It is now clear that leases cannot be assigned to the tenant’s guarantor but serious issues arise out of the recent High Court case of EMI Group Limited v O&H Q1 Limited which specified that any lease assignment by a tenant to its guarantor is void. This means that the assignment is not effective, the lease is still held by the previous tenant and the intended assignee remains the guarantor of that previous tenant (and does not become the new tenant of the lease). In addition, be aware that the court’s decision applies retrospectively. This post summarises action landlords and tenants may want to take now and assesses the issues arising.
What should landlords now do?
- On a new lease, require the valuable covenant to be the tenant company (perhaps jointly with the occupying entity)
- Make sure new leases prohibit intra-group assignments to retain the guarantee for as long as possible
- Make it a pre-condition to an assignment that any guarantor of the outgoing tenant guarantees the obligations in the AGA and a new guarantor guarantees the assignee where required. Repeat guarantees do not work either
- Review portfolios to establish whether any leases post January 1996 have been assigned by a tenant to a guarantor and start to consider what action needs to be taken. Rectifying past assignments which are now considered void may be complex and could take time
- Make sure there is full due diligence on any new investment acquisitions so that all lease assignments are assessed for validity and there is not just a review of the most recent AGA.
- Do not give permission to a tenant who wishes to assign the lease to itself and another party or wants to assign between partners. It remains an uncertain whether assignments like these would be valid too.
What is the position for tenants?
- Scrutinise the lease wording carefully when planning a disposal and consider whether utilising any underletting rights may be more practical
- Expect a refusal from the landlord to any request to assign to the current guarantor
- Understand that new leases are likely to restrict freedom to transfer between group companies
- For key leases consider whether there has been a previously void assignment that will create doubt over the status of the tenant’s right to occupy.
Other implications of the EMI case?
The decision in the EMI case applies to any assignment of a lease granted since January 1996 – this therefore raises commercial and practical issues that may need to be addressed where previous assignments are now considered to be void. In particular, landlords, tenants and their lenders are left with a number of unanswered questions in relation to any void assignments –
- What is the position if the previous tenant has gone into liquidation or has been removed from the register of companies? Leases impose strict deadlines for the landlord to require a guarantor to enter into a new lease or pay rent – and these deadlines may have expired already. If that is the case, there are means of getting some companies restored onto Companies House registers but landlords with a claim are going to face complex procedures to do this if it is not voluntary. Another point to consider is that the lease may now be Crown-owned (which happens if the lease was not surrendered or assigned on the winding-up of the company) and the Crown in turn has the ability to disclaim such leases. The landlord will therefore need to review all its options and remedies (if any).
- What is the status of underleases or any other interests such as a charge created by the assignee following the void assignment?And worse, what if the lease has been assigned following the void assignment? Whilst we wait for these points to be tested in court, it is likely that these later transactions will also be treated as void. A significant amount of work will be required to ‘unscramble’ the effect of the void assignment and to deal with the consequential losses in any specific case.
- What is the actual status of the proposed assignee/guarantor if it has been in occupation and paying rent direct to the landlord? Could it be argued that the rent has been paid as guarantor as the tenant had defaulted? Might there have been a new, implied periodic tenancy? The position is uncertain and each case will turn on its facts.
- What if a previous tenant has assigned to itself and a third party – is this valid? It still remains unclear whether this will be treated as a valid assignment.
Many points will therefore need to be reviewed and considered further as the outcome of the EMI case sinks in and the consequences of the decision are tested in the courts. In the meantime we wait to see whether the EMI case will be appealed. After the Good Harvest case of 2010 and the K/S Victoria Street v House of Fraser case in 2012 we have faced considerable difficulties giving clients certain advice about aspects of the law in this area but now it is entirely clear that assignments to current guarantors are void and we have to deal with the consequences.
The High Court has ruled that it is unlawful for a landlord to require an assignee’s obligations to be guaranteed not only by the outgoing tenant under an authorised guarantee agreement, but also by the outgoing tenant’s guarantor. Any such guarantee is void and unenforceable.
