A tenant cannot assign to its guarantor

29th April 2016

In the case of EMI Group Limited v O & H Q1 Limited [1], the High Court considered the effect of an assignment of a lease by a tenant to its guarantor and concluded that such an assignment is prohibited by the terms of the Landlord and Tenant (Covenants) Act 1995 (the LTCA 1995). An assignment such as the one in question frustrates the purpose of the LTCA 1995 and is void by virtue of section 25(1). In approving obiter comments made by Lord Neuberger, the High Court has settled a point that has been outstanding since it was debated by the Court of Appeal in the case of K/S Victoria Street [2] in 2011.

Background

The LTCA 1995 came into force a little over 20 years ago on 1 January 1996. The Act implemented (with a number of significant amendments) the recommendations made by the Law Commission in its report ‘Landlord and Tenant Law: Privity of Contract and Estate (1988) and represented a significant change in the law relating to landlord and tenant liability. The LTCA 1995 was designed to address the issue of the continuation of liability of the parties to a lease long after they had disposed of their interests in the property to which that lease related. The LTCA provides that where a tenant assigns a ‘new’ lease (i.e. one entered into after commencement of the LTCA 1995):

• The benefit of landlord covenants and the burden of the tenant covenants pass to the assignee (section 3(2)(a) LTCA 1995);
• The outgoing tenant is released from future liability under all of the tenant’s covenants, save in relation to an excluded assignment (section 5(2) LTCA 1995); and
• If the assigning tenant is released from a tenant covenant as a result of the LTCA 1995 then any guarantor of the tenant is released to the same extent (section 24(2) LTCA 1995).

The LTCA 1995 also contains a general anti-avoidance provision at section 25(1), which renders void any agreement relating to a tenancy that would have the effect of excluding, modifying or otherwise frustrating the operation of the act.

The anti-avoidance provisions of the LTCA 1995 were considered in the case of Avonridge [3] in which the House of Lords confirmed that whilst section 25(1) should be interpreted widely, so as to give effect to the aims of the act, the statute was not intended to remove the ability of the parties to limit their liability under lease covenants in whatever way they may agree.

Possibly the most high profile case on the LTCA 1995, K/S Victoria Street, considered whether a requirement for an outgoing tenant to act as a guarantor of its assignee was void under section 25(1).  Confirming the earlier decision of the High Court in Good Harvest Partnership v Centaur Services [4] the Court of Appeal decided that a tenant’s guarantor cannot agree to give, nor give, a guarantee for the assignee (albeit they can guarantee the outgoing tenant’s obligations under any authorised guarantee agreement). Although the court were not required to decide the issue in K/S Victoria Street, they also considered the point at question in the present case, namely whether the tenant’s guarantor could take an assignment of the lease from the tenant, or whether this would be rendered void because the effect was that the guarantor would not be released to the same extent as the tenant. Lord Neuberger, who gave the leading judgment, made the following obiter comment when considering the point:

“It would also appear to mean that the lease could not be assigned to the guarantor, even where both tenant and guarantor wanted it”.

Facts

HMV UK Ltd (HMV) occupied premises in Worcester by virtue of a lease dated 26 September 1996. The lease was a ‘new’ tenancy for the purpose of the LTCA 1995. EMI Group Limited (EMI) guaranteed HMV’s liabilities under the lease pursuant to a deed of guarantee also dated 26 September 1996.

HMV went into administration in 2013 and on 28 November 2014 the landlord, O & H Q1 Limited (OH) granted to HMV a licence to assign the lease to EMI.  The licence to assign contained a standard covenant in favour of OH which obliged EMI to perform and observe the tenant’s covenants in the lease for the remainder of the term. The assignment of the lease completed on 28 November 2014 making EMI the new tenant.

On 18 December a letter was sent by EMI’s solicitors to OH’s solicitors stating that whilst the assignment was valid, the tenant’s covenants could not be enforced against EMI on the basis of Lord Neuberger’s comments in K/S Victoria Street. EMI proceeded to seek a declaration that although the lease vested in it as a matter of law, the tenant’s covenants were void and unenforceable against it. OH sought permission to bring a counterclaim for alternative declarations and by a consent order a trial of the following preliminary issue was directed, namely whether the court should declare that for the purposes of the LTCA 1995:

• As sought by EMI; the lease had vested in it by assignment and by operation of law the covenants were void and unenforceable;
• As sought by OH; notwithstanding the lease had vested in EMI the covenants were valid and enforceable; or
• As sought by OH in the alternative; the purported assignment was void and of no effect with the result that the lease remained vested in HMV and EMI remained bound as guarantor.

Decision

The High Court ruled that a tenant is precluded from assigning a lease to its guarantor and an agreement that sought to effect such an arrangement would be void. The whole purpose of the LTCA 1995 was to prevent the re-assumption or renewal of liabilities either on a tenant or guarantor. As a result, if a tenant and its guarantor were each liable for the tenant’s covenants under a lease then the guarantor could not, as a result of assignment of the lease to it, re-assume those same liabilities as the tenant.

The effect of an assignment is that the tenant and guarantor are released from the covenants under the lease by virtue of sections 5(2) and 24(2) of the LTCA 1995 respectively. Where that assignment is from a tenant to its guarantor, at the very same moment that the guarantor is released from its obligations as guarantor it then becomes bound as the new tenant as a result of section 3(2)(a) of the LTCA 1995. In practical terms there is therefore no release as the guarantor immediately re-assumes its liabilities [5]. This frustrates the operation of the LTCA 1995 and is therefore void under section 25(1) of the act.

The court held that the lease did not therefore vest in the guarantor and instead remained vested in the tenant with the guarantor remaining bound under the terms of its guarantee.

WM Comment

Whilst this case has affirmed earlier judicial comment and clarified a question that remained unanswered by previous case law, the decision is likely to be unpopular, particularly with businesses wishing to assign leases between group companies. However as the judge in the present case, Amanda Tipples QC observed “the fact that such a conclusion is unattractively limiting and commercially unrealistic is neither here nor there“. A guarantor, such as EMI cannot have their cake and eat it, they cannot pick and choose which parts of the lease survive an assignment so as to circumvent their obligations.  Any attempt to undertake such an assignment will be struck down as void.

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[1] EMI Group Limited v O & H Q1 Limited [2016] EWHC 529 (Ch).
[2] K/S Victoria Street v House of Fraser (Stores Management) Ltd and others [2011] EWCA Civ 904
[3] London Diocesan Fund v Avonridge Property Company Limited [2005] UKHL 70
[4] Good Harvest Partnership LLP v Centaur Services Ltd [2010] EWHC 330 (Ch)
[5] Though a discussion as to the differences between guarantees and indemnities is beyond the scope of this article, in many cases the liability assumed by the guarantor as the new tenant would be identical to its original liability under the guarantee as most guarantees contain a provision making the guarantor primarily liable in respect of the tenant covenants of a lease as opposed to merely guaranteeing the tenant’s obligations i.e. being secondarily liable.