Virtual assignments are in the spotlight following Clarence House. James Knox and Katie Bradford examine the recent decision
Virtual assignments have twice been reviewed by the Court of Appeal. Although nerve jangling for those involved in structuring deals that use such assignments, this is positive because the two areas in which misapprehensions had arisen have been clarified.
In Abbey National plc v Commissioners of Revenue & Customs (formerly the Commissioners of Customs & Excise) [2006] EWCA Civ 886; [2006] 3 EGLR 153, the Court of Appeal dealt with the VAT aspects of virtual assignments. Now, through the latest decision in Clarence House Ltd v National Westminster Bank plc [2009] EWCA Civ 1311; [2009] PLSCS 341, the landlord and tenant position is also put beyond doubt.
Not an avoidance mechanism
Virtual assignments have existed for more than a decade. They have mostly been used by tenants of multiple properties (for example, the government and financial institutions) to tackle their lease liabilities, usually where some properties have become surplus to their requirements.
The virtual assignment is an arrangement under which all the economic benefits and burdens of the relevant lease (including any management responsibilities) are transferred to a third party. No actual assignment of the leasehold interest is made nor is there any change in the occupancy of the premises in question.
In other words, the appointee arranges with the tenant to collect the rent from subtenants and to manage the premises, while paying the rent due to the landlord and dealing with the lease obligations. However, unlike a managing agent, the appointee accepts the risks and rewards of management and cannot recover any payment from the appointing tenant.
These assignments are typically used where the lease contains covenants against assigning or parting with possession of the demised premises without the consent of the landlord. Their use is often combined with portfolio sale and leasebacks of freehold assets, where the consent of the relevant landlords may not be given in advance of the scheduled date for completion of the transaction. The key issue for the tenant is to ensure that the virtual assignee has the financial strength to meet the liabilities that it is undertaking. The tenant remains liable under its lease but expects the virtual assignee to manage the premises so as to ensure lease compliance.
Virtual assignments are not a clever avoidance mechanism to deprive the landlord of covenant strength, but rather an economic arrangement outside the landlord and tenant relationship. Ward LJ, giving the unanimous judgment of the Court of Appeal in Clarence House agreed with NatWest’s submissions that: “As its name suggests, the virtual assignment is not in fact an assignment – it merely mimics the economic result of one without changing the legal position vis-à-vis third parties at all”.
Ward LJ recognised that: “Virtual assignments are strange new beasts in the forest that one must circle around them suspiciously and cautiously; but the moment one gets close and has a good sniff, the overwhelming smell is one of contract.”
He confirmed that they do not transfer to the virtual assignee any proprietary rights or interests in the property, nor do they create any form of trust.
The Court of Appeal decision should not be a surprise. Landlords are not prejudiced by these arrangements. The tenant remains the same and the virtual assignee has no rights to occupation.
Usually – although in Clarence House this did not happen owing to an oversight – the landlord and any undertenants are given written notice that a virtual assignment has been put in place. Although deals that comprise virtual assignments are relatively few, in aggregate they have involved thousands of properties. This means that many landlords have properties of which the leases have been virtually assigned and few issues have been raised. Many bidders involved in deals with virtual assignments have been some of the
Many smaller landlords may not be familiar with virtual assignments and Clarence House is therefore welcome because it explains the legal position of such arrangements clearly, confirming that the landlord’s position is not prejudiced.
What next?
First, the legal profession should not attempt to prevent virtual assignments through expanding alienation clauses. The landlord and tenant relationship in a lease should not be used to obstruct the economic arrangements that a tenant may put in place behind the scenes that do not adversely affect the landlord. If legal practitioners take anything from this judgment, it will probably be to review the alienation provisions in leases to consider the way in which they refer to parting with and sharing of “possession”.
Clarence House has clarified that “possession” should be given its normal meaning. Ward LJ said: “The hallmark of the right to possession is the right to exclude all others from the property in question. That is the ordinary and normal sense of the word and that is the meaning that should be given in this covenant.”
Leases should cover appropriate landlords’ concerns, rather than seek to stretch expressions away from their generally understood meaning.
Second, traditional virtual assignments are already dated and rarely used on new transactions. They have been overtaken by other arrangements, some of which have evolved from them. Even if Clarence House had been decided differently, the latest forms would not have been undermined.
However, the position is now clear. The Court of Appeal’s endorsement focusing on the underlying landlord and tenant relationship provides helpful guidance because arrangements continue to evolve.
In the current economic environment, the property and finance directors of occupiers of leasehold properties should be aware of these arrangements and how they work, because they represent an important tool when considering long-term occupational strategies.
WHAT THE COURT SAID |
The Court of Appeal held that the Clarence House virtual assignment did not breach a standard form lease alienation clause because it was not an assignment (in law or equity), an underletting, a parting with /sharing of possession or occupation, nor did it amount to a declaration of trust. The court endorsed in law virtual assignments for what tenants and their lawyers always intended them to be, namely: agency arrangements, which are in substance no different to a managing agent’s appointment. The underlying relationship between landlord and tenant is not altered. |
James Knox is a real estate partner and Katie Bradford is a litigation partner at Linklaters LLP
