EMI Group Ltd v O&H Q1 Ltd [2016] EWHC 529 (Ch); [2016] EGLR 26 highlighted once again the difficulties that property professionals and the courts face when seeking to apply what ought to be a simple and straightforward Act: the Landlord and Tenant (Covenants) Act 1995 (“the 1995 Act”). The appeal in EMI was due to be heard by the Court of Appeal in May, but the parties have now settled.
Reminder of the facts
EMI concerned the assignment of a lease (a “new tenancy” under the 1995 Act) by an original tenant (T1) to its own guarantor (G1), so that G1 became the new tenant (T2). The assignment was made with the consent of the landlord (L). Following the assignment, EMI contended that, while the estate created by the lease was vested in EMI (as T2), EMI (as T2) was not bound to observe and perform the tenant covenants contained in the lease. EMI proposed that the right of re-entry continued to have effect so that, for example, should EMI (as T2) not pay the rent or observe and perform the tenant covenants then L could exercise that right of re-entry so as to bring the tenancy to an end.
L sought to persuade the court that either: (i) the assignment of the lease to G1 was valid and G1 (as T2) was bound to observe and perform the tenant covenants in the lease or, in alternative; (ii) that the assignment of the lease to G1 (as T2) was invalid and the lease remained vested in T1.
Property professionals will be familiar with the obiter remarks of Lord Neuberger in K/S Victoria Street v House of Fraser (Stores Management) Ltd and others [2011] EWCA Civ 904; [2011] 2 EGLR 11 that the application of the 1995 Act “would also appear to mean that the lease could not be assigned to the guarantor, even where both tenant and guarantor wanted it” [37].
The transaction in EMI occurred during the latter part of 2014 and had L refused its consent to the assignment on the basis of Lord Neuberger’s obiter remarks, then L would probably not have been acting unreasonably and T1 and EMI would have had to accept that refusal of consent.
In the event, L did consent to the assignment and the outcome of EMI depended on how Lord Neuberger’s obiter remarks translated into the actual interpretation and application of various sections of the 1995 Act following the assignment of the lease by T1 to G1.
The relevant sections of the 1995 Act in EMI are:
(a) sections 3(1) and 3(2) – the annexation of covenants to the premises and the transmission of the burden of tenant covenants (and the benefit of landlord covenants);
(b) section 4 – the transmission of rights of re-entry;
(c) section 5(2) – the release of an assigning tenant from the burden of the tenant covenants;
(d) section 24(2) – the release of other persons (usually guarantors) from the burden of the tenant covenants on the release of the tenant; and
(e) section 25(1) – the anti-avoidance provisions.
Two-question approach
There are two questions which need to be answered in a situation such as this:
(a) Are any provisions of the 1995 Act frustrated by the transaction so that section 25 needs to be engaged?
(b) If section 25 needs to be engaged, what is the effect of section 25 on the transaction?
In EMI those two questions were answered as follows:
(a) “Yes”, because the 1995 Act requires that on an assignment by T1, G1 must be released from the tenant covenants to the same extent as T1 is released and that release must be real, as opposed to illusory or fleeting, so the burden of the tenant covenants cannot fall on G1 as the new tenant, T2.
(b) The court held that in order to avoid the operation of those releases being frustrated, section 25(1) had to be applied and ruled that the assignment itself was void, in effect putting the parties back to the position in which they had been prior to the assignment taking place.
This article looks at whether or not the operation of sections 3, 5 and 24 of the 1995 Act results in a position where the anti-avoidance provisions of section 25 are engaged, while part two will look at what the effect of section 25 is (or ought to be) on the various elements in the transaction.
Landlord and Tenant (Covenants) Act 1995
The main purpose of the 1995 Act was to provide for the release of tenants (and their guarantors) from the burden of the tenant covenants on a lawful assignment of the lease so that there would be a “clean break” between the parties: that was, and remains, the overriding rationale underlying the 1995 Act.
The immediate release of the tenant and its guarantor on assignment is, of course, subject to the exceptions of an authorised guarantee agreement by T1 and a guarantee of T1’s authorised guarantee agreement by G1.
In order to safeguard the goal of the 1995 Act, parliament included section 25(1): a “comprehensive anti-avoidance provision” drafted in “wide terms” and one which is to be “interpreted generously” (Avonridge Property Co Ltd v Mashru [2005] UKHL 70; [2006] 1 EGLR 15).
