Real Estate monthly digest - April 2019

RICS consultation on the new version of the Code for Leasing Business Premises

The RICS (Royal Institution of Chartered Surveyors) is currently consulting on the ‘Professional Statement: Code for Leasing Business Premises, 1st edition’ (the Code). The RICS notes that this professional statement builds on “the previous industry Code which did not have official RICS status and therefore no regulatory requirements attached”.

Background

The first code of its kind dates back to 1995, emanating from the early 1990s recession and the government’s attempt to help protect business tenants without damaging the property industry (and, in particular, the pension funds making up a significant proportion of property landlords). A review of the effectiveness of that code a few years later led to a new version in 2002. In 2007 we then had a further code on which this 2019 version is closely based.

Each time there has been a review there is an overwhelming conclusion that the level of awareness of rights and obligations within the tenant population is generally poor and, likewise, the awareness of a code of practice itself equally poor.

So, what will make a difference this time?

The answer proposed is to make some elements of the new Code mandatory.

Because the new Code will be an RICS professional statement, the provisions will be implemented by way of the professional standards that the RICS monitor and enforce in respect of its members.

It is worth noting that unrepresented landlords dealing with unrepresented tenants would not, therefore, be directly affected.

The detail…

The mandatory sections of the proposed Code are limited. Importantly for landlords, there are no requirements or restrictions on what lease terms must be agreed (some may recall the 2007 code was largely a response to avoid legislation banning upward only rent reviews). The mandatory elements are that:

• negotiations should be constructive and collaborative
• parties that are unrepresented by an RICS member or other property professional must be advised by those parties that are so represented of the existence of the Code and must be given a recommendation that they obtain professional advice, and
• heads of terms (HoTs) must deal with a prescribed list of 20 points and be clearly marked ‘subject to contract’ (renewal HoTs can be shorter if the relevant terms are to be carried forward, subject to modernisation).

For the majority of the professionally managed property industry there will be no issues with complying with these requirements, just a change in process relating to the form of HoTs. By mandating the scope of HoTs the industry might start to behave more consistently. Perhaps we will get to a more standardised approach. Indeed, one of the stated aims of the RICS is to improve efficiency in the legal formalities, and better quality HoTs will definitely assist with that. However, challenges will still arise if key commercial issues remain unresolved at HoTs stage and are instead left to be determined during the course of legal drafting.

For multi-let buildings and for portfolios, some landlord agents would be well advised to either ensure the longer form HoTs are consistent with other lease terms and/or the landlord’s own policies. Some landlords with large portfolios will have clear "house" views or more formal policies on terms they will insist on (or at least try to). These will usually be informed by a necessity or strong desire to have a consistent approach to issues that can arise (e.g. standard service charge arrangements). Other points will be born out of specific experiences that managers have had where they feel they need certain protections. At least with the new Code there will be a clear benchmark against which tenants and their advisors can test where landlords are seeking to deviate, and likewise landlords can more easily test where tenants are seeking to deviate from what they regard as a standard position.

For lease HoTs in a multi-let building scenario or for landlords that have more general requirements, letting agents may resort to including a caveat that the terms set out are "subject to the landlord's standard lease" or similar. If that happens then the stated aims of the new Code will be adversely impacted and could hinder rather than help by giving a false sense of hope to the tenant that they have an agreed position.

Comment

When acting for tenants we already experience some landlords and their solicitors ignoring or contravening (perhaps mistakenly) agreed positions in HoTs, so the new Code may not do much to advance that.

It must be accepted that in some cases it will be expedient to find a short cut that may, on the face of it, not be in the spirit of the mandatory elements of the Code. Ultimately there has to be a balance and there would no point in seeking to legislate against such realities. Related to this is the unending debate as to whether or not it is better to have long form or short form HoTs. There will always be divided opinion on that. At least the new Code would ensure that, for most transactions, there will be an enhanced starting point for lower- and mid-market transactions.

Presumably the only sanction available to a party who might feel aggrieved is to complain to the RICS, who could then decide to sanction the relevant member at fault. Is a tenant agent likely to blow the whistle on a landlord agent? They might feel there would be commercial repercussions if they did so.

Overall, there's nothing really to complain about with this new Code and there will surely be something for everyone to gain from this initiative, even if only marginally.

