Following last week’s coverage of one aspect of the decision in EMI Group Ltd v O&H Q1 Ltd [2016] EWHC 529 (Ch); [2016] EGLR 26, this second article takes a critical look at how the court came to its answer in relation to the second aspect: if section 25 of the Landlord and Tenant (Covenants) Act 1995 needs to be engaged, what is the effect of section 25 on the transaction?
The relevant part of section 25(1) reads:
“(1) 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, […]” (emphasis added).
There are three sub-questions relevant to the operation of section 25(1):
(a) Which provisions of the 1995 Act have been frustrated, etc, by the transaction?
(b) Which is the relevant agreement that then needs to be considered? and
(c) To what extent must the relevant agreement be rendered void so as to ensure the relevant provision of the 1995 Act is not frustrated?
Which provisions of the 1995 Act have been frustrated?
Simply put, in EMI, it is the release of EMI (as G1) to the same extent that T1 is released which was frustrated, ie section 24(2).
Which agreements are relevant?
The answer is “those agreements which frustrate the required release of G1 by re-imposing the tenant covenants on T2”.
An assignment usually involves three documents: the lease which imposes the burden of the tenant covenants; the licence to assign containing a direct covenant from T2 to perform the tenant covenants; and, the deed of assignment between T1 and T2, to transfer the estate between the parties.
The key point being that the deed of assignment is usually only relevant for the 1995 Act because on the assignment of the tenancy, the benefit and the burden of all landlord and tenant covenants pass with the premises (section 3(1)(b)) but it is only as from that assignment of the tenancy that the release of T1 and G1 from, and the imposition on T2 of, the burden of the tenant covenants takes effect.
The deputy judge decided, in our view incorrectly, that the relevant agreement which frustrated the relevant provisions of the 1995 Act was the deed of assignment.
However, section 25(1) only requires the court to ensure that the burden of the tenant covenants does not fall on EMI (as T2) as from the assignment. EMI’s position was that it is only the lease and the licence to assign which (re-)impose the tenant covenants on EMI (as T2) and not the deed of assignment (which only causes the estate to pass).
To what extent must the relevant agreement be rendered void so as to ensure the relevant provision of the 1995 Act is not frustrated?
Here the importance of the words “to the extent that” in section 25(1) cannot be emphasised enough. Section 25(1) has been judicially described as “comprehensive” and is to be “interpreted generously”, but, we say, not
so as to ignore the limitation on its operation set out in the section itself, ie it is only to operate to the extent which is required to preserve the operation of the relevant provision of the 1995 Act.
That principle of restraint is clearly expressed in the Law Commission’s report which led to the enactment of the 1995 Act and there is judicial acknowledgment of this principle in Tindall Cobham 1 Ltd & others v Adda Hotels (an unlimited company) & others [2014] EWCA Civ 1215; [2014] 3 EGLR 36. In that case, Patten LJ said that section 25 “makes it clear in terms that it operates only to invalidate limited parts of the relevant agreement.” [47]
Admittedly, Patten LJ also said that applying section 25(1) should not leave an agreement “emasculated and unworkable”. In EMI, excessive importance was placed on those words and the overriding consideration that “the words ‘void to the extent that’ indicate that parliament did not intend to invalidate more of the relevant agreement than was necessary to safeguard the objectives of the Act in the context of the particular assignment under consideration…” (Patten LJ, [46]) was ignored.
Of course, Lord Neuberger in K/S Victoria Street v House of Fraser (Stores Management Ltd) and others [2011] EWCA Civ 904; [2011] 2 EGLR 11, said that “the lease could not be assigned to the guarantor, even where both tenant and guarantor wanted it” and a shorthand has been adopted to refer to certain transactions as being “void” or “not possible”. The 1995 Act is, however, more nuanced and requires the agreements to be looked at within the context of a transaction.
EMI represents undoubtedly a safe option of applying Lord Neuberger’s remark in a literal way. The deputy judge said it was not for the court to pick and choose which aspects of a transaction ought to survive this assignment. Yet that is precisely what section 25(1) requires the court to do: to consider which aspects of an agreement frustrate the operation of the 1995 Act and, taking a balanced approach, to strike them down, leaving the remainder of the agreement intact but not emasculated or unworkable.
