by Gerald Sherriff
In times when finances are difficult there are unfortunately more and more tenants who are unable to pay their rent, service charges and other payments under their lease in full. Some of these tenants become insolvent and a landlord will need advice as to how he can best protect his interests.
This article primarily explores the manner in which a landlord can make a claim in respect of non-payment of rent or other breach of covenant against a former tenant or the guarantor of a former tenant.
There are a number of straightforward ways in which a landlord can seek to recover payment from the current tenant. Distress (where the bailiff seeks to recover arrears from the sale of the tenant’s goods) can be effective in the case of payments reserved as rent where businesses are seeking to continue trading, because tenants will sometimes pay the bailiffs rather than have their equipment taken, as this would prevent them trading further. However, distress is of no real help when the tenant has to cease trading.
Suing the tenant himself is equally ineffective at this stage, if the tenant is insolvent. Even if judgment is obtained this does not guarantee that the money is paid. If there is a guarantor, action could be commenced against the guarantor, although frequently in the case of small companies the guarantors are the proprietors of the company, and if the company fails their ability to pay may be limited or of no practical assistance to the landlord. Using the rent deposit (if any) paid by a tenant will at least give the landlord a payment of a quarter’s rent while deciding what further steps he can take.
Where the current tenant is insolvent a claim in the bankruptcy/liquidation is one possibility, although a landlord needs to be aware that a receiver or liquidator can sometimes disclaim a lease after which the liability of the insolvent tenant and his guarantor ceases.
Where any of these methods of recovery is unlikely to be successful a landlord will look to see if there are any previous tenants (or their guarantors) who may be able to pay the landlord, and this article indicates the basis upon which such claims may be made. There may often be practical difficulties in tracing former tenants and sometimes tenants in the chain are dead or have been wound up, but the following shows who a landlord can seek to pursue, and in respect of what breaches of covenants.
How it works
Assume landlord L1 lets to tenant T1. L1 assigns the reversion to L2 who assigns to L3. T1 assigns the lease to T2 who assigns to T3.
The basis of liability is either privity of contract or privity of estate:
Privity of contract
T1 and L1 remain liable to each other under privity of contract throughout the whole term of the lease, even after they have assigned their respective interests. The liability extends even during the statutory extension of a business lease, and during a renewal pursuant to an option. T2 and T3 will be in the same position as T1 regarding liability if they covenant directly with the landlord to observe the lease covenants for the residue of the term. (By contrast, assignees of the reversion rarely covenant direct with tenants or assignees to observe the covenants on the landlord’s part in the lease but, if they did, then they would be liable to the tenant in respect of all covenants for the residue of the term as above.) If the first tenant, T1, is sued by the landlord after T1 has assigned, T1 can usually sue T2 under indemnity covenants and T2 can sue T3 etc in an attempt to recover what T1 has paid to L1.
Privity of estate
The people who are in the relationship of landlord and tenant at the time are liable to each other for breaches of covenant “touching and concerning the land” — ie most of the major covenants, but not personal covenants. So L3 could sue T2 for breaches of the major covenants while they were landlord and tenant. L3 could alternatively sue T1, leaving T1 to claim an indemnity from T2.
As a guarantee is an indemnity, and subject to special provisions in the guarantee clause, if L3 were landlord and T2 were a defaulting tenant (of clauses touching and concerning) L3 could sue T1, T1’s guarantor, T2 or T2’s guarantor. If the current landlord and tenant were L3 and T3, and there was a breach of a clause touching and concerning, L3 could sue T1 or T1’s guarantor or T3 or T3’s guarantor. L3 could sue only T2 (or T2’s guarantor) if they had given direct covenants which would make them liable under privity of contract.
Privity of contract
Further examples
A lease is a contract between landlord L1 and tenant T1 and they each remain liable to each other in respect of all covenants for the whole of the term, even after they have parted with their interest. The liability is a primary liability, not merely that of a surety who would be liable only if the assignee (T2) does not perform his obligations. (If an assignee, T2, becomes insolvent and his trustee in bankruptcy disclaims the lease, the guarantor of T2 is released but not the first tenant, T1.) Under the doctrine of privity of contract, L1 can sue T1 for breach of covenant even after T1 has assigned to T2, even though L1 can also sue T2 under the doctrine of privity of estate for most breaches during the period while L1 and T2 are in the relationship of landlord and tenant. T1 can claim an indemnity from T2 in such circumstances (eg Warnford Investments Ltd v Duckworth [9] Ch 127), although the landlord will normally sue only the original tenant because the current tenant is insolvent (as in Warnford) or the landlord is unable to obtain satisfaction from the current tenant for some other reason, and so T1 may have a legal remedy against T2 which is in reality worthless.
