Surrender and secured property: Trap for unwary tenants

5th October 2017

As we have explained in a previous briefing, surrender of a lease can happen by operation of law, without any legal documentation or formality.  That lack of any requisite formality can lull parties (and sometimes practitioners) into a false sense that they do not need to devote to lease surrenders the same care and consideration that they would any other real estate transaction or termination.  That is a dangerous misconception for various reasons, one of which is highlighted in the recent case of Co-Operative Bank v Hayes; Deutsche Bank v Sentrum [1].

Deceptively straightforward surrender

The head tenant, Deutsche Bank, had sublet the premises in question to an undertenant whose obligations were guaranteed by Sentrum. Hayes was the ultimate landlord, whose freehold was charged to Co-Operative Bank.  When the parties agreed to surrender both the headlease and the sublease and to release the undertenant’s guarantor, Deutsche Bank’s solicitors failed to check the freehold title.  They therefore failed to note the charge, and so did not obtain the chargeholder’s consent to the surrender of the headlease.  That meant that the surrender of the headlease (which was conditional upon Co-Operative’s consent) did not take effect [2], whilst the sublease and the guarantee fell away.  Deutsche Bank therefore remained ‘on the hook’ pursuant to the headlease for the remainder of the term (a further 6 years), at an annual rent which was rising incrementally to over £2.6 million per year.

Deutsche Bank tried to mitigate its position. It tried to establish that the surrender of the sublease was also invalid, so that it could continue to receive sublease income:

• Deutsche Bank alleged that the deed which purportedly gave effect to both surrenders and to the release of guarantor contained an implied condition precedent that the sublease would only be surrendered if the headlease was also surrendered. Taking into account authorities on the implication of contractual terms [3], the High Court disagreed. It decided that implying such a condition precedent was not necessary to give business efficacy to the deed and could not be said to have been the intention of the parties.
•  Deutsche also attempted to claim that the freeholder and undertenant had impliedly made fraudulent representations that the headlease surrender would take effect when in fact they knew it would not. That argument failed as the court found that Deutsche had relied on its own solicitors, and not on the actions or representations of other parties, when entering the deed.
•  Finally, Deutsche argued – unsuccessfully – that the deed was void overall due to a mistake as to its legal effect and/or that the guarantor had been unjustly enriched by being released from its obligations.

Practical advice

The Deutsche Bank case gives rise to a number of legal and practical points, which real estate owners, occupiers and advisors should bear in mind in any surrender situation.

• Surrender of a lease can occur automatically by operation of law, without the need for any legal document or formality. (If a party vacates premises and delivers up the keys, therefore, great care should be taken as to the basis on which those keys are accepted. Whilst acceptance of keys in itself and/or on a without prejudice basis may not constitute acceptance of a surrender by operation of law, all the circumstances of a case will be relevant and the risk of inadvertent surrender may remain.)
• Nevertheless, there are legal requirements which must be met before a surrender (whether it is documented or not) can take effect.
• For example, one of the requirements that is necessary in order for a lease to be surrendered by operation of law is that both the landlord and the tenant must unequivocally act in a way that is inconsistent with the continuance of the lease. Like with any other contractual arrangement, there must be an unequivocal offer to surrender, and an unequivocal acceptance of that offer.
• Also as with any other contractual arrangement, terms will not be implied lightly. When deciding whether or not to imply a term, the court will consider the presumed intention of the parties at the time the contract was made. In order for a term to be implied, it must be necessary to give business efficacy to the contract and where the parties have entered into a document, particularly where they have been legally advised, it will be difficult to imply any term(s).
• Another requirement is that, where a landlord’s title is mortgaged, statute and, in most cases, the terms of the mortgage itself require mortgagee’s consent. Tenants (or, where instructed, their solicitors) should therefore always check the landlord’s title and obtain any necessary consents.
• Conversely, the consent of a tenant’s lender is not needed in order for the surrender of a tenant’s lease to be effective. Charges can, however, survive surrenders, so landlords too are best advised to check their tenant’s titles before surrendering, so as to avoid inadvertently becoming encumbered with a mortgaged property once the lease has fallen away.
• Following completion of a surrender, the landlord should ensure that the leasehold title is closed at HM Land Registry and any note of it cleared from its title, not least so as not to hinder or delay any potential future sale of the property.

If you would like any advice or assistance in relation to the surrender or other early termination of any lease arrangement, please do not hesitate to contact David Manda or any member of the Real Estate Litigation team.

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[1] [2017] EWHC 1820 (Ch)
[2] Where a landlord’s interest is charged, the terms of the mortgage and section 100 of the Law of Property Act 1925 generally provide that the lender’s consent will be required before the landlord can accept a surrender.
[3] In particular, M&S v BNP Paribas [2015] UKSC 72, and see our briefing.