Tenant Release on Assignment
The decision relates to the Landlord and Tenant (Covenants) Act 1995, which abolished the old rule that a tenant remained liable to pay the rent and comply with the tenant’s other lease obligations throughout the whole term of the lease, even after the lease has been assigned. The Act provides that for leases granted after 1995 the tenant is automatically released from liability once the lease is assigned. It also ensures that any guarantee of the tenant’s obligations will fall away when the tenant is released.
Authorised Guarantee Agreements
There is one exception to the blanket release of liability on assignment: the landlord may require the outgoing tenant to give an “authorised guarantee agreement” (commonly called an AGA) guaranteeing the liability of the assignee. The contents and extent of the AGA are strictly prescribed by the Act. They may not extend to the liability of anyone other than the first assignee or to any time after that assignee is released from the lease obligations.
The Outgoing Tenant’s Guarantor
However, the Act does not make clear whether the landlord may require the outgoing tenant’s guarantor also to back the obligations of the assignee. Commercially it is important that the landlord should be able to call on the guarantor to stand behind the AGA. The tenant could be a single purpose vehicle with no assets other than the lease, or a company which will cease trading once the lease is disposed of. The landlord might not have accepted the tenant unless a parent company or a couple of directors stood behind it.
The Form of the Guarantee
There are two ways in which the guarantee can be given. The first is a direct guarantee, where the guarantor joins in the AGA to guarantee the assignee’s obligations. That is what happened in the recent case. However it is more usual for the guarantor not to guarantee the assignee’s obligations directly, but instead to guarantee the assignor’s obligations under the AGA. This is sometimes described as a sub-guarantee and it is the way Dechert’s leases are drafted.
The High Court decided that a direct guarantee is not permitted and is unenforceable. The reason for the ruling is that the Act contains a wide anti-avoidance provision which declares an agreement void to the extent that it would frustrate the operation of any provision of the Act. The court decided that allowing a guarantor to guarantee the assignee’s obligations would frustrate the operation of the requirement that a guarantor’s obligations must end on an assignment.
The ruling does not affect sub-guarantees so they remain enforceable, however the judge commented that it is not by any means clear that they are permitted by the Act. Nevertheless it is believed that sub-guarantees are permitted because the provision which requires the guarantor to be released relates only to guarantees of obligations to be complied with by the current tenant, whereas a sub-guarantee relates to the obligations of the former tenant under the AGA. It can also be said that a sub-guarantee is not inconsistent with the policy behind the Act. It does not extend the guarantor’s liability beyond the date on which the tenant is released or make the guarantor responsible for the obligations of future tenants.
Implications of the Decision
It is likely that the landlord will appeal against the ruling but in the meantime the judgment has serious implications for landlords. The decision is not restricted to future transactions but applies also to existing arrangements. The outgoing tenant’s obligations under the AGA remain enforceable, but the guarantor’s liability under a direct guarantee cannot now be enforced. This is likely to have an adverse effect on the value of property where such a guarantee has been given. The decision may not be entirely good news for tenants either. If landlords become more wary of accepting weak tenants backed by substantial guarantors it may become harder for tenants to dispose of their leases.
One possibility is for the landlord to take an alternative form of security, such as a large rent deposit or a bank guarantee. But these will inevitably be limited in amount and so will not provide the same level of security as a parent company or personal guarantee. They will also be unattractive to tenants as they will require large amounts of capital to be tied up.
Another option is for the guarantee given on the assignment to be by a different party from the one that joined in the lease. This would not fall foul of the antiavoidance provision in the Act because the guarantor would not be covered by the wording which requires the lease guarantor to be released on assignment. A large organisation is likely to include more than one substantial company which could provide a guarantee but this route would probably not be possible for smaller tenants.
If the case is not quickly overturned on appeal, landlords may consider including in new leases a tenant’s obligation not only to enter into an AGA, but also to procure a guarantee of the AGA obligations by an entity acceptable to the landlord which has not also guaranteed the tenant’s lease obligations.