Varying the original tenant’s liability
The liability of the original tenant continues to apply even where the terms of the lease are varied, for example where the landlord agrees to release the guarantor of the assignee, Allied London Investments Ltd v Hambro Life Assurance Ltd (1984) 269 EG 41, or perhaps where the landlord changes the user clause, thus making the rent payable on review likely to be higher, or where the repairing obligation of the tenant is increased by agreement.
The original tenant, T1, remains liable during the term where the rent is increased in accordance with review provisions even though T1 usually has no way of influencing the negotiations (Centrovincial Estates plc v Bulk Storage Ltd (1983) 268 EG 59). It was pointed out that the lease contemplated rent reviews and so, even though the amount was not known at the time when the lease was completed, the parties were aware that the rent would be varied. In Selous Street Properties Ltd v Oronel Fabrics Ltd (1984) 270 EG 643, in the following year, this was emphasised when T1 was liable for rent on review which reflected an improvement made by T2 where the lease prohibited improvements but the landlord had agreed to them.
If the change is so drastic as to amount to a surrender of the old lease (by operation of law) and regrant on new terms, then the privity of contract between L1 and T1 is broken and the privity of contract is then between those parties who are landlord and tenant at the time of the change.
Duration of the original tenant’s liability
The liability of the original tenant under privity of contract extends during a period of renewal pursuant to an option in the lease: Baker v Merckel [0] 1 QB 657. It also extends, in the case of a business lease, during the statutory extension under section 24(1) of the Landlord and Tenant Act 1954. A subtenant who had covenanted direct with a landlord remained liable for breach during the statutory extension (GMS Syndicate Ltd v Gary Elliott Ltd (1980) 258 EG 25), although it was earlier held that the original tenant’s guarantor was not liable during the statutory extension unless the guarantee provisions made this clear.
Who can enforce the original parties’ liability?
Obviously, L1 can enforce covenants against T1 while both are still parties. The Law of Property Act 1925 provides that where a landlord assigns the reversion (section 141(1)) or a tenant assigns the lease (section 142(1)) the benefit of the other party’s covenants pass to the assignee of the reversion or the assignee of the lease, as the case may be, so far as such covenants “have reference to the subject-matter of the Lease”: see below under privity of contract for more details, but this basically means all covenants other than purely personal covenants.
According to Re King [3] Ch 459 and London & County (A & D) Ltd v Wilfred Sportsman Ltd [1971] Ch 764) (a very difficult case) the effect of section 141(1) is that where a landlord has assigned the reversion only the assignee can sue the tenant in respect of breaches having reference to the subject-matter of the lease. However, according to City & Metropolitan Properties Ltd v Greycroft Ltd [1987] 2 EGLR 47; (1987) 283 EG 199, section 142(1) does not prevent the original tenant from suing the landlord after the original tenant has assigned the lease. It is hard to see the justification for this difference.
Two further contrasting cases: Arlesford Trading Co Ltd v Servansingh [1] 1 WLR 1080 showed that L2 could sue T1 on covenants having reference to the subject-matter of the lease even though T1 had assigned before L2 acquired the reversion. In Celsteel Ltd v Alton House Holdings Ltd (No 2) [1987] 1 EGLR 48 at p49 the Court of Appeal suggested that the converse applies so that T2 can sue L1 where T2 became tenant after L1 assigned the reversion, at least for covenants having reference.
