An assignment from a tenant to its guarantor is void. Really?

Lord Neuberger once famously confessed, as Master of the Rolls in Day & Anor v Hosebay Ltd [2010] EWCA Civ 748 (a decision on leasehold enfranchisement), that he had “started, in Boss Holdings [2008] 1 WLR 289, paragraph 26, what I now think is a hare by suggesting an over-literalist approach to the language used by the legislature”. He wished to depart from his over-literalist approach and so the hare was recaptured. In K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904, Lord Neuberger’s apparent interpretation of the language of the Landlord and Tenant (Covenants) Act 1995 has set loose another hare which, unless captured and extinguished, is likely to cause significant damage in landlord and tenant transactions. This much is evident from the recent decision in EMI Group Ltd v O & H Q1 Ltd [2016] EWHC 529 (Ch).

Background

The background to this decision is the case of K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904. It will be recalled that this case was the Court of Appeal decision that determined, in relation to post-1995 Act tenancies, that a direct guarantee of an immediate assignee’s liabilities given, on assignment, by the assigning tenant’s guarantor is rendered void by section 25 LTCA 1995, because it operates to frustrate that guarantor’s release from liability on assignment under section 24(2) LTCA 1995.

However, in the course of his judgment, Lord Neuberger intimated that an assignment of the lease to the assigning tenant’s guarantor might itself be void by reason of section 25. Applying the ratio of that case (i.e. that section 25(1) invalidates any agreement which involves a guarantor of an assignor directly guaranteeing the liabilities of the assignor's assignee), Lord Neuberger said (in obiter) that an extension of this interpretation “would also appear to mean that the lease could not be assigned to the guarantor, even where both tenant and guarantor wanted it” since such an assignment would involve a continuation of the guarantor’s liability under the lease beyond the moment of his/her statutory release. 

As a result of that comment, some leases started to include terms prohibiting an assignment from the tenant to its guarantor, yet many commentators doubted whether Lord Neuberger truly intended to rule that such an assignment could not be made. Subsequently, in UK Leasing Brighton Ltd v Topland Neptune Ltd (also known as Zinc Cobham 1 Ltd v Adda Hotels) [2015] EWHC 53 (Ch), Morgan J. described Lord Neuberger’s comment as “obiter and somewhat tentative”.

The EMI decision

In EMI Group Ltd v O & H Q1 Ltd, Miss Amanda Tipples QC (Deputy High Court Judge) elected to follow Lord Neuberger’s dicta, and concluded that, as the effect of such an assignment is that the guarantor, as tenant, re-assumes precisely the same liability in respect of the tenant covenants as it is released from on assignment, that re-assumption frustrates the release of the guarantor under section 24(2)(b) LTCA 1995: “…and the assignment is rendered void by section 25(1)(a), 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.”

In this case, the landlord had granted licence to assign a 25 year lease granted in 1996 from the original tenant (HMV UK Ltd, but now operating as Record Shop 1 Ltd, and in administration) to EMI Group Ltd (who was the guarantor of the lease). The assignment was completed in 2014 (and an underlease to HMV Retail Ltd was completed shortly after the assignment). One assumes the assignment/transfer was registered at the Land Registry. Subsequent to completion, the claimant, EMI Group Ltd, asserted that the effect of the decision in House of Fraser (and, in particular, Lord Neuberger’s comment) was that, although the lease had become vested in the claimant, the tenant covenants could not bind the guarantor as an assignee of the lease. Section 25(1)(a) would preclude this. The landlord disputed this and argued that either (a) an assignment to a guarantor was not precluded by the 1995 Act or (b) if it was precluded, that it was the whole assignment that was void, not just the assumption of liability under the tenant covenants. The judge ruled that the purported assignment was void and of no effect. The result was that the lease remained vested in the original tenant, and that the claimant remained bound as original guarantor, and had not been released from its obligations under the guarantee.

Comment

The implications of this decision are quite staggering. No-one anticipated when the Act was first put onto the statute book that a tenant could not, with landlord’s consent, perform the relatively simple task of assigning its lease to its guarantor. A guarantor, faced with potential liability for rent (e.g. where the tenant is insolvent) or wishing to arrange a corporate restructuring may want to take over the lease. The decision in EMI Group Ltd says that this cannot be done. Some guarantors have the benefit of call option clauses so that, if the tenant defaults in performance of its covenants, and the guarantor is called upon to remedy the default of the tenant, the guarantor can call for an assignment of the lease. The decision in EMI Group Ltd would rule that this cannot be done.

At the heart of the decision is what is described in the case as the “whole thrust of the Act”, which is that there should be no re-assumption or renewal of liabilities, whether on the tenant or the guarantor. The main thrust of the Act is that a tenant or any other person who is associated with the tenant's liability should not remain liable under a tenancy after the tenant has been released from his liability. (This is of course subject to rules relating to AGAs and guarantees of AGAs as considered by Lord Neuberger in House of Fraser). Miss Tipples QC, in EMI Group Ltd concluded that the objective effect of the assignment to the guarantor was that the guarantor “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 section 24(2)(b) and the assignment is rendered void by section 25(1)(a)”.

So, consider another case of release and re-assumption. Where a lease is assigned by T1 to T1 and to T2, such an assignment, made lawfully, operates to release T1 from the tenant covenants of the tenancy under section 5(2)(a) LTCA 1995. However, the effect of the assignment is also to cause T1 and T2 to assume liability under those covenants under section 3(2)(a) LTCA 1995 as from the assignment. Such a re-assumption would not be allowed on the basis of the reasoning in EMI Group Ltd. Such an assignment would be void.

Is the assignment really void?

Is an assignment from a tenant to its guarantor really void? Are the courts taking this “whole thrust” principle a little too far? Some will query whether a lease assignment is an “agreement” within section 25 of the Act. Maybe it is. However, it is difficult to see how an agreement that is not made with the landlord can be said to frustrate the release of a liability owed to the landlord.

Miss Tipples QC said, at para [79], that: “if 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.” Applying the “whole thrust” principle, it would appear that if, following release, a guarantor assumes essentially the same liabilities, the assumption would be rendered void.

So let us take this a step further. Let us assume that the tenant assigns its lease legitimately to a third party assignee, but that the tenant’s guarantor, to facilitate the assignment, agrees to indemnify the assignee against all future liabilities it incurs under the lease. It is as if the guarantor has re-assumed liabilities (“essentially the same liabilities”) as it was subject to under the guarantee of the lease. Would the indemnity agreement be void, because the consequences of it frustrate the guarantor’s release from liability under section 24(2) LTCA 1995? Surely the answer would be “no”. The “agreement” to indemnify is not made with the landlord, but with a third party. And in the same way, the assignment by which the guarantor takes on liabilities under the lease is not an agreement made with the landlord. Admittedly, section 25 applies to “any agreement” but, in the circumstances contemplated, it must at least be arguable that only an agreement entered into by the guarantor with the landlord (e.g. the repeat guarantee agreement that was ruled unlawful in House of Fraser) can be said to frustrate the guarantors release from a liability owed to the landlord.

Let us hope that there is a speedy review of the decision. The implications of it are too troubling to contemplate.

Add new comment

(If you're a human, don't change the following field)
(If you're a human, don't change the following field)
(If you're a human, don't change the following field)