by Patrick McLoughlin
Recent disputes have shed light on whether a landlord acts reasonably or unreasonably in refusing consent to the assignment of a lease. If a lease has an absolute prohibition on assignment the landlord can, of course, act arbitrarily if it so chooses. Most leases, however, contain a qualified covenant restricting assignment without the consent of the landlord. In most such cases, whether or not it is expressly agreed, there is an implication that the landlord should not act unreasonably (section 19(1), Landlord and Tenant Act 1927). If the landlord refuses consent, the onus of proving reasonableness is placed upon the landlord by the Landlord and Tenant Act 1988. The Act also requires the landlord to make its decision within a reasonable time.
The main reason why a landlord might restrict assignment is to ensure that any new tenant by assignment is able to pay the rent and perform the other obligations in the lease. The landlord may also be concerned if the value of the landlord’s interest in the property is affected by the identity of the tenant in occupation. This will be of particular concern if the landlord is an investor which holds the freehold or other reversionary interest for its capital investment value, in addition to the entitlement to rental income.
Financial standing of proposed assignee
The financial standing of the proposed assignee is the primary factor of importance to the landlord, and the landlord’s agents or surveyors will seek satisfactory financial references or other evidence of the financial viability of the proposed assignee.
The first form of evidence likely to be provided is references given in respect of the assignee. Judicial comments indicate that a landlord need not be satisfied with the usual superficial references provided by banks, solicitors and other referees. In two cases in 1986 Peter Gibson J and Warner J (in British Bakeries (Midlands) Ltd v Michael Testler & Co Ltd [6] 1 EGLR 64; (1986) 277 EG 1245 and Ponderosa International Development Inc v Pengap Securities (Bristol) Ltd [1986] 1 EGLR 66; (1986) 277 EG 1252 respectively) decided that standard short references describing the proposed assignees as responsible and trustworthy, but excepting the referees from liability, need not be given much weight by the landlord. Warner J in the Ponderosa case added that if the standing of the referees themselves was uncertain then “No blame could … attach to anyone who treated references given by them with some reserve”.
More recently, Judge Finlay QC in Warren v Marketing Exchange for Africa Ltd [8] 2 EGLR 247 confirmed that a landlord need not be content with references of a qualified and unenthusiastic character.
Trading profits
In the absence of strong references, a landlord may ask for the trading profits of the proposed assignee, and several recent court decisions demonstrate that, in the case of a business assignee, some level of profitability may reasonably be required by the landlord before it provides its consent, so that the landlord is reasonably satisfied that the assignee will be capable of paying the rent.
In British Bakeries (Midlands) Ltd v Michael Testler & Co Ltd (supra) evidence was given that “a generally accepted test of the financial standing of any proposed assignee is that his accounts should show a pre-tax profit of not less than three times the amount payable under the lease in question”. The proposed assignee was intending to embark upon a new venture in the premises and, consequently, it could not demonstrate that its proposed business in the premises would produce profits at the level of three times the rent. For this reason it was held that the landlord’s refusal was reasonable.
The British Bakeries test has been acted upon for several years by practitioners, but the recent decision of Harman J in Venetian Glass Gallery Ltd v Next Properties Ltd [9] 2 EGLR 42; [1989] 30 EG 92 sheds doubt on this approach. In that case, the assignee was a company with relatively poor trading figures which was increasing and improving its trade at a rapid rate. Harman J held that “no reasonable landlord would refuse consent to the tenant on the ground that it has only recently begun to trade into a figure where it might meet this rent out of trading profits. That is, in my view, to take far too narrow a view of the responsibility and respectability of a proposed assignee”.
Thus, a landlord cannot assume that it is justified in refusing consent merely because the assignee’s trading profits do not equal three times the rent (or indeed the rent itself). It should consider not only the present profits but also the immediate prospects of the assignee.
