Most commercial leases prevent the tenant from assigning, underletting, or parting with or sharing possession or occupation of its premises without the landlord’s consent. Some leases also prohibit tenants from establishing trusts that separate their legal and beneficial interests. Such restrictions often prove inconvenient in the context of property outsourcing arrangements or on the sale of leasehold portfolios, where time is tight and consents are required from a multiplicity of landlords. Hence, the virtual assignment was born.
A virtual assignment is an arrangement under which all the economic benefits and burdens of a lease are transferred to a third party, but without any actual assignment or change in the occupancy of the premises. Thus, as far as the landlord is concerned, the virtual assignor remains the tenant. However, as between the parties to the virtual assignment, responsibility for the premises passes to the virtual assignee. The device is in widespread use, but its legality – in the context of the landlord and tenant relationship – has only just been tested in court.
Clarence House Ltd v National Westminster Bank plc [2009] EWHC 77 (Ch); [2009] PLSCS 25 concerned a virtual assignment of a leasehold interest that was subject to an underlease. The landlord was not informed of the arrangement, and therefore did not consent to it, and the undertenant remained in occupation throughout. However, the High Court ruled that, by entering into the virtual assignment, the tenant had parted with, or was sharing, possession of the property. Consequently, the tenant was in breach of the alienation covenants in its lease.
The decision turned on the wording of the particular lease, but most modern leases contain similar restrictions. Interestingly, the judge rejected the landlord’s argument that the virtual assignment was a breach of the tenant’s covenant against assignment because previous cases have established that, unless the context otherwise requires, covenants against assignment deal only with legal assignments. In addition, the assignment of a registered lease (as this lease was) must be perfected by registration – and there was nothing to register.
The judge also rejected assertions that the covenant against underletting had been breached on the ground that the virtual assignment did not reserve any reversion to the virtual assignor. The judge had more difficulty with the argument that the virtual assignment constituted a breach of the tenant’s covenant not to execute any declaration of trust in respect of the property, but decided that the parties had entered into a contractual, rather than an equitable, relationship.
Subject to the outcome of any appeal, the court will now assess the damages payable for the tenant’s breach of covenant. The landlord will no doubt press home its concerns that the rental income from the undertenant belongs to the virtual assignee and may affect the virtual assignor’s ability to discharge its obligations to the landlord. Practitioners and their clients will have to wait and see what the courts decide and will be keen to learn the amount payable, as and when the damages are quantified.
Allyson Colby is a property law consultant