Indemnity
On assignment of a lease a tenant usually takes an indemnity from an assignee. This is often an express indemnity and construction thus depends on its terms. In the case of registered land an indemnity is implied in any transfer (Land Registration Act 1925, section 24(1)): in the case of unregistered land section 77(1)(c), the Law of Property Act 1925 implies an indemnity covenant only in the case of an assignment for valuable consideration. The implied indemnity is to pay rent and observe all the other obligations, and is thus not limited to covenants “having reference”, and is for the remainder of the term, not just while the assignee is tenant. Accordingly, there will normally be an implied indemnity on any assignment by a tenant except in the case of assignments of unregistered land not for valuable consideration. Even in the latter case the Court of Appeal in Johnsey Estates Ltd v Lewis & Manley (Engineering) Ltd [7] 2 EGLR 69; (1987) 284 EG 1240 suggested that the obligations undertaken by an assignee by virtue of section 77(1)(c) constituted valuable consideration, thus implying the covenant for indemnity in a rather circular fashion. (There is no statutory indemnity where a landlord assigns the reversion and accordingly a landlord should take an express indemnity for his own protection.)
Since an original tenant normally has no right to enter to remedy a breach by a successor his liability is normally for payment of money, but he is entitled to reimbursement either from his assignee (under the express or implied indemnity) or from the person who was tenant at the time of the breach under a quasi-contractual right of reimbursement: Moule v Garrett (1872) LR 7 Ex 101. What that indemnity is worth is, of course, another matter.
If the original tenant (T1) is sued he can normally claim only against his assignee (T2), leaving T2 to sue T3 and T3 to sue T4 etc down to the current tenant. If the chain of indemnity is broken (by parties who have ceased to exist or cannot be traced or are insolvent) those parties earlier in the chain seem only to have two means of passing on their liability: the quasi-contractual liability under Moule v Garrett is one and the other (where an intermediate assignee has become insolvent) is taking an assignment from the trustee in bankruptcy or liquidator of the right of the (insolvent) assignee to indemnity from the next person in the chain: Selous Street Properties Ltd v Oronel Fabrics Ltd.
Mitigating the prospect of liability by an original tenant
The original tenant can always seek to negotiate in the lease that his liability will end when he assigns, although landlords rarely agree. In business leases tenants often seek to ensure that their liability ceases at the end of the contractual term (ie not during the statutory extension) if they are not the tenant at that time.
Instead of assigning the lease when he ceases to need premises a tenant who is concerned about first tenant liability could underlet as an alternative. In this way he would retain the original leasehold interest and would have control (as landlord) over the undertenant. This does, however, involve the original tenant in management time for no direct benefit (unless he can underlet at a profit), as well as the possibility of a shortfall if the undertenant does not pay, and tenants normally prefer to assign to an assignee whose references seem good in the hope that they will not be called on again.
Privity of estate
General
The preceding section covered privity of contract where the concern was the liability of the original landlord and the original tenant for covenants in the lease. This section deals with privity of estate and concerns the enforceability of obligations between the landlord and tenant for the time being, following assignment of the lease, or the reversion, or both.
If an assignee of the lease enters into a direct covenant with the landlord, for example in the licence to assign, then the liability is contractual and the principles mentioned in the preceding section apply.
What lease covenants are enforceable against successors?
The answer is that those covenants which “touch and concern the land” are enforceable, Spencer’s Case (1583) 5 Co Rep 16a, and personal or collateral covenants are not.
Examples of (enforceable) tenant’s covenants which “touch and concern the land” or “have reference to the subject-matter of the lease” (which are effectively the same) are:
(a) to pay rent, Parker v Webb (1693) 3 Salk 5;
(b) to repair buildings, Martyn v Clue (1852) 18 QB 661;
(c) to insure against fire, Vernon v Smith (1821) 5 B & Ald 1;
(d) as to use for domestic purposes only, Wilkinson v Rogers (1864) 2 de G J & S 62;
(e) not to assign without the landlord’s consent, Williams v Earle (1868) LR 3QB 739 and Cohen v Popular Restaurants Ltd [7] 1 KB 480; and
(f) to sell only the landlord’s brand of goods from the premises, Clegg v Hands (1890) 44 ChD 503.