Covenant reversion value
Often the landlord’s objection to the transfer is based not simply upon the assignee’s ability to comply with the provisions of the lease but more upon how this will affect the value of the landlord’s interest. In the property market the value of the landlord’s reversion is affected by what is termed the “strength of the tenant’s covenant”. If there is a good tenant, a purchaser of the landlord’s interest is likely to pay more. If a proposed assignee is of a lesser standing than the original tenant, then the market-place may perceive the assignee’s covenant as weaker, and a landlord may be reluctant to consent to an assignment. In the leading authority of International Drilling Fluids Ltd v Louisville Investments (Uxbridge) Ltd [6] Ch 513; [1986] 1 EGLR 39 it was said that this might be particularly true if the present tenant is a government department and the proposed assignee is a limited liability company. Although the Court of Appeal recognised that the diminution in the “paper value” of the landlord’s interest might be a relevant consideration, it should be weighed against other factors. On the facts (the assignee wished to use the premises as serviced office accommodation rather than the existing ordinary office use, and this would affect the paper value of the reversion) the benefit to the landlord in refusing was outweighed by the detriment to the tenant, and the landlord could not reasonably withhold consent.
The scales tipped the other way in Ponderosa International Development Inc v Pengap Securities (Bristol) Ltd (supra). The effect of a transfer would be the substitution of a financially unestablished assignee in place of a tenant with an international reputation. Warner J held that the landlord’s refusal was reasonable. International Drilling Fluids was distinguished on the ground that in that case the landlord had no particular plan to sell the reversion and the loss was purely notional; in Ponderosa International the landlord wanted and needed to sell, so that it would suffer a tangible loss through the diminution in value resulting from the reduction in strength of the tenant’s covenant.
It seems, then, that the diminution in value of the landlord’s interest consequent upon a weakening of the tenant’s covenant is a matter of significance, particularly if the landlord is likely to suffer an imminent loss. Landlord’s surveyors and valuers should be alert to this factor and consider carefully the valuation aspects of the landlord’s consent to assignment.
If the strength of the assignee’s covenant and the effect which it may have upon the value of the reversion is a sticking point, a compromise solution may be for the landlord to consent to a subletting instead of assignment. The existing tenant with the stronger covenant will remain, so that the market value of the reversion may be unaffected. In the Ponderosa case the landlord’s willingness to allow a subletting instead of assignment was another factor which indicated that the landlord’s refusal was reasonable, even though this would lead to more administrative complexity (in dealing with rents, dilapidations etc) than an out-and-out transfer.
If the practice of refusing consent to assignment while offering consent to subletting instead was to become widespread it is not clear whether other judges would follow the lead given by Warner J in Ponderosa. It may at least be regarded as a factor to be taken into account.
Relevance of sureties
Another factor which a landlord might consider before consenting to an assignment is whether a surety will stand to guarantee performance of the lease by the assignee. The importance of this factor will vary according to the financial standing of the assignee itself. If the financial standing of the assignee is exceptionally strong, it may be quite unreasonable for the landlord to require a surety.
If the assignee’s position is a little weak, then the landlord might reasonably request a surety and, indeed, the existence of a surety might make a landlord’s refusal unreasonable. In the Venetian Glass Gallery case the fact that the assignee intended to carry on a novel business was offset partly by the presence of a strong surety. Harman J said: “Of course the covenant of the assignee is important, it is wrong to pay attention only to that. It is right to look at the whole of the situation as it stands. Here is a plain commitment by the individual behind the company to the venture. He is guaranteeing the landlord all its obligations.”
Although the availability of a surety is influential it is not a substitute for an adequate tenant, and if the tenant is wholly unsatisfactory the landlord can reasonably disallow a transfer even if there is a surety. This principle was one reason used by Judge Finlay QC in Warren v Marketing Exchange for Africa Ltd (supra), where he held that a landlord’s refusal was reasonable. He considered that the financial inadequacy of the assignee was not cured by the offer of a guarantee: “… I find that the offering of a guarantee is not a satisfactory substitute for a satisfactory and responsible tenant”.
Relevance of liability of original tenant
Another factor which might be thought relevant to the reasonableness or otherwise of a landlord’s refusal to consent is the continuing liability of the original tenant. Under the legal concept of privity of contract the original tenant remains liable on the lease for its whole term. If the present tenant was an assignee who entered into a direct covenant with the landlord, then the present tenant may also be liable for the whole term. It is also possible that there might be some continuing liability of a surety for the original tenant or some assignee. Since a landlord has the benefit of such continuing liability, it might be argued that it is unreasonable to refuse consent on the grounds of the financial inadequacy of a proposed assignee. In the Venetian Glass Gallery case Harman J was influenced by this factor. In deciding that the landlord’s refusal was unreasonable, he said that the lease was “a lease very recently granted and the original covenantor will remain liable for the rent and performance of the covenants to the landlords …”.