The consultation closes on 05 May 2019.

Frustrating issues continue to appeal...

The European Medicines Agency has now lodged an appeal against the decision that Brexit does not amount to an event of frustration in relation to their 25 year lease of premises at 25-30 Churchill Place, Canary Wharf. The outcome of the appeal is eagerly anticipated, particularly given the sums involved and the potential implications of the decision not only in relation to leases of property but to commercial contracts more generally.

The judgment has been appealed to the Court of Appeal and currently has a hear-by date of 16 March 2020.

Government proposes "a generational change to the law that governs private renting"

The Government has issued its response to the July 2018 consultation “overcoming the barriers to longer tenancies in the private rented sector”. In the July 2018 consultation, the Government proposed the introduction of a minimum three-year tenancy in England. However, in its response the Government confirms that “there was no widespread support from either landlords or tenants for the three-year tenancy model". Instead the Government has announced that it “intends to change the legislative framework by removing the Section 21 “no fault” eviction process, alongside strengthening the grounds for eviction under Section 8 of the Housing Act 1988 and simplifying court processes to make it easier to gain possession through the courts”. The Government response states that “[t]hese changes would create flexible, open ended tenancies and deliver a more robust system which works for both parties”.

The current Section 21 “no fault” eviction process means a landlord can seek to obtain possession of a residential property provided it has given the tenant not less than two months’ notice once the fixed term has expired (no other reason is required). By contrast, Section 8 contains various grounds for eviction which the landlord must make out for the court to make an order for possession; some grounds are mandatory if proven, while others are discretionary.

The Government response highlights plans to introduce two new Section 8 grounds, in parallel with removing section 21, which would allow landlords to seek possession when they want to sell or move into the property themselves. However, the Government notes that it is considering “limiting the use of these new grounds until the tenancy has lasted for two years to provide tenants with additional security”.

The Government is clear that removing no fault evictions will be part of a package of reforms and notes that a separate consultation will follow on “the details of a better system”. Reform of the court processes for obtaining possession as well as increasing tenants’ awareness of their rights are on the Government’s agenda.

The response also notes the Government’s intention to work with “other types of housing providers outside of the private rented sector who use these powers”. Further, exemptions will be considered for certain groups and developed further as part of the new framework.

In the detail of the response at paragraph 187, the Government notes that it “does not support the introduction of rent controls to set the level of rent at the outset of a tenancy. Historical evidence suggests that these would discourage investment in the sector, and would lead to declining property standards as a result, which would not help landlords or tenants”. The response simply states that “the Government’s proposed approach will ensure that tenants cannot be effectively evicted through unreasonable and excessive rent increases”. However, no specific details in relation to this appear to be outlined in the response.

Most short-term assured shorthold tenancies (ASTs) currently provide for a fixed rent. If this new legislation is introduced we are more likely to see rent review provisions coming into ASTs. It may be that market practice will simply apply an RPI or CPI increase or a fixed percentage increase, but if ASTs start to become longer we may find the concept of open market reviews creeping into the sector along similar lines to those adopted in the commercial lease market.

Any further consultations and time frames for implementation are awaited with interest.

Sale and leaseback treated as a composite transaction for input VAT recovery purposes

The European Court of Justice (ECJ) has indicated that a sale a leaseback transaction may be regarded as a single transaction for the purposes of determining whether a person has disposed of property in the context of the operation of the capital goods scheme: Mydibel SA v Belgium (Case C201/18) (ECJ, 27 March 2019). The decision stands in sharp contrast to the recent decision of the Court of Session in Balhousie.

The Court has endorsed an approach, in this context at least, which recognises the composite nature of a transaction and applies the input VAT rules to that composite transaction, ignoring individual elements. How far this principle may extend is a matter of conjecture.

Further detail and analysis in relation to this decision can be found here.

Is it guaranteed? Co-operative Group Food Ltd v Shah Properties Ltd and others [2019] EWHC 941 (Ch)

This case concerned supermarket premises in Birmingham originally let in 2006 to Somerfield Stores Limited and guaranteed by Somerfield Limited. In January 2011, via a transfer of engagements, Co-operative Group Food Limited (the Co-op) assumed liability under the guarantee.

