Paying your dues

The House of Lords' decision in Scottish & Newcastle Plc v Raguz [2008] UKHL 65 has been welcomed by many as a great simplification of the law relating to the service of notices under s.17 of the Landlord and Tenant (Covenants) Act 1995 (the 1995 Act). However, the decision raises some uncomfortable issues of interpretation, with the court preferring to adopt a common-sense approach as to what parliament intended rather than relying upon the strict wording of the section.

Parliament chose to link the landlord's duty to serve notices under s.17 to the date that sums 'fall due'. The difficulty facing the Court of Appeal and the House of Lords was that liability for some lease payments (for instance the additional rent which will be payable once an outstanding rent review has been settled or a service charge balancing payment has been calculated) can arise before the date on which those payments are quantified and can be demanded. On what date could such payments be said to 'fall due'?

In the Court of Appeal, Lloyd LJ commented that the policy of the 1995 Act is to ensure that former tenants get prior notice of the possibility that they will be looked to for the recovery of sums due under a lease that they may have assigned many years before. The court considered the content of, and guidance notes to, the statutory forms produced under subsidiary legislation and concluded that parliament's intention was that the duty to serve a notice arose on the date that liability to pay accrued. In the case of an outstanding rent review, if the lease imposes a liability on the tenant to pay the additional rent on each quarter day then, the court held, a notice would need to be served within six months of each quarter day specifying that the amount outstanding was 'nil'. This obligation would apply both where the existing tenant is in arrears (the arrears situation) and also where all payments are up to date (the no arrears situation).

An inconvenience to landlords

The court acknowledged the inconvenience that 'nil' notices would cause. In reality landlords faced a considerable procedural pitfall. They and their property managers had a new obligation to monitor information in relation to past tenants and guarantors and arrange service of the relevant notices, or risk the financial implications of failing to do so.

Purchasers had a new due diligence issue to consider when buying a property subject to leases with outstanding rent reviews.

Many felt these disadvantages were unjustified given the limited benefit in practice to the recipient of a 'nil' notice. An overriding lease could not be claimed although it might allow the recipient time to make some provision for a potential possible liability (or perhaps allow the less scrupulous to strip assets from the vulnerable vehicle!). Companies needed to reflect contingent liabilities in their accounts and it is also unclear whether landlords have been willing to keep former tenants appraised of the final outcome of the review negotiations in those cases where, in practice, the current tenant settles the additional rent payable.

Nonetheless, the decision of the Court of Appeal did serve the policy of the 1995 Act in that it prevented landlords from allowing a significant liability to accrue and then surprising the former tenant or guarantor with a demand without warning. The decision made sense of s.17(4) of the 1995 Act, which allowed notices to be served on the basis that the amount claimed could be increased at some time in the future, and also the guidance attached to the statutory forms which suggested that s.17(4) notices would be used where additional rent could become due following settlement of an outstanding rent review. In practice, many landlords and their commercial advisers have been taking a commercial decision to serve 'nil' notices only where the existing tenant is in arrears of unreviewed rent or is likely to fall into them.

In the House of Lords, Lord Hoffman described the 'remarkably silly consequences' of the Court of Appeal decision. The subsidiary legislation and statutory forms were ignored on the basis that they could not be used to shape the interpretation of the 1995 Act. The House of Lords concluded that parliament had intended 'fall due' to mean the date on which a sum was quantified and could be demanded. In the case of additional rent following review, this means that a s.17 notice would only need to be served once the review has been completed. In relation to service charge balancing payments, a notice would only be required once the accounts have been produced and the exact liability known. In consequence, 'nil' notices have been consigned to history.

Landlords v tenants

Landlords have warmly welcomed the decision as a triumph of good sense and a timely release from the perceived bureaucracy of 'nil' s.17 notices. Tenants and guarantors have, of course, been less enthusiastic. In their view, the decision again allows the accrual of a substantial liability, which is then presented to a former tenant or guarantor without warning. Precisely the practice that the 1995 Act sought to prevent.

Procedural problems remain

Procedurally, however, practitioners will be disappointed that an element of uncertainty still remains in arrears situations. The majority of the House of Lords took the view that unreviewed rent and the additional rent that will be payable following review are separate and distinct charges. In an arrears situation this requires a landlord to serve initial s.17(2) notices for each quarter in arrears and a further s.17(2) notice within six months of the date on which the additional rent falls due for payment following determination of the review. Since the charges are separate and distinct, para.4 of the initial s.17(2) notice (which warns the recipient that the liability could subsequently be determined for a greater amount) does not need to be completed. As a result of the majority approach, s.17(4) of the 1995 Act is rendered redundant in the majority of cases. This point did not go unnoticed and the minority of the House of Lords considered that the correct procedure, in an arrears situation, would be to serve a s.17(2) notice (including para.4) in relation to each quarter in arrears and, within three months of the date that the review is finalised, a s.17(4) notice in respect of the additional rent.

The distinction is important since the statutory forms differ and the period for notice served under s.17(4) is both substantially shorter and commences at a different time. If the application of the decision is questioned in any case (perhaps because of the wording of the lease), it is possible that the right for the landlord to recover the additional rent could be lost. To avoid this possibility a practitioner might consider serving one set of notices in accordance with the majority procedure and a second set (without prejudice to the first) in accordance with the minority procedure! This is hardly the outcome their Lordships would have hoped for!

Issues for practitioners

When drafting or reviewing leases, practitioners should now be particularly careful to specify when payments are due under the lease.

For instance, the term dealing with interest on additional rent following rent review should make clear that interest will run from the review date rather than the later date when the additional rent has been quantified and can be demanded, but that it is the latter date which triggers the payment of any rent shortfall.

Lord Hoffman noted that 'every original tenant can be expected to know from the contents of the lease that he entered into, that the lease contains provision for periodic rent reviews and will know that there will almost invariably be an interval before the revised rent is ascertained'.

However, practitioners might question the commercial reality of this statement. The majority of tenants that assign their interest in a lease treat their obligations under it as permanently released notwithstanding advice that may have been given to them to the contrary. Records are all too often destroyed or lost and the individuals with the relevant knowledge move on. The longer the period since the assignment (and accordingly the greater the potential liability) the more likely it is that the former tenant or guarantor will have slipped into a state of blissful, yet dangerous, ignorance of its historic liabilities.

To redress the balance, a tenant's solicitor might seek to impose a contractual notification procedure to supplement the statutory one. One way to do this might be to amend the Licence to Assign so as to impose a duty on a landlord to notify the former tenant and any guarantor in the event that a subsequent rent review is outstanding and a liability may be accruing for which the recipient of that notice could be responsible.

Only well-advised tenants in the strongest of bargaining positions are likely to achieve this type of amendment. Ironically, it is also this particular type of tenant that might reasonably be assumed to have the ongoing knowledge to which Lord Hoffman referred.