Section 25(1) provides:
“Any agreement relating to a tenancy is void to the extent that –
(a) it would apart from this section have effect to exclude, modify or otherwise frustrate the operation of any provision of this Act…”
In EMI, the relevant provision of the 1995 Act which was at risk of being frustrated was the release of G1, as guarantor, from the burden of the tenant covenants to the same extent as T1, as tenant, was being released pursuant to section 5(2) on the lawful assignment of the lease. It was argued that what would frustrate that release of G1 would be the imposition of the burden of the tenant covenants on G1 as the new tenant, T2.
Although EMI was primarily concerned with the impact on G1/T2, it is worth remembering that the 1995 Act was also operating to release T1 from the burden of the tenant covenants.
The first question: are any provisions of the 1995 Act being frustrated?
What needs to be considered is whether the burden of the tenant covenants is passed from T1 to G1 (as T2) by an assignment of the lease and, if it is, is that passing of the burden such as to frustrate any provisions of the 1995 Act.
It would seem unarguable that, subject to any operation of section 25(1), the 1995 Act provides that the burden of the tenant covenants passes with the premises (or the leasehold estate) such that the burden of those covenants falls on the person who is, from time to time, the tenant under the tenancy. So if the premises are assigned by a tenant to its guarantor, the guarantor on becoming the (new) tenant also assumes the burden of the tenant covenants.
Property professionals will be aware of the analysis of the operation of sections 3 and 5 of the 1995 Act by Morgan J in UK Leasing Brighton Ltd v Topland Neptune Ltd; Zinc Cobham 1 Ltd v Adda Hotels (an unlimited company) [2015] EWHC 53 (Ch); [2015] EGLR 20. Morgan J subsequently expanded on this in a talk to the Property Bar Association in November 2015.
What Morgan J says, in essence, is that the releases from, and imposition of, the burden of the tenant covenants are separate, sequential steps within the operation of the 1995 Act so that T1 and G1 are released (sections 5(2) and 24(2)) and then T2 (the former G1) becomes bound by the tenant covenants (section 3) and therefore the anti-avoidance provision (section 25(1)) was not engaged: “The operation [of the 1995 Act] in one way does not frustrate the operation of the Act in the other way” ([72] of the talk).
The deputy judge in EMI asked the parties for their written submissions on Morgan J’s talk after the trial but before giving judgment. The landlord’s submission was that the analysis advanced by Morgan J was correct. However, EMI’s submission was that the use of the words “as from the assignment” in sections 3(2), 3(3), and 5(2) negate the interpretation of the relevant provisions of the 1995 Act operating in “two consecutive ways” ([72] of Morgan J’s talk) and this submission was accepted by the deputy judge and, in her decision, formed the basis of the answer to our first question.
EMI also submitted that Morgan J’s suggestion that section 25(1) could not be engaged to render the operation of another section of the 1995 Act void was incorrect. EMI submitted that:
(a) the words of section
25(1)(a), ie “it would apart from this section have effect to….”, showed that the intention of parliament was that all other sections of the 1995 Act (save one, section 16(1)) should be read as being subject to section 25(1);
(b) the fact that when parliament wished to “make an exception to the rule”, the 1995 Act did so in an unambiguously forthright manner by expressly allowing, through the wording of section 16(1) and sections 25(1)(a) and 25(3), for an authorised guarantee agreement; and
(c) this drafting in the 1995 Act can only go to show that all other provisions of the 1995 Act must be read as subject to the anti-avoidance provisions of section 25(1): thus section 25 is paramount.
If Morgan J’s interpretation is correct then this would expose a potential fault line in the 1995 Act. Given the appropriate commercial circumstances, might not a landlord simply insist that the alienation provisions in a lease require (as a condition imposed in accordance with section 19(1A) of the Landlord and Tenant Act 1927) that any assignment of the lease must be made by T1 to T2 and T1 (& G1) as co-tenants so that the burden of the tenant covenants is re-imposed on T1 (& G1) from the assignment? This would undermine the whole purpose of the 1995 Act.
However, EMI was successful in its contention that the burden of the tenant covenants could not be reimposed on it as T2 if its release from that burden as G1 (as required by the 1995 Act) was not to be frustrated and that the anti-avoidance provisions of section 25(1) had been engaged.
What the court had to consider next was how the anti-avoidance provisions of section 25(1) should now operate on the transaction. For that, see part two, next week.
Harvey Posener and Matthew Phillips are partners at GSC Solicitors LLP. GSC acted on behalf of EMI in the case.
■ See also EMI v O&H part II: engaging the 1995 Act