In 2011 the tenant wished to assign to 99p Stores Limited. In this connection a Licence to Assign and an authorised guarantee agreement (AGA), which was annexed to the Licence, were entered into and the assignment followed. In the Licence the guarantor provided covenants in relation to the future performance of the lease obligations.

In due course the original tenant and the assignee entered into administration and the landlord sought the continuing rent from the Co-op under the guarantee obligations in the Licence.

The Licence contained the following material provisions.

• Recital 1.1 defined the AGA as meaning the agreement set out in the form annexed in the Schedule to the Licence.

• Recital 1.7 provided that the Schedule formed part of the Licence and was to have effect as if set out in full in the body of the Licence and that any reference to the Licence included the Schedule.

• Clause 4.1 contained a covenant by both the tenant and the guarantor to observe and perform the obligations set out in the AGA immediately after completion of the assignment.

• Clause 4.2 contained an acknowledgment that the consent granted by the Licence was granted at the guarantor’s request and that the guarantor consented to the tenant entering into the Licence. Sub-clause 4.2(b) read that “in consideration of the consent granted by the landlord and subject to clause 4.3 the Tenant’s Guarantor agrees that its guarantee and other obligations under the Lease remain fully effective and ……. shall extend and apply to the covenants given by and the obligations on the part of the Tenant under this Licence”.

On the landlord’s summary judgment application for rent, the Co-op sought to argue that the provisions of clause 4 were caught by the wide anti-avoidance provisions of the Landlord and Tenant (Covenants) Act 1995 (the Act) and hence void. Section 25 of the Act voids any arrangement that frustrates the purpose of the Act, namely the release of a tenant from its obligations upon assignment (section 5) and the release of the tenant’s guarantor from its obligations upon assignment (section 24).

The Master had decided that the obligations undertaken in both clauses 4.1 and 4.2 operated as sub-guarantees (GAGAs) and were valid and enforceable.

On appeal by the Co-op, both parties accepted the following key propositions based on the decisions in the leading authorities, including Good Harvest v Centaur Services Ltd and K/S Victoria Street v House of Fraser.

• If clause 4 of the Licence contained a guarantee of the guarantee obligations of the former tenant under the AGA it was valid, and the guarantor was liable for the rent claimed. In other words, if it contained a sub-guarantee then it was valid.

• If clause 4 contained a direct guarantee by the guarantor of the obligations of the assignee its effect was nullified by the Act and the guarantor was not liable for the rent claimed.

Mr Justice Mann dismissed the appeal.

He found that clause 4.1 was a direct guarantee. He did not consider it possible to interpret the clause as a sub-guarantee in the way proposed by the Master. In clause 4.1 both the tenant and the guarantor covenanted to observe the obligations undertaken under the AGA. The obligations under the AGA were guarantees of the obligations of the assignee, so that would make the guarantor’s obligation in effect a direct guarantee of the assignee and therefore void under the provisions of the Act.

However, in relation to clause 4.2(b) he considered that on the true construction of the Licence the “obligations on the part of the Tenant under this Licence” included the former tenant’s obligations under the AGA. This amounted to a sub-guarantee which survived the avoiding provisions of the Act.

There were two routes to this conclusion.

• Clause 4.1 contained a covenant by the tenant to observe and perform the obligations in the AGA which gave rise to obligations under the Licence. Those obligations were covered by the clear guarantee given by clause 4.2 (b).

• The other route was via clause 1.7, which provided that any reference to the Licence included the Schedule which set out the terms of the AGA. The reference to the Schedule should therefore be interpreted as being a reference to the obligations described in the AGA. The terms of the Schedule were to have effect as if its terms were set out in the Licence and were capable of having direct contractual effect. That effect would then be an obligation of the former tenant in the Licence, which would in turn be an obligation covered by the guarantee in clause 4.2(b).

The decision in this case clearly rests upon the oddity of the provisions in the Licence. The strained construction placed by the judge on clause 4.2(b) of the Licence was clearly designed to give it some useful effect and to be consistent with his conclusions that the parties intended meaningful obligations to be assumed by the guarantor notwithstanding the terms of the Act.

While it is useful to have further judicial consideration of the Act, the judicial time being taken up with cases arising from the operation of the Act emphasises its fundamental flaws and lack of commercial and at times rational application.