Guarantor was released from obligations when alterations to property were made without its consent, Appeal Court confirms

Out-Law News | 23 Jan 2014 | 2:32 pm | 2 min. read

The guarantor of an insolvent commercial tenant cannot be held liable for outstanding obligations if changes were made to the lease without its consent which had the "potential" to increase the burden on the guarantor, the Court of Appeal has confirmed.

Upholding last year's High Court ruling against the landlord of a former DIY store, the Court of Appeal ruling said that a licence for alterations granted to the insolvent company "envisaged" that its repairing and reinstatement obligations could be increased. The parent company could not therefore be liable for the outstanding rent in its role of guarantor, said Mr Justice Arnold in the ruling.

"The Court of Appeal decision has reiterated the well-known legal principle that a guarantor will be released when parties enter into subsequent licences and/or other variations to the original lease which have the effect of increasing, to the guarantor's detriment, that guarantor's obligations," said property litigation expert Kayleigh Humphreys of Pinsent Masons, the law firm behind Out-Law.com.

"Landlords and subsequent purchasers of the landlord's reversions must keep a close eye on whether guarantors may be, or have been, inadvertently released and take steps to ensure a guarantor is party to agreements which increase their liabilities to avoid the mistake made here," she said.

The landlord in this case, Topland, had invested in a property that was let to WH Smith's now-defunct subsidiary Payless DIY in 1981. In 1987, Payless entered into a licence with the previous landlord allowing it to construct a new garden centre. Payless went into administration in 2011, and was dissolved in 2012.

Under common law rules, a guarantor's liability for the obligations in a lease is discharged where there has been a "material variation" in the terms of the lease without the consent of the guarantor. There is an exception in cases where it is "self-evident" that the variation is "insubstantial" or "cannot be prejudicial to the guarantor". It is not up to the court to consider whether or not there is actual prejudice or damage, or whether the variation is substantial.

In her original judgment, Deputy Judge Alison Foster said that the parent company, now known as Smiths News Trading, was released from its obligations by virtue of the licence, as the work covered by it was "not in the contemplation of" the tenant at the time that the lease was guaranteed. The Court of Appeal backed her findings.

"I consider that the deputy judge was right to conclude that the licence had the clear potential, to put it at its lowest, to increase the obligations on the lessee, and hence on the surety in the event of the lessee's default," said Mr Justice Arnold.

He also backed the deputy judge's findings that 'forbearance' provisions contained in the lease, providing that the surety would not be released where the landlord failed to enforce the tenant's covenants, did not apply in this case.

"Having regard to the context and purpose of the proviso, I consider that 'forbearance' connotes a decision by the landlord not immediately to enforce the observance or performance of a covenant against a tenant who is in breach of that covenant, but rather to tolerate the breach for the time being," he said.

"In the present case I agree with the deputy judge that there was no forbearance by [the original landlord, which granted the licence]. Payless was not in breach of the covenant against alteration, and accordingly [the landlord] did not decide not to enforce the observance of the covenant. On the contrary, [the landlord] positively authorised Payless to construct the works," he said.