The pain of settlement: the EMI case and the 1995 Act

There was universal disappointment amongst those with an interest in commercial certainty and sensible development of the law when it was discovered that there was to be no appeal hearing in the case of EMI Group Ltd v O & H Q1 Ltd [2016] EWHC 529 (Ch). The parties have reached a settlement agreement.

This is the 2016 High Court case in which it was held that a tenant cannot assign a post-1995 Act lease to its guarantor. The case related to an assignment of a lease, with landlord’s consent, from the original tenant (HMV UK Ltd, then operating as Record Shop 1 Ltd in administration) to EMI Group Ltd (who was the guarantor under the lease). The court held that the effect of such an assignment was that the guarantor, as assignee, was re-assuming precisely the same liability in respect of the tenant covenants of the lease as it had been released from on assignment. The deputy judge held that the re-assumption of liability by the guarantor, as tenant, frustrated the statutory release on assignment of a guarantor under section 24(2)(b) of the Landlord and Tenant (Covenants) Act 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.”

It may be worth recalling why the judge felt constrained to arrive at this conclusion. At the heart of the decision is the effect of section 25 LTCA 1995, which would invalidate (inter alia) any agreement frustrating a guarantor’s release from liability on assignment. Buoyed by comments made by Lord Neuberger in K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904, that section 25 “would also appear to mean that the lease could not be assigned to the guarantor, even where both tenant and guarantor wanted it”, EMI Group Ltd asserted that, although the lease had become vested in it as an assignee, the tenant covenants could not bind it. Section 25(1)(a) would preclude this. The judge was therefore faced with a choice between two unsatisfactory outcomes argued for by the litigants: (a) for EMI Group, the assertion that while the lease was vested in it, the assignee had no liability under the tenant covenants of the lease; or (b) for the landlord, that the whole assignment was void. (There was a third possibility; i.e. that an assignment to a guarantor was not precluded by the 1995 Act. However, Lord Neuberger’s comments were adhered to). The judge ruled that the assignment was void.

As a result of this decision (and notwithstanding the apparent commercial absurdity in the outcome), there are a number of practical implications.

Withhold consent to assign? Landlords should consider withholding consent to applications for licence to assign a post-1995 Act lease from a tenant to its guarantor. Since the High Court’s view is that such an assignment would be void, the landlord should be on safe ground in arguing that the withholding of consent is reasonable.

Absolute prohibitions? Landlords may consider including an absolute prohibition on the assignment of a lease from a tenant to its guarantor. The Model Commercial Lease already prohibits such assignments by providing that “the Tenant may not assign to a Current Guarantor” (defined as “someone who, immediately before a proposed assignment, is either a guarantor of the Tenant’s obligations under this Lease or a guarantor of the obligations given by a former tenant of this Lease under an AGA”). A tenant may wish to resist an absolute prohibition, pointing to the ability of the landlord to block the assignment on reasonable grounds. Indeed, the landlord may consider whether it is wise to prohibit such assignments for all time. The EMI Group decision is controversial and, while there is no indication of any similar litigation in the pipeline, in the fullness of time, we may find that the decision is overturned so that such assignments are allowable.

Protections for guarantors? Guarantors may consider the worth of pursuing an option to take an assignment of the lease from the tenant in the event of tenant default, given that the assignment would appear to be void. However, as above, such an option may still work in the future if the decision in the EMI Group case is ever subject to review.

Corporate restructurings? Corporate entities undergoing a restructuring, including transfers of property ownership, must take this decision into account, and avoid a restructuring that involves a transfer of leases from a tenant to its guarantor. While a surrender and the grant of a new lease to the “assignee/guarantor” would not be caught by the EMI Group decision, SDLT would become payable, and overlap relief would not apply.

Due diligence? Those acquiring buildings subject to leases should check carefully to ascertain whether the current tenant was formerly a guarantor of the lease. Landlords might consider reviewing lease liabilities where the current tenant is in default. A former, apparently released, tenant may not have been released from liability at all if the tenant had assigned the lease to its guarantor. The lease may still be vested in the former tenant.

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