Judge allows hotel companies to reassign leases without losing benefit of associated guarantees

Out-Law News | 20 Jan 2015 | 2:43 pm | 4 min. read

A High Court judge has approved arrangements allowing companies within the Hilton group to reassign leases between themselves without the landlord losing the benefit of a guarantee granted by the parent company.

Last year the Court of Appeal ruled that a property lease had been unlawfully assigned as assignment needed the consent of the landlord. This meant that the original tenant and its guarantor were still liable for the tenant's obligations under the lease. 

The companies involved, along with another hotel where the facts were broadly the same, returned to the High Court to establish whether there was a way that they could reassign the leases back to the original tenants without the landlord losing the benefit of the guarantee. Mr Justice Morgan ruled that a method put forward by the landlord, where the new tenant reassigned the lease direct to the original tenant and the guarantor granted a fresh guarantee, would be effective. A more complicated solution put forward by the tenants would not be effective, he said.

Generally, when a lease is assigned to a third party, tenants and their guarantors are automatically released from liability to the landlord. However, an authorised guarantee agreement (AGA) allows an outgoing tenant to guarantee the incoming tenant's liabilities, when a lease is assigned. AGAs were created by the 1995 Landlord and Tenant (Covenants) Act and their content is strictly regulated by statute. Previous case law has confirmed that an existing guarantor cannot guarantee the new tenant's obligations directly, even if the old and new tenants are part of the same corporate group. That was the concern in this case, as the landlord and the tenant disagreed on how the leases could be validly re-assigned, without the landlord losing the benefit of the guarantee. 

The case in dispute involved two companies within the Hilton Group hotel chain, Adda Hotels and Puckrup Hall Ltd, which had transferred the leases to property that they occupied to other companies within that group. Those leases were guaranteed by Hilton Worldwide, the Hilton Group's parent company. The transfers were made without the landlord's consent, but the Court of Appeal held that the leases had been validly assigned, albeit as an 'excluded assignment'. The effect was that both the former tenants and Hilton Worldwide would remain liable under the leases until it was next assigned in accordance with the terms of that lease.

The case had returned to court because the new tenants, which were companies set up expressly for the purpose of taking these assignments, wanted to reassign the leases back to their original tenants. However, this transfer was taking place in accordance with the terms of those leases and with the consent of the landlord, meaning that the outgoing tenant and its guarantor would normally be released. Although it was simple enough for Hilton Worldwide to issue a fresh guarantee, all parties were concerned that this would fall foul of anti-avoidance provisions governing AGAs contained in the 1995 Act.

However, Mr Justice Morgan said that this approach, preferred by the landlords, would be effective. This was based on the operation of the words "to the same extent as the tenant is released from that tenant covenant" in the 1995 Act; meaning that if the new tenant was released from its obligations under the lease then Hilton Worldwide as guarantor should be too, but there was nothing to prevent Hilton Worldwide entering into a fresh guarantee. Although Mr Justice Morgan said that he reached this conclusion "after some hesitation", the circumstances of the case were such that the qualification "produced a sensible commercial result", he said.

Although he said it was not strictly necessary, Mr Justice Morgan then went on to consider the tenants' proposal that the leases first be assigned to a 'newco' new subsidiary company with no parent guarantee before then being assigned back to the first tenants under the benefit of a new guarantee. This approach was technically valid, but fell as a result of the anti-avoidance provisions in the 1995 Act, he said.

"The problem arises because, before [Hilton Worldwide] is released on the assignment to Newco, it is being required to agree that it will commit itself again as a guarantor, admittedly not immediately on the assignment to Newco but shortly thereafter on the assignment by Newco to [the original tenants], which Newco and [the original tenants] will contract to effect," he said. "In view of the meaning given in [existing case law] to the phrase 'otherwise frustrate the operation of any provision in this Act', I consider that the suggested agreement would frustrate the operation of [the 1995 Act]."

Property law expert Nicholas Vuckovic of Pinsent Masons, the law firm behind Out-Law.com, said that the case demonstrated the continuing uncertainty over the validity of certain guarantees in the context of the 1995 Act, following a 2010 High Court case known as Good Harvest, and the 2011 K/S Victoria Street Court of Appeal decision.

"Here, despite all parties agreeing that they wished for a mere return to the position before the lease was first assigned, they were - no doubt frustratingly - forced to turn to the High Court for an assessment of the current state of the law and guidance as to how this might be achieved," he said.

"In this decision, the High Court recognised that the Court of Appeal in the K/S Victoria Street case selected an interpretation of the 1995 Act which they acknowledged was 'unattractive and commercially unrealistic'. However, against this backdrop, a sensible conclusion was nonetheless reached to achieve the parties' aims: namely, that it is possible for an original guarantor of an original tenant of a lease, who continues to be bound by its obligations as a result of an excluded assignment of that lease, to give a fresh guarantee upon a further assignment back to that original tenant," he said.

Mr Justice Morgan's conclusions on agreements structured to deliberately circumvent the 1995 Act also provided "useful guidance", he aid.

"Inevitably, given the subject matter, the High Court judge had a degree of self-doubt, and was unwilling to overtly challenge the troublesome obiter comment from Lord Neuberger in the K/S Victoria Street case that a lease 'could not be assigned to the guarantor, even where both the tenant and the guarantor wanted it'," he said. "However, this decision still usefully serves to plug another hole in the 1995 Act and adds to the tapestry of judicial authority which practitioners must consider when interpreting it."