Georgina Redsell and Phillip Gale discuss some of the problems the Landlord and Tenant (Covenants) Act 1995 continues to present for commercial property professionals
Question: I am a partner in a partnership of 20 people, four of whom are named as tenants in a lease of commercial premises; the rest are guarantors. One of the tenant partners is retiring and he wants to come off the lease; one of the other partners is proposed to replace him. We want to enter into an assignment of the lease to reflect this new position but I am worried about the Landlord and Tenant (Covenants) Act 1995 (the Act).
Answer Unfortunately, the anti-avoidance provisions of the Act mean that there is a risk that the proposed assignment may be void with the effect that the retiring partner will remain liable under the lease after the assignment. There are arguments that this is not the case but the guarantors will not be able to provide a repeat guarantee for the new tenant partners. One option may be for the retiring partner to enter into an authorised guarantee agreement (AGA) and the former guarantors could enter into a guarantee of the AGA (a so-called GAGA). Alternatively you could create a company to hold the lease with each partner being a shareholder, but this would not solve the repeat guarantee issue. If there is a new partner they could offer a guarantee or you could offer a rent deposit.
Explanation The Act was passed to release tenants (and their guarantors) from liability under leases on assignment to a new tenant. Before this, original tenants and guarantors would remain liable for the full term of the lease, meaning they might have to pay for any rent arrears racked up by subsequent tenants many years after the lease had been assigned (and this remains the case for leases entered into before 1 January 1996).
The Act contains comprehensive anti-avoidance provisions which invalidate any attempt to prevent tenants and guarantors being released from their covenants on an assignment. These provisions have been interpreted widely by the courts to ensure that the purpose of the Act is not frustrated, whether directly or indirectly.
Unfortunately this has led to restrictive and uncommercial results. For example, in K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904; [2011] 2 EGLR 11, a department store in Wolverhampton was let first to one then to another of House of Fraser’s subsidiaries (for tax reasons) and the parent company had agreed to be guarantor of both subsidiaries. The Court of Appeal held that the parent company’s agreement to guarantee the assignee’s liabilities was void as a guarantor was required by the Act to be released on an assignment.
Similarly, in EMI Group Ltd v O&H Q1 Ltd [2016] EWHC 529 (Ch); [2016] EGLR 26, an assignment by a tenant to its guarantor was found to be void so that the original tenant continued to be bound by the lease. The court considered that the same conclusion would be reached even if everybody wanted the guarantor to become the tenant.
As you know, a partnership (as opposed to a limited liability partnership or LLP) has no separate legal personality and so cannot enter into a lease. Usually, as is the case here, the partners themselves will enter into the lease. Since land cannot be vested in more than four people, it is common for partnerships comprising more than four partners to nominate trustee partners. With that in mind, there are two potential difficulties for you.
First, an assignment from partners 1, 2, 3 and 4 to 2, 3, 4 and 5 might be said to be problematic as partners 2, 3 and 4 wouldn’t be released on the assignment. However, as the partners would hold the lease as joint tenants, it is likely that they would be treated as a single entity, which would collectively be released on the assignment. This is supported by section 28(4) of the Act which provides that where “two or more persons jointly constitute either the landlord or the tenant” any reference to the landlord or the tenant is “a reference to both or all of the persons who jointly constitute the landlord or the tenant”. However, there is no established case law on this point and so the position is far from certain.
Second, following K/S Victoria, it is unlikely that the partners who guaranteed the lease originally could validly provide a “repeat” guarantee for the partners following the assignment. Section 28(4) of the Act does not refer to guarantors.
One option may be for the retiring partner to enter into an AGA permitted by the Act and the former guarantors to enter into a GAGA. You could also create a company with each partner being a shareholder to hold the lease. If the landlord requires additional security (because a new company will be of limited financial standing) a further guarantee could be offered by any partners who have not acted as guarantors before and/or a rent deposit might be offered. Some commentators suggest that a surrender and re-grant might be offered. However, this is arguably void as it involves the prior agreement of the landlord, the purpose of which is to frustrate the Act.
The position is far from satisfactory and similar issues will arise in the context of company restructuring arrangements and where there are joint tenants, with one of them or a third party acting as a guarantor. It is clear that the only solution is legislative reform. The Property Litigation Association has (with the support of the British Property Federation, the British Retail Consortium and the Property Bar Association) asked the Law Commission to look at a revision of the Act to permit repeat guarantees and for a tenant to be able to assign to its guarantor. Despite industry-wide consensus that this area is ripe for reform it was not included in the Law Commission’s 13th programme. In the meantime, the only sure way to impose continuing liability on departing tenants is via AGAs.
While original guarantors cannot guarantee the liabilities of an assignee, it is reasonably clear that they can guarantee the departing tenant’s AGA: this was considered possible by the judges in K/S Victoria. Beyond AGAs, a degree of risk or complex “workarounds” may have to be considered in order to achieve the commercially desired result.
Phillip Gale is a barrister at Enterprise Chambers and Georgina Redsell is a senior associate at Charles Russell Speechlys LLP