The test to decide whether covenants “touch and concern”
There have been a number of general tests over the years. For example, a covenant will touch and concern the land (a) if it per se affects the nature, quality or value of the land, Dyson v Foster [9] AC 98 at p 102, and (b) if it affects the landlord in his normal capacity as landlord and the tenant in his normal capacity as tenant, Hua Chiao Commercial Bank Ltd v Chiaphua Industries Ltd [1987] AC 99, and (c) if the covenant is beneficial to the owner for the time being of the covenantee’s land and to no one else, Vyuyan v Arthur (1823) I B & C 410. (The House of Lords in P & A Swift Investments Ltd v Combined English Stores Group plc [1988] 2 EGLR 67 set out a test putting these factors together, to which the reader is referred.)
The Law Commission report of 1988, Privity of Contract and Estate, comments on the liabilities and cites as examples of inconsistency Woodall v Clifton [5] 2 Ch 257 which held that a landlord’s covenant to renew ran with the land, and Re Hunters’ lease [1942] 1 All ER 27 where a landlord’s covenant to make a payment to the tenant at the end of the lease or to grant a new lease in default did not run with the land. As a further example a covenant not to employ a named person on business premises binds the tenant’s successors (Lewin v American & Colonial Distributors Ltd [1945] Ch 225), but a covenant not to employ a particular class of people on the property does not (Mayor of Congleton v Pattison (1808) 10 East 130).
Deposits and sureties
In Hua Chiao Commercial Bank Ltd v Chiaphua Industries Ltd the lease provided for the tenant to pay to the landlord a substantial deposit at the outset which was to be returned at the end of the term if there was no breach of the tenant’s covenants. The lease did not require the landlord to transfer the deposit to an assignee of the reversion nor did it put any obligation on the tenant to assign to an assignee of the lease the right to call for the deposit at the end of the term. The reversion was assigned, after which the original landlord who had not transferred the deposit to the assignee became insolvent. The Privy Council held that the obligation to return the deposit did not run with the land and the original tenant could not claim its return from the new landlord: it was a personal obligation and the tenant was left to make such claim as he could from the insolvent first landlord.
Lord Oliver, giving the judgment, made it clear that not every covenant which relates to some other obligation which does touch and concern the land (for example, the obligation to pay rent) necessarily has the same characteristics as that obligation.
In Kumar v Dunning [7] 2 EGLR 39; (1987) 283 EG 59 the Court of Appeal held that the covenant of a surety, guaranteeing performance of covenants by the tenant which touch and concern the land, does have the same characteristics and therefore can be enforced by an assignee of the reversion. The House of Lords expressly approved the decision in P & A Swift Investments v Combined English Stores Group plc.
Normally the liability of a surety depends on the terms of the surety clause. Some are limited to the period while the principal is tenant, while others are for the whole term. The guarantor’s covenants “touch and concern”, Kumar v Dunning, and so they can be enforced against the guarantor by an assignee of the reversion. As the liability of the surety is (subject to modification in the surety clause) the same as that of the principal, the guarantor of the original tenant is liable throughout the term, although not during the statutory extension of a business lease, Junction Estates Ltd v Cope (1974) 27 P&CR 482 and A Plesser & Co Ltd v Davis (1983) 267 EG 1039. Where any assignee of the tenant (for example, in a licence to assign) has covenanted directly with the landlord to observe the covenants during the remainder of the term his guarantor (if any) is similarly liable (again subject to the express terms of the guarantee clause).
Where the principal debtor’s liability ceases, so does that of the guarantor: where the original tenant became insolvent and his trustee in bankruptcy disclaimed the lease the liability of the original tenant ceased, and so did the liability of his guarantor, Stacey v Hill [1] 1 KB 600. Where the original tenant had assigned and the assignee became bankrupt, after which the assignee’s trustee in bankruptcy disclaimed the lease, the effect was that the assignee (T2) and the guarantor of the assignee ceased to be liable, but the original tenant (T1) and the original tenant’s guarantor both remained liable; see Warnford Investments v Duckworth.
Duration and liability
The assignee is liable only in respect of breaches occurring while he is tenant. For example, the assignee of the lease is not liable for breaches occurring before he acquired the lease, unless they are continuing breaches, such as breach of the covenant for repair, Granada Theatres Ltd v Freehold Investment (Leytonstone) Ltd [9] Ch 592. Again, under privity of estate, an assignee is not liable for breaches occurring after he has assigned, Paul v Nurse (1828) 8 B & C 486, unless he has entered into a direct covenant with the landlord to observe the covenants during the residue of the term.