But this fact will not carry great weight in many cases; otherwise it could almost always be argued that a landlord’s refusal was unreasonable, even if the assignee’s financial position is precarious. Just as it was established in Warren v Marketing Exchange for Africa Ltd (supra) that a surety is not a substitute for a satisfactory tenant, so also the liability of an earlier tenant or surety should not be a substitute for a present tenant of adequate standing.
Imposition of conditions
The landlord’s agents and solicitors should also consider whether it is appropriate to make consent conditional upon the tenant or assignee satisfying relevant requirements.
If, for example, there are substantial arrears of rent it would probably be reasonable for the landlord to withhold consent until the tenant clears the arrears. In respect of other breaches of covenant the position is not so clear. The landlord should not impose conditions too readily, since the imposition of an unreasonable condition will be a breach of statutory duty under section 1(4) of the Landlord and Tenant Act 1988 and would render the landlord liable to pay compensation to the tenants.
The recent case of Orlando Investments Ltd v Grosvenor Estate Belgravia [8] 2 EGLR 97; [1988] 49 EG 85 concerned a proposed assignment of the lease of a house on the Grosvenor Estate. The house was in a poor state of repair and the landlord was prepared to consent to an assignment only if the prospective assignee would agree with the landlord to repair in accordance with the terms of the lease, and also in accordance with a strict timetable for completion of the works. When it became apparent that the assignee was unwilling to agree in these terms the tenant sought a declaration that consent was unreasonably withheld. Hoffmann J decided that the imposition of the requirement to carry out the repairs was reasonable and the Court of Appeal confirmed that in the circumstances the landlord was justified in refusing consent.
It may be, however, that imposition of similar conditions will not be appropriate in all cases. The disrepair in Orlando was very substantial. If the disrepair or breach of covenant is minimal the landlord may have to be satisfied with its right to enforce the lease against the incoming tenant: see Farr v Ginnings (1928) 44 TLR 249, which was distinguished by the Court of Appeal in Orlando [9] 2 EGLR 74; [1989] 43 EG 74.
Statutory protection
Another factor often of concern to the landlord’s agents is that a proposed assignee or subtenant might obtain security of tenure under the Housing Act 1988, the Landlord and Tenant Act 1954 or some other statute. The courts have applied various tests in determining whether the landlord has acted reasonably in refusing consent because of this possibility.
The prevailing test currently used seems to be that expressed in the International Drilling Fluids case (supra). Here the Court of Appeal emphasised that the disadvantage to the landlord in allowing the assignment must be weighed against the disadvantage to the tenant in refusing. The test was put into practice in Deverall v Wyndham [9] 1 EGLR 57; [1989] 01 EG 70, where the landlord refused consent to sublet because the subtenants might become protected tenants under the Rent Acts if the head tenant did not remain in residence during the term of the subtenancy so as to ensure that the subtenancies were unprotected by reason of there being a resident landlord for the purposes of the Rent Acts. Judge Paul Baker QC held that the risk of the landlord being saddled with statutory tenants was low, while the prejudice in not allowing the tenant to sublet was high. In these circumstances the landlord ought to give consent.
Change of use and consent to assignment
It is not unusual that a proposed assignee wishes to carry on a business different from that of the present tenant. In these circumstances a landlord might refuse consent for the reason that the proposed user would be in breach of the terms of the lease. It has been decided that the landlord’s refusal is not reasonable if it is possible for the assignee to comply with the user covenant: Killick v Second Covent Garden Property Co Ltd [3] 1 WLR 658. If, however, the assignment would inevitably lead to a breach of the user covenant, because there is only one possible use by the assignee, then the landlord’s refusal will be reasonable, according to Warren v Marketing Exchange for Africa Ltd (supra).(*) A further point arising from the latter, and more recent, case the application for consent to assignment cannot be separated from the question of change of use, and the landlord may reasonably take the user issue into account.
Conclusion
If a landlord wishes to oppose assignment the decision is a difficult one, and if the landlord refuses consent there is a substantial risk that it may be found to have acted unreasonably. The landlord’s valuers should examine carefully the financial effects, which should be considered with the advice of the landlord’s solicitors.
(*) The proposed assignee’s only business was that of tour operator and travel agent. Such use would not be within the existing permitted use, and the landlord was reasonable in withholding consent.
