High Court: commercial tenant cannot assign lease to its guarantor

Out-Law News | 21 Mar 2016 | 3:44 pm | 3 min. read

Anti-avoidance provisions in the 1995 Landlord and Tenant (Covenants) Act prevent a tenant from assigning a lease to its guarantor, the High Court has ruled.

Judge Amanda Tipples QC backed comments made by Lord Neuberger in his judgment in the leading case in this area, 2011's K/S Victoria Street Court of Appeal decision. Lord Neuberger said at the time that the legislation "[appeared] to mean that the lease could not be assigned to the guarantor, even where both tenant and guarantor wanted it". However, his comments did not form part of the formal judgment in that case as the court was not asked to decide on the issue.

In a detailed judgement, Judge Tipples said that allowing the tenant to assign the lease to its guarantor would frustrate the whole purpose of the 1995 Act, which is that there should "be no re-assumption or renewal of liabilities, whether on the tenant or the guarantor".

"[I]f a tenant and the tenant's guarantor are each liable for the same or essentially the same liabilities as a result of the tenant's covenants of the tenancy, the guarantor cannot as a result of assignment by the tenant to it of the tenancy re-assume those very same, or essentially the same, liabilities as the tenant," she said. "Or, using the terminology used in some of the cases, G1 cannot on an assignment by T1, become T2."

Both the tenant and its guarantor are supposed to be released from their liabilities under the lease at the point of assignment, she said. However, assigning the lease to the guarantor would release it from the tenant covenants of the tenancy while "at the very same moment in time" binding it with those same covenants, she said.

"In practical terms therefore, there is no release at all for G1 in respect of its liabilities under tenant covenants. This is because the liabilities under the tenant covenants are simply re-assumed by the guarantor, but this time as an assignee (and not as a guarantor). Further, the liability re-assumed by G1 as T2 [the new tenant] is the very same in a case such as the present, where the guarantor is also primarily liable in respect of the tenant covenants," she said.

"The objective effect of the assignment is that G1 re-assumes precisely the same liability in respect of the tenant covenants as a result of becoming T2 pursuant to the assignment. It is that consequence which 'frustrates' the operation of [the 1995 Act] and the assignment is rendered void by ... an anti-avoidance provision which is to be interpreted generously. The guarantor is therefore absolutely precluded from becoming the assignee, on an assignment by the tenant whose tenant covenants he is guaranteeing," she said.

The dispute in this case related to music retailer HMV’s tenancy of a shop in Worcester, granted by landlord CHB Group in 1996. EMI Group, HMV’s parent company, was guarantor of the lease. In 2013 the tenant, then known as Record Shop 1 Ltd, went into administration, by which point the landlord had transferred its interest in the lease to the defendant in this case, O&H Q1 Ltd. The following year, the new landlord permitted the insolvent company to assign the lease to EMI, which has since sublet the premises to a new company, HMV Retail Ltd.

As the original tenant is now insolvent, the lease is now vested in the Crown as ‘bona vacantia’ and EMI will be required to enter into a new lease with the landlord if it wishes to continue trading from the site.

Property litigation expert Craig Downhill of Pinsent Masons, the law firm behind Out-Law.com, said that the case would be of particular interest to groups of companies wishing to re-arrange their property holdings within the group, if members of the group had provided guarantees in the past to a related tenant.

“It is a reminder that, where leases are concerned, the anti-avoidance provisions in the 1995 Act should be considered carefully at an early stage to ensure that any restructuring within the group which involves the property portfolio is effective and not liable to be struck down,” he said. “Landlords might also want to review their portfolio to see whether any of their leases might be affected by this decision.”

“In this case, there appears to have been an advantage to the landlord in the transaction being void as it was open to it to rely upon the contractual provision in the lease which required a guarantor of the tenant to take a new lease on the dissolution of the tenant and a disclaimer of the lease,” he said.