Intra-group lease assignment: repeat guarantees not allowed, but court finds a way to a commercial outcome

30 October 2014

The Court of Appeal decision in K/S Victoria Street v House of Fraser is applied in another case so that a lease provision requiring a repeat guarantee on an intra-group assignment was void.

Key points

  • Lease provision requiring a repeat guarantee on an intra-group assignment was void
  • However, this did not mean that the assignment could automatically proceed without any guarantee being given
  • On the drafting, the court was able to preserve an obligation to obtain landlord's consent to an intra-group assignment, not to be unreasonably withheld
  • In practice, a landlord may usually be able to require a new guarantor where the assignee covenant is insufficient

Background

In the much-publicised 2011 Court of Appeal decision in K/S Victoria Street v House of Fraser, it was held that a guarantor of an assigning tenant could not - whether compulsorily or voluntarily - provide a continuing guarantee for the performance of the lease covenants by the assignee.

Such a 'repeat' guarantee would breach the wide anti-avoidance provisions in s.25 of the Landlord and Tenant (Covenants) Act 1995. This is because the Act provides for an outgoing tenant - and their guarantor - to be released from liability on an assignment of the lease (although entry into an Authorised Guarantee Agreement (AGA) is permitted).

This decision has important implications for commonly-used corporate restructuring arrangements in that where one company (T1) transfers the lease to another group company (T2), the existing guarantor (G1) - which is often the parent company of both T1 and T2 - cannot act as guarantor for T2, even if it is willing to do so.

Lease alienation provisions

In Tindall Cobham 1 Limited & Others v Adda Hotels (an unlimited company) & Others a lease of commercial premises included alienation provisions requiring the prior consent of the landlords to any assignment. The leases provided that such consent could be withheld in certain specified circumstances, or imposed subject to a number of specified conditions.

A further provision separately provided for landlords' consent to be obtained for an assignment to an associated company of the tenant, but subject only to two specific conditions as set out below:

"...3.14.6 The Tenant shall not assign this Lease to any Associated Company of the Tenant without the prior consent of the Landlord Provided Always that ...the Landlord shall be entitled to impose any or all of the following conditions set out in sub clauses (a) and (b) below:

(a) that the Tenant shall provide the Landlord with notice of any such assignment within 10 Working Days of completion of the same;

(b) that on any such assignment, the Tenant shall procure that the Guarantor and any other guarantor of the Tenant shall covenant by deed with the Landlord in the terms set out in the Sixth Schedule at the Tenant's sole cost

and subject to the Tenant's compliance with such conditions the Landlords consent shall be given..."

The Sixth Schedule set out the terms of the guarantee and included obligations to pay the lease rents and perform the tenant's covenants.

High Court ruling

In the High Court, the judge had held that this clause permitted an intra-group assignment subject to the prior consent of the landlords (not to be unreasonably withheld) and allowed the landlords to require compliance with conditions (a) and (b). In the case of condition (b), this entitled the landlords to require the assigning tenants to procure a new guarantor (approved by the landlords) in place of the existing lease guarantor.

This construction of the lease provision was challenged on appeal to the Court of Appeal.

The Appeal: a different construction?

Upon considering the effect of the anti-avoidance provisions of s.25 of the 1995 Act in the context of the clause, the Court of Appeal held as follows:

  • As a matter of ordinary language, the reference to "the Guarantor and any other guarantor of the Tenant" meant the persons who at the time of the assignment were the guarantors of the tenant's obligations under the lease
  • The only obligation in (b) was for the tenant to procure a new guarantee from those persons (and not a new guarantor)
  • Such a condition, requiring a guarantee to be procured from an existing guarantor, was an agreement which had the "effect to exclude, modify or otherwise frustrate the operation of any provision of the [1995] Act" within the terms of s.25 (1) and was thereby rendered void
  • However, conditions (a) and (b) of the proviso to the clause were parts of a composite, interdependent proviso and the removal of the more important condition in (b) also logically called for the removal of the final words of the proviso (requiring the landlord to give consent) as well

In light of the above, and in order to give effect to s.25 while respecting the structure of the contract between the parties, the Court of Appeal held that the solution in the present case was to treat the entirety of the proviso as being avoided by the legislation. This (in the words of the court) "...leaves clause 3.14.6 as a qualified covenant against assignment which can be operated according to its terms".

In other words, assignment to an associated company would be permitted, but subject to the prior consent of the landlords (not to be unreasonably withheld).

Comment

There are a number of points of note here:

  • This case turned on a construction of the particular clause viewed in the context of the lease as a whole. However, given that cases on the operation of the 1995 Act are relatively few, it is nevertheless instructive to see the approach taken by the court. Significantly, it was able to preserve an operative part of the offending lease clause, thereby satisfying the s.25 restrictions while still achieving a result which avoided producing "capricious and uncommercial" consequences
  • Section 25 renders provisions "void to the extent that" they offend the Act. The court thought that while this was an indication that Parliament intended that nothing more should be invalidated than was necessary to safeguard the objectives of the 1995 Act, it was nevertheless entitled to look at the structure of the lease "in an objective and common sense way, [taking]...a balanced approach to invalidation which, whilst neutralising the offending parts of the contract, does not leave it emasculated and unworkable....

    Had the court only removed condition (b), the landlord would have been compelled to consent to any intra-group assignment subject only to the condition that the landlord be given notice of assignment within 10 working days. This lack of protection for the landlord was quite the opposite of what the parties had intended when agreeing the clause, so the court strove to avoid this being the result. In another case, different drafting might of course produce a different result
  • The construction adopted by the court removed the landlord's unfettered right to insist upon a guarantee being given on assignment of the lease. However, in practical terms, the continuing requirement for simple qualified consent would nevertheless mean that a landlord faced with an application to assign the lease to an assignee of limited or no substance could still insist on an adequate guarantor as a condition of consent, given the general criteria for reasonableness at common law
  • The court noted that the otherwise "absolute" effect of the provisions of s.25 was subject to the limited exception allowed by means of an AGA. It is interesting to observe the court's view that, following the Court of Appeal decision in the K/S Victoria Street case, it is permissible for the outgoing tenant's AGA liabilities to be guaranteed by the existing guarantor

    That particular issue was, in fact, not a binding part of the 2011 case as it was not necessary for the court to decide the question before it. However, it has since generally come to be regarded as the accepted position. Its explicit endorsement by a differently-constituted Court of Appeal should only serve to strengthen that view going forward
  • Finally, while (not being the subject of this appeal) the court did not have to consider or comment upon the general assignment provisions in the lease, it is notable that these required the first assignment of the lease outside the group to be made via the guarantor. On the basis of the court's general comments in the K/S Victoria Street case, that would more than likely have been found to be in breach of the anti-avoidance provisions of s.25.

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