In terms of the reform of the law for commercial leases, the Landlord and Tenant (Covenants) Act 1995 is perhaps most in need of attention.
The effect of the legislative provisions on the release of outgoing tenants and the provision of guarantors for new tenants has potentially serious valuation implications.
The Act’s mechanisms are intricate but in some respects not quite as clear as they might be, and the wide-ranging anti-avoidance provisions might strike down valuable guarantees where a court determines an uncertainty of the Act in an unpredicted way. Also is it right that the anti-avoidance provision should apply where legally advised parties clearly intend otherwise?
It is crucial that parliament resolves such uncertainties and commercial concerns so the lease parties can be assured their contractual provisions will be enforceable and property values protected.
Impediment to the parties’ intentions
Some of the Act’s failings are understandable, arising from key concepts such as the authorised guarantee agreement provisions being introduced late in the legislative process and not being properly integrated into the Act.
The result is that the Act, in some respects, has become an impediment to what should be day-to-day transactions, such as a guarantor guaranteeing an assignee of a lease or becoming the assignee. The consequential uncertainty over the efficacy of particular drafting can interfere with intra-group restructuring which can end up being more detrimental to the tenant and its guarantor (who the Act primarily seeks to protect) than to the landlord.
A repeat guarantee is invalidated even where the tenant and its guarantor intend that the guarantee is provided or freely offer it. Defeating freedom of contract in those circumstances seems unreasonable. To protect the property valuation, a landlord may be forced to stymie the tenant’s restructuring proposals, exacerbated often by there being only one financially strong company in the tenant’s group. Neither the landlord nor the tenant win in that situation.
Sub-guarantors
The Act provides that if a tenant assigns a “new tenancy” (essentially, one entered into from 1 January 1996), it is released but can be required by a landlord to guarantee its immediate assignee only, under an authorised guarantee agreement. But could the outgoing tenant’s guarantor be required to guarantee the assignee?
In K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904; [2011] 2 EGLR 11, the Court of Appeal decided a tenant’s guarantor cannot validly guarantee the liability of a future assignee (even if the guarantor wishes to do so), because of the anti-avoidance provisions. This decision causes serious problems for landlords seeking to rely on an existing guarantee by an assignor’s guarantor of an assignee, but can also cause problems for tenants in potentially preventing intra-group assignments.
While the court, obiter, sanctioned the so-called “sub” or “parallel” guarantee, by which an existing or contracting guarantor of a tenant can validly be required to guarantee the assignor’s liability under the AGA, such a guarantee should clearly be referenced in the Act. It is a curious anomaly that the Act does not specifically address the position of tenant’s guarantors.
If the tenant assigns intra-group, the guarantor can sub-guarantee, but what if the assignee further assigns to another company in the group? Can the original guarantor directly guarantee T3? The judgment, on its words, would suggest the original guarantor can directly guarantee T3, even when it had previously sub-guaranteed T1’s AGA obligations for T2, but the judgment did not specifically address a direct guarantee for T3. Legislative clarification will be welcome.
Assignment to guarantors
In EMI Group Ltd v O&H Q1 Ltd [2016] EWHC 529 (Ch); [2016] EGLR 26, the High Court (following obiter comments in House of Fraser) decided a tenant could not assign a “new tenancy” to its guarantor. Any agreement which sought to give effect to such an arrangement was void, because it frustrated the purpose of the Act, since there is no release for the guarantor for its liabilities under the tenant covenants.
There are doubts about the correctness of this decision, but it is the law and its retrospective effect creates uncertainties over what happens if an assignment is now treated as void as a result of the decision. It appears the assignment does not take effect to vest the lease in the guarantor as an assignee, so the assignor remains the tenant and the guarantor retains its liability as guarantor. So what is the impact on registration of the assignee at the Land Registry or on any mortgage of the assigned lease?
Also, if a tenant cannot assign a “new tenancy” to its guarantor, can a tenant assign to itself and another party? It is strange the court decided the guarantor is unable to become the tenant and use the premises, even if all the parties desired it.
Unexpected commercial outcomes
The Act has had an impact on the property industry and through its abolition of privity of contract provided much-needed protection for former tenants. But uncertainties in the drafting of the legislation have led to court decisions that have created unexpected commercial outcomes with potential implications for value. Many would welcome the Law Commission reviewing the Act to resolve the uncertainties and address the commercial concerns.
Warren Gordon is a senior professional support lawyer at CMS