It was EMI’s contention that the release of EMI (as G1) can be preserved in relation to:
(a) the lease by saying that while G1 is T2, any obligation to perform the tenant covenants is unenforceable and, to maintain a fair balance, T2 is not entitled to the benefit of the landlord covenants; and
(b) the licence to assign by saying that the covenant on the part of G1, as the assignee (T2), in favour of L to perform the tenant covenants is void.
In the context of the transaction, those are the agreements relating to the tenancy which are relevant and that is the extent to which their respective provisions need to be rendered void by section 25(1).
Why did the deputy judge strike down the assignment?
Underlying the decision in EMI is, seemingly, a concern as to the relationship between the parties should EMI’s position be accepted, namely:
(a) the lease was vested in EMI (as T2);
(b) EMI (as T2) was not bound by the tenant covenants – but was without the benefit of the landlord covenants and the right of re-entry continued to be available;
(c) upon the next lawful assignment then the assignee (T3) would be bound by the tenant covenants.
The deputy judge said that such a relationship “[does] not make any sense at all” and suggested that L exercising the right of re-entry would amount to “back door enforcement” of the tenant covenants that the 1995 Act had rendered void.
The deputy judge seemed unable to accept that a lease could subsist independently of any tenant (or landlord) covenants. The landlord’s counsel suggested such an arrangement was a “Frankenstein’s monster” of a lease (even though he conceded that a person could grant a lease to another without a rent or any covenants).
However, the Law of Property Act 1925 provides that a “term of years absolute” is a legal estate being “a term of years (taking effect either in possession or in reversion whether or not at a rent) […] and either certain or liable to determination by notice, re-entry, operation of law […]”. It is clear that for the leasehold estate to subsist there is no need for any covenants, whether by a landlord or a tenant, nor even for a rent to be reserved, the tenant must be simply granted exclusive possession of the premises for the term.
Just look at how the 1995 Act deals with the annexation of the covenants to the premises or reversion, the transmission of the burden and benefit of the covenants on assignment of the premises or reversion and the transmission of rights of re-entry on assignment of the reversion.
Rather than talk of a “Frankenstein’s monster” of a lease, there is already a legal precedent for a hybrid lease to be found in Hindcastle Ltd v Barbara Attenborough Associates Ltd [1996] UKHL 19. A Hindcastle lease is “dead” as far as the estate and the tenant’s obligations are concerned, but “alive” as to the guarantor’s obligations.
As for “back door enforcement” of the tenant covenants, the means by which covenants are enforced is through an action for specific performance and/or a claim for damages for breach of covenant. The exercise of a right of re-entry is a means by which a landlord determines the tenancy and recovers possession of the premises.
The landlord does not procure the tenant’s compliance through re-entry, it recovers possession: if there are rent arrears, the landlord does not recover those arrears through re-entry, it must sue for them separately. To conflate the exercise of a right of re-entry by a landlord with the enforcement of the tenant covenants is too simplistic and is wrong.
In the context of the 1995 Act, section 3(1) passes the covenants with the premises (or reversion) and sections 3(2) and 3(3) effectively give the rights of enforcement.
Conclusion
The overriding intention of the 1995 Act was that on lawful assignment of a tenancy, the assigning tenant and any guarantor should be released from the continuing burden of the tenant covenants.
The court in EMI felt that EMI’s position was unattractive, uncommercial or even capricious yet any such feeling is to be disregarded as the reported cases acknowledge that the 1995 Act may well operate in such a way. One must look at the effect of the agreement and not at the intention or desires of the parties.
The courts must work within the confines of the 1995 Act and, in particular, when applying the anti-avoidance provisions of section 25(1), keep to the fore the fact the 1995 Act requires these provisions to be applied with precision.
The decision in EMI, perversely, had the effect of defeating the aim of the 1995 Act. By striking down the assignment itself, the burden of the tenant covenants again fell on both the assigning tenant (T1) and its guarantor (G1), a burden from which a lawful assignment of the tenancy had seemingly released them and for which the 1995 Act was designed.
Harvey Posener and Matthew Phillips are partners at GSC Solicitors LLP and acted for EMI in the case.
See also Settlement means EMI guarantor assignment case won’t go to appeal
