A "virtual assignment" is an arrangement under which all the economic benefits and burdens of a lease are transferred to a third party, but without any actual assignment of the leasehold interest.

In Clarence House Ltd v National Westminster Bank plc, the High Court had to consider whether such an arrangement was a breach of the terms of a lease. The lease contained the usual restrictions on alienation. The tenant entered into a virtual assignment with a company called New Liberty. The tenant granted a power of attorney to New Liberty enabling New Liberty to act in the name of the tenant in relation to the property. The landlord was not informed about the virtual assignment.

The property in question had been fully sublet. Under the terms of the virtual assignment, New Liberty was obliged to manage all dealings with the landlord and the undertenant as if the property had been assigned to it. The document stated that all monies receivable from the undertenant therefore belonged to New Liberty.

The High Court considered each of the limbs of the alienation covenant in turn. It ruled that the virtual assignment did not amount to an underletting, since it did not reserve a reversionary interest to the tenant. The court also rejected the submission that the virtual assignment was a breach of the covenant against assignment. It cited previous case law that held that a prohibition on assignment in a lease is confined to a legal assignment only. This was a registered lease, with the result that, in order to be legal, an assignment would have to be registered at the Land Registry (which the virtual assignment had not been).

With some hesitation, the court also decided that the virtual assignment did not constitute a breach of the covenant in the lease not to execute a declaration of trust in relation to the property. The landlord argued that, since the intention of the virtual assignment was to transfer all the economic benefits and burdens to New Liberty, the tenant merely remained the nominal owner of the lease, which (it argued) amounted to the tenant being a bare trustee.

The court recognised the similarity with the characteristics of a trust. However, in its view this transaction was founded in contract rather than in equity. Under the kind of bare trust alleged by the landlord, the beneficiary would have the right to put the trust to an end at any time by calling for a transfer of the legal title to itself. No such right was available to New Liberty under the terms of the virtual assignment.

The court then turned to the prohibition on sharing or parting with possession or occupation of the property. As the premises were fully sublet, there was no breach of the occupation covenant. The tenant argued that since New Liberty had no right to occupy the property, it could not be in possession. The court disagreed. Possession and occupation were separate concepts. The court ruled that, by entering into the virtual assignment, the tenant had either parted with possession of the property, or at least was sharing possession with New Liberty. This view was reinforced by the definition of "possession" in the Law of Property Act 1925, which includes the receipt of rents, or the right to receive rents.

Things to consider

The device of a virtual assignment is used in a number of situations. It may be used in large portfolio transactions, where there is not time to obtain all the landlords' consents prior to completion of the deal, or on deals where real estate is not the main asset. The ruling in this case means that such arrangements are highly likely to be unlawful. However, in the current climate, where landlords may be reluctant to issue proceedings for forfeiture, it remains to be seen whether a landlord faced with a virtual assignment will be able to demonstrate that it has suffered any loss to enable it to claim damages. The landlord pointed out that the fact that the underlease rent was now being received by New Liberty may impact on the tenant's ability to pay the rent under the headlease. However, in this regard it should be noted that in the case of non-payment of rent under the headlease it is of course open to a landlord to require the undertenant to pay the rent directly to it.