In the recent case of K/S Victoria Street v House of Fraser (Store Management) Limited and others [2011] EWCA Civ 904 ("K/S"), the Court of Appeal upheld the decision reached by the High Court in Good Harvest LLP v Centaur Services Limited [2010] EW HC 330 ("Good Harvest") that section 25 of the Landlord and Tenant (Covenants) Act 1995 prevents the guarantor of a tenant's obligations from guaranteeing the obligations of that tenant's assignee.

The case of K/S itself addressed two points:

  1. whether a lease clause specifying an assignee and obliging the current guarantor to guarantee that assignee's obligations was invalid, and
  2. whether, if the lease was assigned, the terms of the lease could permit the lease to be assigned back.

The facts themselves were quite specific and the main focus was on the Court of Appeal's interpretation of the first point in relation to the High Court decision in Good Harvest .

The facts

Under a sale and leaseback agreement, K/S bought the freehold of a department store from House of Fraser (Store Management) Limited ("Management"), a subsidiary of House of Fraser plc ("HoF"), and immediately leased the property back to Management. Management's obligations under the lease were guaranteed by HoF.

The purchase and leaseback agreement provided for assignment within the first three months of the lease to a different subsidiary company of HoF and failing this to House of Fraser (Stores) Limited ("Stores").  In either scenario, HoF was to guarantee the assignee's liabilities under the lease.

The lease was not assigned within the three month period and K/S started proceedings to enforce the assignment of the lease to Stores and secondly for HoF to act as Stores' guarantor.  Management and HoF argued that, in line with the ruling made in Good Harvest, the requirement for HoF to guarantee the assignee's obligations under the lease fell foul of the 1995 Act.

The Court of Appeal's decision

The Court of Appeal held that while K/S could enforce the assignment from Management to Stores, the requirement for HoF to guarantee Stores' obligations under the lease was void.  The Court of Appeal explained its decision on the basis that section 5(2)(a) of the 1995 Act releases a tenant from its liabilities under a lease from the moment of assignment and section 24 (2) of the 1995 Act extends this release to any guarantor of the tenant's covenants.  Section 25 of the 1995 Act prohibits any agreement, whether entered into before or at the same time as the lease, which excludes or modifies the provisions of the 1995 Act.

Wider implications

The Court of Appeal took the opportunity to look more fully at some of the High Court's findings in Good Harvest as that decision had resulted in a degree of controversy and uncertainty.

In Good Harvest the lease required, as a condition of assignment, both the outgoing tenant and the outgoing tenant's guarantor to enter into an authorised guarantee agreement ("AGA") to guarantee an assignee's performance of the lease covenants. A tenant entering into an AGA is the one exception from the automatic release of a tenant upon an assignment.  However, the requirement for the tenant's guarantor to guarantee the assignee's obligations was held to be void under section 25 of the 1995 Act.  This condition frustrated the operation of section 24(2) of the 1995 Act by preventing a guarantor from being released from its obligations.

The Court of Appeal considered the following scenarios in more detail:

Guarantees freely given in respect of an immediate assignee

The Court of Appeal looked at whether guarantees would be void under the 1995 Act if freely given.  On balance, it was decided that a strict interpretation of section 25 of the 1995 Act was preferable, prohibiting a tenant's guarantor from giving a repeat of a guarantee in respect of an immediate assignee.  This interpretation would remove any possibility of uncertainty in the future as to whether or not a guarantor had indeed freely entered into such an agreement.

Guarantees given in respect of subsequent assignees

The Court of Appeal considered the commercial implications of a strict interpretation of the 1995 Act and reasoned that a guarantor can validly guarantee the liability of a subsequent assignee.  The intermediate assignment would have released the guarantor from its liability as required by the 1995 Act and leaves the guarantor free to decide whether to grant a fresh guarantee at some point in the future.

Guarantee of a tenant's obligations under an AGA (sub-guarantee)

The 1995 Act does not expressly state whether a guarantor is entitled to guarantee the obligations of a tenant under an AGA.  However, the Court of Appeal found that a guarantor could sub-guarantee in this way.  The Court of Appeal stated that the purpose of section 24 of the 1995 Act was to release a guarantor so far as the tenant itself had been released from its liabilities under the lease.  In guaranteeing a tenant's obligations under an AGA, the purpose of section 24 of the 1995 Act is not impacted upon, and the guarantor remains liable only to the same extent as the outgoing tenant.

Conclusions

The decision in the Court of Appeal case of K/S was presented by the Master of the Rolls.  The main point of law is that a guarantor cannot be required to guarantee the obligations of an immediate assignee, however the decision states an absolute prohibition: i.e. not only can the guarantor not be required to do so, he cannot freely enter into such an arrangement.  Although this extended outcome is not binding, due to the decision beyond whether a guarantor can be required to give a guarantee, not being relevant to the facts of the case, the full extent of the decision is nonetheless likely to be followed.

Landlords may now seek to revisit existing lease arrangements.  Any guarantees repeated in respect of immediate assignees will be considered void and may impact on the value of an investment.

In respect of new leases, landlords would be wise:

  • to not accept offers from an outgoing tenant's guarantor to guarantee the tenant's assignee.  This will be void under section 25 of the 1995 Act even if the parties agree to proceed on this basis;
  • to look for alternative methods of protection of their investments to replace repeat guarantees, such as rent deposits;
  • to require that tenants seek consent and consider introducing more rigorous tests for intra-group assignments.  If tenants are free to assign intra-group, landlords miss the opportunity to request that the tenant enters into an AGA and that a guarantor provides a sub-guarantee in respect of the tenant's obligations under the AGA; and
  • to provide generally for a tenant to be obliged to enter into an AGA on assignment and for its guarantor to grant a sub-guarantee of that tenant's obligations under an AGA.

To read the decision in K/S Victoria Street v House of Fraser (Store Management) Limited and others click here.