Update: commercial property

Three recent cases have shed light on landlord and tenant issues where there was previously some doubt as to whether practices commonly adopted in the market were in accordance with the underlying legal position. One example is the court's confirmation of the efficacy of so-called 'virtual assignments' and on that issue the position now seems to have been clarified. Further clarification, welcome for landlords, has been provided in relation to the characterisation of rent liability for companies in administration. Landlords will be notably less pleased, however, by the Good Harvest decision which '“ at least until the outcome of the appeal is known '“ casts a significant shadow over the practice of accepting guarantors on leases on the assumption that they can be required to enter into an authorised guarantee agreement (AGA) when the lease is assigned.

Guarantees on assignment

Ever since the Landlord and Tenant (Covenants) Act 1995 came into force on 1 January 1996, there has been some uncertainty about whether an outgoing tenant's guarantor could be asked to be a party to an AGA on assignment. It had, however, become common practice for guarantors to enter into an AGA and this had been supported by commentary on the point. Good Harvest Partnership LLP v Centaur Services Limited [2010] EWHC 330 (Ch) has finally delivered guidance on the issue but the decision that a guarantor cannot be a party to an AGA is not proving to be the welcome news to tenants or guarantors that it first appears.

Good Harvest concerned enforcement action taken by the landlord, Good Harvest Partnership LLP, against the original guarantor, Centaur Services Limited. Centaur had entered into an AGA when the original tenant, Chiron CS, assigned its lease in 2004 and Good Harvest subsequently took action against Centaur to recover arrears pursuant to that AGA. As a preliminary issue on the claim, Centaur argued that the AGA could not be enforced as it would be in breach of the anti-avoidance provisions in section 25 of the 1995 Act. Newey J ruled in favour of Centaur and held that section 25 of the 1995 Act did indeed bar Good Harvest's claim against Centaur. The basis of his judgment was that the 1995 Act contains specific provisions releasing both outgoing tenants and guarantors (sections 5 and 24) but that there is no specific provision in section 16 (which contains the provisions relating to AGAs) or elsewhere in the Act for guarantors to give further guarantees.

The decision has immediate implications for landlords and tenants. First, from an enforcement perspective, landlords will no longer be able to rely on any covenants given by guarantors in AGAs to recover, for example, rent arrears. Second, on applications for consent to assign, a landlord will need to assess the merits of a prospective assignee without taking into account the additional security of an AGA from an existing guarantor of the tenant's obligations. In practice, this may mean an increase in the circumstances where it will be reasonable for a landlord to refuse consent to an assignment. It may also result in an increased use of rent deposits or other forms of security.

The wider concern with the Good Harvest case is, however, that Newey J also indicated that any guarantee provided by a guarantor of an outgoing tenant would be void under the terms of the Landlord and Tenant (Covenants) Act 1995 even if that guarantee was given voluntarily. On an intergroup assignment, for example, it is common for an outgoing tenant to offer the same parent company guarantee for the assignee group tenant '“ not under the terms of an AGA but as a new guarantor. According to the decision in Good Harvest, such arrangements would now be void. This is likely to lead to some practical problems as, in the case of intergroup assignments, there may only be one company capable of being guarantor for an assignee.

Good Harvest has already appealed the decision and, for the sake of both landlords and tenants, it would be helpful if a distinction could be drawn between a guarantee given as part of an AGA and a guarantee given independently by, for example, a parent company on behalf of an assignee. Until the result of the appeal is known, however, landlords need to be cautious about accepting guarantors at any stage in a transaction. Tenants should also be aware that applications to assign may prove more complicated in the future, particularly in a group company situation.

Virtual assignments

While the Good Harvest case addressed a long-standing assignment question, another recent case has provided guidance on the new territory of 'virtual assignments'. Clarence House Limited v National Westminster Bank plc [2009] EWCA Civ 1311 has confirmed that it is possible to have a virtual assignment which does not breach the alienation provisions in a lease but which has the contractual effect of transferring the economic benefits and burdens of a lease. The most obvious example is on portfolio sales, where it may be difficult to coordinate landlords' consent to assignment within the timescale required. Virtual assignments may also be useful where a tenant wishes to remove lease liabilities '“ perhaps because it needs the figures off its balance sheet or where it wishes to outsource.

