High Court confirms a tenant cannot assign to its guarantor

The High Court has approved the obiter dictum in K/S Victoria Street - a tenant cannot assign to its guarantor. This is prohibited under the Landlord and Tenant (Covenants) Act 1995 (LT(C)A 1995)

Background

EMI Group Ltd v O & H Q1 Ltd (2016) EWHC 529 (Ch)
A tenant went into administration. The landlord gave licence for the tenant to assign to guarantor and the lease was assigned the same day.Subsequently, the guarantor asserted that, although the assignment of the lease to it was valid, the landlord could not enforce the tenant's covenants in the lease against it. The guarantor relied on the obiter remarks of Lord Neuberger in the Court of Appeal's decision in K/S Victoria Street in support of this proposition.

What is the law in this area?

When the tenant of a new lease is released following a lawful assignment, the guarantor is released 'to the same extent'.

In some instances a landlord might prefer to take an authorised guarantee agreement (AGA) from the tenant’s guarantor as opposed to the tenant. However, LT(C)A 1995, s 16(2) provides that the outgoing tenant must give the AGA. Consequently, an agreement requiring the guarantor (as well as or instead of the tenant) to give an AGA would fall foul of the anti-avoidance provisions in LT(C)A 1995, s 25.

In K/S Victoria Street, the Court of Appeal confirmed that the High Court ruling in Good Harvest was correct. A tenant’s guarantor cannot agree to give, nor give, a guarantee for the tenant’s assignee other than by guaranteeing the tenant’s obligations under an AGA.

Lord Neuberger acknowledged that this approach meant that a lease could not be assigned to a guarantor, even where both tenant and guarantor want it. This conclusion was obiter, as it was unnecessary to the decision.

The focus of the argument in EMI was, on the correct interpretation of LT(C)A 1995, whether this statement was actually correct. This point was raised, but not decided, in UK Leasing Brighton.

What did the High Court decide?

The High Court decided that a tenant is precluded under LT(C)A 1995 from assigning the tenancy to its guarantor and any agreement which seeks to give effect to such an arrangement is void under LT(C)A 1995, s 25(1) as it frustrates the purpose of LT(C)A 1995. Therefore, on an assignment by T1, G1 cannot become T2.

Morgan J’s talk to the Property Bar Association

The court acknowledged that Lord Neuberger's statement in K/S Victoria had given rise to considerable debate in the property sector. The judge, Miss Amanda Tipples QC, was therefore curious to know whether there had been any academic writing on the topic. Counsel were unable to find any articles which were directly relevant. The judge then became aware of a talk delivered by Morgan J (the judge in UK Leasing Brighton) to the Property Bar Association on 4 November 2015 entitled 'The Landlord and Tenant (Covenants) Act 1995: 20 years on'.

In his talk, Morgan J confirmed that in his decision in UK Leasing Brighton he had left open whether Lord Neuberger’s statement was right. However, he did not think that it was. He said that LT(C)A 1995 operates in two different ways. LT(C)A 1995, s 3(2)(a) provides that an assignee becomes bound by the tenant covenants on an assignment. LT(C)A 1995, s 24(2) provides that a guarantor for the assignor is released on the assignment. In Morgan J’s view, there was no reason why LT(C)A 1995 should not operate to the full in both of these ways:

The operation on one way does not frustrate the operation of the Act in the other way. The release under section 24(2) does not frustrate the operation of section 3(2)(a). The imposition of the burden of the covenants under section 3(2)(a) does not frustrate the release under section 24(2).

Both counsel reminded the judge that these observations were made by Morgan J in the context of a talk (rather than as a result of legal argument) and they should not be given more weight than 'the words of any reputable author'.

Tindall Cobham—the operation of LT(C)A 1995, 25

The judge also referred to Tindall Cobham to demonstrate the Court of Appeal’s approach to the operation ofLT(C)A 1995, 25. There, one of the conditions in the proviso to a clause permitting intragroup assignment with landlord’s consent—that the tenant procure that the guarantor enter into a direct covenant with the landlord guaranteeing the assignee’s obligations—was (following K/S Victoria Street) void under LT(C)A 1995, s 25.

However, the Court of Appeal confirmed that this did not mean that the tenant could assign intragroup merely by giving notice, which was the other condition in the proviso. Rather the court held that the solution that respected the structure of the contract and gave effect to the provisions of LT(C)A 1995 was to regard the whole of the proviso as avoided. This left just the qualified covenant against assignment, which could be operated according to its terms and to the usual requirement to act reasonably under the Landlord and Tenant Act 1927, s 19(1).

To do otherwise would be 'to create an imbalance in the contractual provisions which in my view the legislation was not intended to create unless unavoidable'.

Reasoning of the High Court

The Law Commission, in its report leading to LT(C)A 1995, recommended that, whenever the liability of a tenant would be wholly cancelled by their recommendations, then liabilities which had been undertaken 'in parallel and are essentially to the same effect' should also be terminated.

The 'whole thrust of the Act' was that there should be no re-assumption or renewal of liabilities, whether on the tenant or the guarantor. That was the effect of LT(C)A 1995, s 5(2)(a) in the case of tenants and LT(C)A 1995, s 24(2)(a) in the case of a guarantor (or 'other person' bound by the tenant covenants). This meant that, if a tenant and the tenant's guarantor are each liable for the same or essentially the same liabilities as a result of the tenant's covenants of the tenancy, the guarantor could not as a result of assignment by the tenant to it of the tenancy re-assume those very same, or essentially the same, liabilities as the tenant. Or, using the terminology used in some of the cases, G1 could not on an assignment by T1, become T2.

