The Landlord and Tenant (Covenants) Act 1995 radically overhauled the law of privity of contract, limiting a tenant’s liability to the period in which the lease remained vested in it and, where the tenant entered into an authorised guarantee agreement (“AGA”), for the period the lease remained vested in its immediate assignee. Guarantors’ liability cannot be more extensive than that of the tenant. Section 25 is a comprehensive anti-avoidance provision which makes any agreement void to the extent that it attempts to frustrate the operation of the 1995 Act.
Even before its implementation, questions had been raised as to the remit of section 25 in relation to areas which the 1995 Act did not expressly cover. For example, whether a guarantee by the outgoing tenant’s guarantor of that tenant’s AGA obligations1 would fall foul of the 1995 Act. This lack of clarity was compounded by opposing opinions from two eminent QCs, both of whom are now on the Bench.
It took 15 years for the court to be troubled by the interpretation of section 25 in relation to guarantees and then, like buses, two cases came along in quick succession.
A good harvest for guarantors
The first case, Good Harvest Partnership LLP v Centaur Services Limited 2, decided in February 2010 concerned a guarantor of a tenant who was required, as a condition of the assignment, to guarantee the assignee’s performance. Mr Justice Newey in the High Court held that the anti-avoidance provisions of the 1995 Act were very broadly drafted so that any condition of assignment which meant a guarantor remained liable following an assignment would be unenforceable.
However, the judge made further, non-binding, comments on the extent of the anti-avoidance provisions which caused great concern in the property sector – particularly in relation to intra-group reorganisations.
First, it was Newey J’s view that even if the tenant’s guarantor volunteered to guarantee the assignee’s obligations, it would be unenforceable. Secondly, he suggested that sub-guarantees were also unenforceable.
The parties settled before an appeal was heard. However, it did not take long before the Good Harvest decision was examined by the court in the case of K/S Victoria v House of Fraser (Stores Management) Limited and others 3.
The Court of Appeal has its say
James Beattie Limited (“Beatties”), a member of the House of Fraser group owned the group’s large department store in Wolverhampton. For tax reasons, the freehold was transferred to House of Fraser (Stores Management) Limited (“Management”), a financially poor group company, which then entered into a sale and leaseback arrangement with K/S Victoria.
The lease was for 35 years at an initial rent of £2.25m per year. Management’s liabilities were guaranteed by its parent, House of Fraser Ltd (“HoF”) and the parties’ intention was that the lease would be assigned to a financially healthier group company, House of Fraser (Stores) Limited (“Stores”) shortly after the grant.
Clause 3.5 of the sale agreement provided as follows:
“(i) [Management] agrees to assign the Lease to an assignee (being a Group Company of [HoF] being of equal or greater covenant strength to [Beatties]), and
(ii) if a company is not chosen by 20 April 2006 then the assignee shall be Stores and Stores agrees to take that assignment by no later than 26 April 2006, and
(iii) [HoF] agrees to enter into a deed of guarantee of that assignee’s liabilities as surety in the form set out in schedule 3 to the Lease.”
Meanwhile, the lease provided that whilst a group company of HoF was the tenant, the landlord’s consent was not required to an assignment to another HoF group company provided that HoF guaranteed the assignee.
In fact the lease was not assigned to Stores and Management and HoF argued that clause 3.5(iii) was unenforceable. Victoria issued proceedings for an order that the assignment and guarantee be performed. The trial judge considered the Good Harvest case and said that, although he had some criticisms of the decision, it was not obviously wrong and therefore he did not have the power to disregard it. He therefore concluded that clause 3.5(iii) was void since it required the original tenant’s guarantor to provide a guarantee for the assignee.
He further decided that the void provision could be severed so that (i) and (ii) were in principle enforceable although Management argued that the proviso in the lease’s alienation clause undermined any order for specific performance of clauses 3.5(i) and (ii) because they could simply re-assign the lease to Management with HoF as the guarantor, which was insolvent on a balance sheet basis.
On appeal the Court of Appeal upheld the decision. They found that the main tenet of the 1995 Act was to release the tenant from its obligations under a lease when it assigned the whole of the premises.4 In relation to guarantors, the 1995 Act specifically provided that they would be released “as from the release of the tenant… to the same extent as the tenant is released.”5
The Court of Appeal agreed that clause 3.5(iii) of the sale agreement was void as it frustrated the 1995 Act as its aim was to prevent the release of HoF from its liabilities under the lease. To hold otherwise, would be to allow a landlord to impose on a guarantor a requirement to guarantee whoever the tenant was under the lease from time to time.
