In March this year, the Court of Appeal upheld the High Court's decision in Scottish & Newcastle Plc -v- Raguz. The decision has surprising implications for those that are seeking to recover monies from former tenants or for those that have suffered by having action taken against them for the recovery of backdated rent and/or balancing service charges.

The High Court decision in Raguz took most property professionals by surprise when it was handed down in spring 2006. Initially many took the view that the decision reached by the Court on the recovery of backdated rent was wrong and anticipated that it would be overturned on appeal. However, the Court of Appeal has unanimously upheld the original decision.

Background - the 1995 Act

The Landlord and Tenant (Covenants) Act 1995 was enacted to address the continuing liability of former tenants for the performance of tenant's covenants following assignment until the end of the term.

The 1995 Act divided leases into two categories. Tenants under 'new leases' (ie. leases granted after 1 January 1996) can remain liable until the expiry of an AGA (authorised guarantee agreement). Tenants of leases granted before that date ('old leases') remain liable following assignment for the due performance of the tenant's covenants until expiry of the term.

Section 17 of the 1995 Act requires landlords to serve notice on former tenants of both new and old leases of their intention to seek to recover 'fixed charges' (such as rent) within six months of the date on which the fixed charge falls due. This is a precondition to recovering such sums from former tenants (or guarantors).

The case

In Raguz a rent review due in 1996 was not settled until 2001 at which time the current tenant was in financial difficulties. Following completion of the review s.17 Notices were served on the original tenant for the additional rent. It paid and sought an indemnity from its assignee who maintained that the original tenant did not need to pay because the s.17 Notices were invalid.

A typical institutional lease will provide that, on review, if the rent is reviewed upwards and the new rent is ascertained (ie. 'completed' either by the parties reaching agreement or by a third party determination) after the review date, the new rent will be payable from the review date and the tenant must make a 'balancing payment'. Typically the balancing payment will be payable on the quarter day following completion of the review.

One of the issues that the Court needed to consider in Raguz was whether, for the purposes of s.17, such a balancing payment fell due on the date it became payable (i.e. the quarter day after the completion of the review) or on a different date.

The Court decided that liability for the reviewed rent did not fall due when the balancing payment became payable but instead accrued as each instalment of the passing rent fell due between the review date and the date the review was completed.

The effect

What this means is that to protect its right to pursue a former tenant for the balancing payment in these circumstances, a landlord must serve a s.17 Notice within six months of each rent day falling within the period from the review date.

Each s.17 Notice must explain that the landlord is protecting its right to claim the balance of reviewed rent once this has been ascertained. Once the new rent has been determined, a further s.17 Notice must be served within three months of that date. Landlords now need to give consideration to former tenant liability and whether a s.17 Notice should be served perhaps months or years before the balancing payment is finally ascertained. In particular, landlords will need to consider the possibility that a solvent tenant with a strong covenant might subsequently run into financial difficulties before the rent review is completed and consider whether to serve protective s.17 Notices.

Landlords may wish to take a selective approach by considering the degree of exposure on a case by case basis in deciding whether or not to serve a protective s.17 Notice, especially given that the typical recovery of costs provision found in affected leases will not allow those costs to be recovered unless or until the current tenant fails to pay the balancing payment.

Such measures may include:

  • identifying those properties with previous tenants and guarantors who may be liable for arrears of rent and service charges; and of these; identifying those properties with outstanding rent reviews/balancing service charge payments;
  • on a regular basis identifying the properties with rent reviews/service charge instalments with balancing payments coming up; considering the solvency of the current tenant;
  • unless you are confident of the existing and future solvency of the current tenant, to serve s.17 Notices within six months of the due date even if the sums are unascertainable and frequent notices have to be served, and then serve further s.17 Notices within three months of the sums being ascertained.