The Court of Appeal has handed down judgment in K/S Victoria Street v. House of Fraser (Stores Management) Ltd1 upholding the decision in Good Harvest Partnership LLP v Centaur Services Limited2 that a tenant’s guarantor is released on a lawful assignment of a lease (entered into after 1 January 1996)3 and cannot act as guarantor for the assignee either by way of an authorised guarantee agreement (“AGA”) or by entering into a new contractual guarantee even if the guarantor is happy to do so.
There is, however, some good news for landlords. The Court of Appeal expressed the view that guarantors can be required to guarantee an assignor’s obligations under an AGA and that they can also validly guarantee the liability of an assignee on a further assignment.
K/S Victoria Street (the “Landlord”) granted a lease to House of Fraser (Stores Management) Ltd (the “Tenant”) on 26 January 2006. The Tenant’s parent company, House of Fraser plc (“HOF”), acted as guarantor. The Tenant was a dormant company, but the Landlord agreed to accept it as the initial tenant to assist the House of Fraser group’s tax affairs. In return, at HOF’s suggestion, the lease terms provided that the Tenant would assign the lease by no later than 26 April 2006 to House of Fraser (Stores) Limited (“T2”) with HOF acting as T2’s guarantor.
By 2010, the lease had still not been assigned. The Landlord brought an application against the Tenant, T2 and HOF for specific performance.
The Tenant, T2 and HOF argued that the obligation to assign to T2 was unenforceable because it required HOF to be guarantor. They relied upon the Landlord and Tenant (Covenants) Act 1995 (“the Act”), as interpreted by Good Harvest, which stated that guarantor’s are released on assignment and any attempt to circumvent the Act was void.
At first instance the High Court held that the requirement that HOF provide a guarantee was void. However, as the guarantee condition was in a separate sub-paragraph to the obligation to assign, the two clauses were held to be independent and the obligation to assign to T2 was, therefore, enforceable. The Landlord appealed the issue of whether HOF could be required to guarantee the assignee’s performance.
The Court of Appeal agreed with the High Court. It held that the guarantor was released by s5 of the Act and that any provision which required HOF to re-assume a liability that it was otherwise released from would frustrate the purposes of the Act, and was, therefore, void and unenforceable.
Although it was not necessary to do so on the facts of the case, the Court went on to consider whether HOF could be required to act as guarantor again if the lease were to be transferred back to the Tenant in accordance with the alienation covenant which permitted intra-group assignments without the Landlord’s consent provided HOF was at all times the guarantor. It held that the alienation covenant would be enforceable on a further assignment, provided that at the time of that assignment HOF was not the guarantor of the assigning tenant.
The Court carried out a wider review of the decision in Good Harvest on the grounds that it had led to ‘‘controversy” and “uncertainty.” It concluded:
- The tenant’s release at s5 of the Act is limited by the provisions of s16 of the Act, which says that a tenant may provide an AGA guaranteeing the assignee’s liability. s16 does not permit a guarantor to guarantee an assignee’s liability;
- Guarantors may not volunteer to guarantee an assignee’s liability. The Court accepted that this appeared to give the Act an “unattractively limiting and commercially unrealistic effect”, but held that any alternative interpretation lead to uncertainty as it would not be apparent on the face of the documents alone whether the guarantee had been provided freely;
- s24(2) of the Act only releases guarantors “to the same extent as the tenant.” In the unanimous view of the Court, a guarantor is released to the same extent as the tenant if it guarantees the tenant’s liabilities under an AGA;
- Guarantors can validly guarantee the liability of an • assignee on a further assignment (whether that is an assignment back to the original tenant or a new tenant). The Court reasoned that this did not fall foul of anti-avoidance provisions at s25 of the Act since it did not alter the fact that the tenant and guarantor were released from its obligations upon the first assignment;
- That as any contractual arrangement which has the • effect of not releasing the guarantor to the same extent as the tenant with effect from the date of the assignment is void this may prohibit an assignment to the guarantor.
Permission was not sought to appeal to the Supreme Court.
The decision in K/S Victoria Street has significantly mitigated the effect of Good Harvest. It means that, although landlords cannot require a guarantor to directly guarantee an assignee’s obligations, it can achieve a commercially similar effect by requiring guarantors to guarantee an assignor’s obligations under an AGA. The Court went so far as to say that it might be possible for the guarantor to act as a co-guarantor under the AGA together with the assignor, but declined to determine the point. If a guarantor is a party to an AGA, it must be the case that its guarantee is clearly effective only in relation to the assignor’s obligations.
One of the practical limitations of the indirect nature of the guarantors permitted continuing obligation is that it requires the tenant to enter into an AGA; the tenant is very unlikely to be prepared to do this if it is in any form of insolvency procedure.
The Court’s general review of the Good Harvest decision was not related to the subject matter of the case and, therefore, is not binding authority. However, the comments will still be treated as very persuasive by other Courts and so should not be lightly ignored.
The practical consequences of the K/S Victoria Street case are:
- Landlords cannot contractually require, before or after the lease is granted, that a guarantee shall continue in force following an assignment;
- Landlords should not accept any person who was the guarantor of the immediately preceding tenant as an assignee’s guarantor. If it does so, the guarantee will be void and the landlord will be left without valid security;
- Where assignments have already occurred, effectively transferring a guarantee from a former tenant to the assignee, a landlord cannot safely rely upon the guarantee;
- On receipt of an application to assign, if a landlord is entitled to require that the tenant enter into an AGA, the landlord can and should require the guarantor to guarantee the tenant’s obligations in an AGA. A contractual term can be included in the lease to that effect;
- Alienation covenants permitting intra-group assignments without consent should be reviewed. Assignees may be required to provide a fresh guarantor of specific covenant strength or the assignor could be obliged to give an AGA the performance of which must be guaranteed by the original guarantor.
The comments made in K/S Victoria Street suggest it may be possible to structure assignments between group companies so that the lease is first assigned to one company (with a full release for the guarantor) with an immediate second assignment to a third company and the return of the guarantor. However, if the first assignment is conditional upon the second assignment the Court may hold that this contradicts the anti-avoidance provisions on the basis that the only purpose of such an arrangement is to ensure the guarantor’s continued liability.
It remains the case that the tenant’s guarantors are not released on an underletting. If the tenant is willing to underlet rather than assign the landlord will retain the benefit of the tenant’s and guarantor’s continuing liability under the head-lease.
Although the decision in K/S Victoria Street has provided some welcome clarification on Good Harvest, the Court’s decision not to reverse the rule against guarantors voluntarily providing repeat guarantees will disappoint many, particularly given the significant impact it has on intra-group assignments.