The Court had “considerable sympathy” for the fact that clause 3.5 had been introduced in order to benefit the tax position of the HoF group. However, they found that the 1995 Act was only concerned with the objective end result of an obligation.
Thus the Court of Appeal indirectly upheld Newey J’s binding decision in Good Harvest. However, they also considered in detail his other reasoning. Although not binding, the property pedigree of two of the appeal judges6 suggests that it will be followed.
First, the Appeal Court agreed with Newey J’s view that section 25(1) invalidates any agreement by an assignor’s guarantor to guarantee the incoming assignee (even where there is no obligation to provide such guarantee). The result is that not only can a guarantor not voluntarily give a fresh guarantee to the immediate incoming assignee, but it cannot validly take an assignment of the lease from the tenant.
However, their Lordships introduced a significant qualification, contrary to Newey J’s finding on the provision of sub-guarantees. Under the 1995 Act, a landlord can, where reasonable, require a tenant to enter into an AGA, thereby limiting the extent of its release. Since the tenant’s guarantor is to be released on an assignment “to the same extent as the tenant”, if the tenant’s release is limited, its guarantor’s release can also be limited by means of a guarantee of the assignor’s AGA.
Applying this reasoning to the facts, the Court of Appeal explained that the proviso to the alienation clause was not void because it covers any intra group assignment, whereas section 25 is only directed at immediate assignments. The Court felt it was unlikely that the anti-avoidance provisions were intended to apply where, following an assignment from T1 to T2, T2 then decides to assign further to T3 (or indeed back to T1) and T1’s former guarantor assumes a further guarantee for T3. HoF could therefore be required to provide a guarantee to alternate assignees (T1, T3, T5, etc.).
The end of the AGA saga?
Have the seeds of doubt raised by the Good Harvest case been dispelled?
Certainly the landlords’ position is clarified, but what about the tenant who wants to assign to a valueless group company? Will the offer of a sub-guarantee be sufficient to support the tenant’s application to a reluctant landlord? This is far from certain for the following reasons:
- 1. When considering the covenant strength of an incoming assignee, the landlord must look at its covenant strength and, if lacking, at any security offered to strengthen the proposal. A landlord can reasonably refuse consent if, together, an assignee and guarantor are insufficient to give comfort that the tenant’s lease obligations will be complied with.
- Where there are practical doubts about the assignee’s ability to comply with the obligations, even where there is the benefit of an original tenant’s covenant (in relation to an old lease)7 or a suitable guarantor8 offered the landlord can, where the facts support it, reasonably refuse consent.
- An AGA and a guarantee of an AGA are always going to be less valuable than a direct guarantee of an assignee because, to pursue a claim against the former tenant (or its guarantor), the landlord must first serve notice on the former tenant and guarantor within a six month window9 of any rent or other fixed charge falling due. This is not needed for a direct guarantor.
The next question to consider is this. Suppose a lease is granted which, following the Victoria Street guidance, imposes an obligation on the tenant’s guarantor to enter into a sub‑guarantee in the event that the tenant assigns its lease and gives an AGA. Suppose also that there is provision that, in the event of any intra‑group assignment, the original named guarantor shall provide a guarantee. According to the Court of Appeal, this clause is valid in relation to the guarantees for alternate tenants (T1, T3, T5, etc.).10 Thus, on multiple intra‑company restructuring assignments, the same guarantor can be required to give a guarantee for T1, a sub-guarantee of T1’s AGA (whilst the lease is vested in T2), a direct guarantee of T3, a sub-guarantee of T3’s AGA and so on. In this way, the landlord succeeds in getting a renewal obligation from that guarantor for the period that the lease remains in the same group of companies. Although this initially sounds wrong, it falls within the Court of Appeal’s reasoning. A tenant can be obliged, or can volunteer, to take an assignment back of a lease, even after it has given an AGA. By the same token, therefore, so can a guarantor.
Ultimately, the Court of Appeal has provided some extremely helpful and long overdue guidance and clarity for landlords and tenants. The intra-group assignment is once again a prospect for group company tenants. However despite this, it is landlords who remain better off – now able to demand the giving of sub‑guarantees if it suits them or, if not and reasonable to do so, to demand a direct guarantee for a proposed assignee.