the current tenant (as the landlord cannot pursue the original tenant and guarantor for matters that it has released the current tenant from).
If the landlord is successful in recovering from the outgoing tenant or their guarantor for the default of the current tenant, the outgoing tenant and guarantor are likely to have a contractual right of indemnity to recover that amount from the current tenant. However, this may be of cold comfort if the current tenant is insolvent and the outgoing tenant and guarantor are simply placed in the queue of unsecured creditors hoping to recover some small portion of this liability.
What should outgoing tenants and their guarantors do now?
Outgoing tenants and their guarantors should check their exposure to liability under leases that have been assigned in the past, including: