The Government has at last committed itself to extinguishing the operation of the doctrine of privity of contract from leases. In a short statement, the Lord Chancellor has announced further reductions in the scope of the proposals of the Law Commissioners for the reform of the law. He has heeded the pleas of the property owners’ lobby and the element of retrospection has been almost entirely removed from the measures first propounded in the report of the Law Commission (Law Comm No 174) – Landlord and Tenant Law, Privity of Contract and Estate. The proposals have been retained in structure, but they are to be enacted only with respect to leases granted after the introduction of the new legislation; they will apply to commercial, and not residential, property; and there is to be no interference with the law as it relates to existing leases, apart from barring tardy claims for arrears of rent and service charge made against former tenants. How will the new regime work?
It will remain, for the time being, a matter of deduction as to how the new law will operate; there is no draft of the new proposals and we are left in the position of adapting speculatively the draft Bill, which the Law Commissioners appended to their report by reference to the Lord Chancellor’s statement. What follows is an exercise in guesswork on that basis. Nor do we know when the new legislation will arrive; the Lord Chancellor’s Department “hope” that it will be reached in the next session of Parliament and find its way on to the statute book in 1994.
The likely new rules for tenants
A tenant who assigns a lease entered into after the introduction of the new law, and which is not granted under an agreement made before then, will generally cease to be liable to comply with the lease covenants. The person who acquires the lease from him will, on assignment, become liable to perform the lease covenants as he becomes entitled to the lease. The doctrines of privity of contract and privity of estate, and the rules as to covenants which touch and concern land, will have no application in relation to those leases; the new statutory rule of release and assumption of liability will apply exclusively. Liability for breaches of covenant incurred by a former tenant, or his guarantor, before the assignment will remain unaffected.
A landlord consenting to an assignment should, if it is reasonable for him to do so, be able to impose a condition that the former tenant guarantee performance of the lease covenants, but the guarantee is to be limited to the tenure of his immediate successor. There is no proposal as to the terms of such a guarantee; the plan is to rely on the operation of the Landlord and Tenant Act 1988; the Act applies to tenancies where the tenant is permitted to assign subject to the consent of the landlord which is not to be unreasonably withheld, either by express provision or by statutory implication. The landlord is placed under a duty to give the consent unless it is reasonable not to do so; giving consent subject to any condition that is not reasonable is a breach of that duty. The burden of proof that withholding of consent, or the imposition of a condition, is reasonable is put on the landlord and breach of the duty potentially renders the landlord liable to the tenant for damages.
It remains to be seen whether the threshold of the “reasonable condition” will be lowered in favour of the landlord to impose a guarantee on the former tenant; the landlord has no power to select who will become his tenant on assignment of the lease and will no longer be protected by the bastion of privity of contract. It may be that the courts will recognise the predicament and permit the requirement of a guarantee to become routine. Certainly, the incorporation of a covenant in the lease that the tenant will, on assignment, guarantee the performance of the lease covenants by his immediate successor should be noted; section 1(5) of the Act would seem to encourage the view that it should; (there it is said that it is reasonable for the landlord not to give approval only in a case where, if he withheld his consent and the tenant completed the transaction, the tenant would be in breach of a covenant). Such a guarantee will not be capable of extension beyond the period of tenure of the lease by the immediate successor.
The regime for the release of former tenants from liability to perform the lease covenants after assignment encompasses other persons who are under parallel obligations to the landlord. It will be of no consequence whether the liability was imposed in the lease itself or in a collateral document. Chains of direct covenants will become a thing of the past. Guarantors will be released alongside former tenants. Conceivably, in appropriate circumstances, a landlord might require as a condition of the grant of a licence to assign that a guarantor should be joined as coguarantor with the former tenant of his immediate successor; again, it may be of assistance to the landlord to stipulate in the lease that such a condition is to be required on assignment.
The statutory release of liability of former tenants will apply only to assignments which are not in breach of covenant. Further, the release rule will not apply to assignments of leases by operation of law.
Releases of landlords
A landlord who assigns the reversion to a lease may be relieved from liability to perform the lease covenants, but release is not automatic. He must first give notice to the tenant in prescribed form. If the tenant gives notice of objection within four weeks, the issue of release is then either to be settled by agreement between them, abandoned by the landlord or dealt with by the court in its discretion if the landlord is minded to apply for an order. If the tenant does not give notice of objection within the prescribed time-limit, the landlord is released.
Where the former landlord is not released from liability on assignment of the reversion, he has the opportunity on a subsequent assignment of the reversion to invoke the procedure for release; however, he is not entitled to notice of the subsequent assignment and may miss the opportunity in ignorance of it.
The reason for the difference in treatment of landlords is that, invariably, the tenant has no control over who will be his landlord; he is not empowered to give his consent to assignments of the reversion to the lease; it may therefore be reasonable for him to require the former landlord to retain liability for performance of covenants.
No contracting out
All contract terms having the effect of subverting the proposals are to be invalidated. This is intended to be of broad effect in order not to allow circumvention of the new rules. Even if a term is not overtly in breach of the statute, but it is demonstrated that that is its purpose, it will fail the test and be overruled. For example, a prohibition on assignments of the lease, but permitting underlettings, without independent commercial justification, may be held to infringe the new regime and not to be effective; it would be a device to retain the liability of a tenant who would be able otherwise to dispose of his interest in the lease. The rules are intended to produce fairness and a narrow interpretation of their scope seems unlikely.
Stale landlord’s claims
The new rules will include a new feature not contemplated by the Law Commissioners. Landlords are to be encouraged to act promptly in respect of both future and existing leases when suing for arrears of rent and service charge; it will be a rule of general application. Notice of any such claims against a former tenant will, in future, have to be served within nine months after the money becomes due. It seems that notice has to be given once only, so that, if the former tenant has been notified, further accruals of arrears to the original claim will be covered. This is the only instance of interference with the law relating to existing leases in the application of the rule to them; it seems likely to produce a spate of actions against former tenants, so as to prevent loss of rights, before the introduction of the new law.
Possible market effects
It is, of course, far too soon to predict accurately the market effects of the introduction of these new measures. Some speculation on the subject, however, will not come amiss. The effect will be interesting and may produce some surprises.
The initial reaction to the announcement has been to encourage the view that a two-tier market will evolve. Higher yields, it is supposed, will be expected in the case of properties let under new leases without the enduring support of former tenant liability. It is evident that a reversion to an existing lease held by a tenant of high financial strength will command a lower yield in the market-place as a better investment, in preference to property let on a new lease where a tenant of high repute may be released from liability in due course. That may be so, but it seems to be unlikely to be an enduring phenomenon; markets even out as they become inured to change. What will be the effect on value of the limited guarantee?
More subtle activity may be experienced. Presumably, old leases will be identified as more onerous, so that, on review, lower rents will be awarded. Would a willing tenant be prepared to pay a given rent insensitive to the issue of continuing liability? Perhaps the vaunted two-tier market will don shades of grey. Doubtless the correspondence columns of the property journals will be filled with informed forecasts of market performance under these contortions.