This was because on the assignment by T1 to G1:

  • T1 was released from the tenant covenants of the tenancy, as from the assignment under LT(C)A 1995, 25 5(2)(a)
  • G1 was released from the tenant covenants of the tenancy, as from the release of T1 under LT(C)A 1995,25 s 24(2)
  • the effect and intention of LT(C)A 1995, s 24(2) was that 'as from the release of [T1]', ie on the assignment to T2 (formerly G1), G1 should be released from its liabilities as guarantor under the lease
  • however, as from the assignment to T2 (formerly G1), T2 becomes bound by the tenant covenants under LT(C)A 1995, s 3(2)(a)

The assignment therefore released G1 from the tenant covenants of the tenancy but, at the very same moment in time, bound G1 (but now as T2) with the tenant covenants of the tenancy.

In practical terms therefore, there was no release at all for G1 in respect of its liabilities under the tenant covenants. This was because the liabilities under the tenant covenants were simply re-assumed by the guarantor, but this time as an assignee (and not as a guarantor). Further, the liability re-assumed by G1 as T2 was the very same in a case such as this, where the guarantor was, under the terms of its guarantee, primarily liable in respect of the tenant covenants.

The objective effect of the assignment was that G1 re-assumed precisely the same liability in respect of the tenant covenants as a result of becoming T2 pursuant to the assignment. It was that consequence which frustrated the operation of LT(C)A 1995, s 24(2)(b) and the assignment was rendered void by LT(C)A 1995, s 25 (1)(a), an anti-avoidance provision which was to be 'interpreted generously'.

The guarantor was therefore absolutely precluded from becoming the assignee on an assignment by the tenant whose tenant covenants he was guaranteeing.

This was what the judge thought Lord Neuberger meant in his comment. In addition, in the main part of the judgment in K/S Victoria Street, before the obiter comments, the Court of Appeal confirmed that:

...the whole thrust of section 24(2), indeed of the 1995 Act itself, is that a person should not remain liable under a tenancy after the tenant with whose liability he is associated has been released from his liability...' (emphasis added)

The High Court did not agree with the reasoning in Morgan J’s talk. There was nothing in LT(C)A 1995, s 3(2)(a)which altered this conclusion.

The landlord’s argument here that it was released from liability under LT(C)A 1995, s 24(2) and then, as a second step, the same liability was imposed on the very same person, but this time as assignee, under LT(C)A 1995, s 3(2)(a) failed.

There was nothing in LT(C)A 1995 which provided for sequential steps in relation to the release of the guarantor from his liabilities under the tenant covenants, and the re-assumption of those very same liabilities on him as the assignee.

Rather, LT(C)A 1995, ss 5(2), 3(2) and 24(2) provided that these events should all happen at the very same moment in time, which was 'as from' the assignment. There was, therefore, no moment in time when a person who was the guarantor, and then became the assignee, was actually released from his liabilities in respect of the tenant covenants. So, whether as guarantor or as assignee, the liabilities in respect of the tenant covenants would have continued unchanged. Indeed, the need for an actual period of release was clear from K/S Victoria Street when Lord Neuberger explained:

...[If] the original tenant and the original guarantor are released from liability under the tenancy on the first assignment, and the fact that they choose subsequently, namely on a further assignment, to reassume liability under the lease cannot be said to "frustrate" their release on the first assignment.

Result of the conclusion

It was quite clear from Tindall Cobham that the court was required to take 'a balanced approach to invalidation which, whilst neutralising the offending parts of the contract, does not leave it emasculated and unworkable', and the court is entitled to look at 'the structure of the agreement in an objective and common sense way'.

The guarantor’s argument that the lease had vested in the guarantor as a matter of law, but that the tenant covenants were void and unenforceable, was unworkable as a matter of law.

The result of the court’s findings was that the purported assignment was void and of no effect, with the result that the lease remained vested in the original tenant and that the guarantor remained bound as guarantor of the original tenant's obligations under the lease as it had not been released from its obligations under the guarantee by the operation of the LT(C)A 1995.

This conclusion lead to a clear, simple and certain position and was reinforced by Lord Neuberger’s comment in K/S Victoria Street that 'the lease could not be assigned to the guarantor, even where both the tenant and guarantor wanted it'. It was not a question of picking and choosing which aspects of the lease will survive the assignment from the original tenant to the guarantor. Rather, as Lord Neuberger said, such an assignment was simply void.

What are the implications of the decision?

The decision in K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904, [2011] All ER (D) 262 (Jul) was unpopular with businesses, with cooperative landlords, seeking to assign leases between group companies where the parent company was the only viable guarantor.

In addition, Lord Neuberger’s obiter comments, until litigated, appeared to close off another approach which was not considered to be conclusively barred by Good Harvest—assignment to a guarantor who then gives an AGA on assignment to a third party assignee.

We now have a definitive answer that this avenue is also closed—a tenant cannot assign to its guarantor in any circumstances.

Amanda Tipples QC observed, that, as was clear from K/S Victoria Street, 'the fact such a conclusion is unattractively limiting and commercially unrealistic is neither here nor there.'

Unfortunately, while the proposals for The Law Commission’s twelfth programme of law reform suggested addressing the property sector’s concerns as to the law on former tenant and guarantor liability, the issue did not make the ‘final cut’ and so is not part of the twelfth programme.

There will be many hoping that this decision is appealed.

 

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