In Clarence House, Natwest had already sublet all of its interest in premises for the remainder of the term. It then transferred all the economic benefits and burdens of the lease and underlease to a Gibraltan company, New Liberty Property, whom it appointed as its agent to act on its behalf in dealing with the leases. When the landlord discovered the situation, it was concerned that the lease had been transferred without consent '“ particularly as the rent was in arrears. The Court of Appeal, however, held that a virtual assignment had taken place and that the arrangement did not breach the terms of the lease '“ Natwest had not parted with possession (it was already not in occupation in any event) and it had not created a trust relationship or underlease.

The decision reached by the appeal judges does not open up new mechanisms to avoid assignment. Instead, it provides judicial guidance on an arrangement already being used in practice by confirming that a virtual assignment does not affect the principal landlord and tenant relationship. This will be a welcome conclusion for those practitioners that have been using such arrangements. It remains to be seen, however, whether this has the effect of bringing the concept of virtual assignments to a wider audience as a positive measure or whether it actually causes some landlords to tighten the wording of their alienation clauses to try to restrict such arrangements going forward.

Rent as an expense of administration

The recent increased incidence of tenant insolvency has flushed out a decision that provides some comfort for landlords of tenants in administration. Where an administrator causes the insolvent tenant company to continue to use all or part of let premises for the benefit of the company's creditors (i.e. continuing to trade the company's business from them) it is now established, via the High Court decision in Goldacre (Offices) Ltd v Nortel Networks UK Ltd [2009] EWHC 3389 (Ch), that the rent payable under the lease will rank as 'an expense of the administration' under rule 2.67 of the Insolvency Rules 1986.

This is significant because, although the making of the payment ultimately depends on the company having sufficient assets, administration expenses are in practice generally paid in full. Prior to Goldacre, the characterisation of rent as an expense required a case-by-case balancing of the interests of landlords with those of other creditors and an exercise of discretion by administrators or courts. Landlords faced being treated as unsecured creditors and thus likely to receive only a small proportion of rent, despite being deprived of the benefit of their premises during the administration. At best, landlords might have been able to negotiate a partial payment of rent by the administrator. The upside for landlords from Goldacre also included a ruling that if the tenant company uses only part of the let premises for the benefit of the creditors (as was the case in Goldacre) then the rent will be due in respect of the whole of the premises let by the lease: the administrator is not permitted to apportion or tailor the rent by reference to the space actually occupied during this period.

All of the above is welcome news for landlords. The Goldacre case, however, does have its limitations, both technical and practical.

In ruling that rent must be paid in full, even where only part of the premises was being occupied, the court seemed to be influenced by the configuration of the particular premises, which could not readily be sub-divided so that the landlord could not in practice exploit the unoccupied parts. Another technicality, which did not arise in Goldacre, is the question of whether premises are actually being used for the benefit of creditors; passively holding a lease while the company's affairs are dealt with, but without actively trading from the premises, probably will not make rent an 'expense'. Moreover, the rule in Goldacre will apply only to rent that actually falls due during the period in which the company is using the premises for the benefit of creditors. If that period begins just after a quarter day, the landlord will suffer a near-full quarter in which the rent is not a priority expense (although, more positively for landlords, the converse also applies, so that if a rent payment date occurs during the period of use the rent due for the whole quarter will be ranked as an expense whether or not the use continues throughout).

Goldacre is, therefore, a welcome decision for landlords, but it is far from being a panacea. Indeed, the very fact that administrators must now effectively budget for the payment of rent in full if they are minded to use the premises for trading may decrease the instances of premises being used at all, in which case the temporary shelter to insolvent but potentially viable businesses that is intended to be afforded by the administration regime has, arguably, been undermined in a manner that will benefit neither struggling companies nor their landlords.