Assignment of lease by tenant to guarantor - void

In EMI Group Limited v O&H Q1 Limited, the latest of a series of cases concerning the Landlord and Tenant (Covenants) Act 1995, the High Court has deal with a significant question which was left unanswered in previous cases. If a tenant purports to assign its lease to its guarantor, that assignment will be void.

The starting point of the saga was the Court of Appeal decision in K/S Victoria Street v House of Fraser (see further commentary here), a case concerning the sale and leaseback of a department store. The arrangements between the parties in K/S Victoria Street involved the grant of a lease to an original tenant (T1) with a more substantial company (G) providing a guarantee, and an obligation requiring T1 to assign the lease to another company (T2) with G providing a fresh guarantee for T2’s obligations. The Court found any guarantee given by G for the obligations of T2 would be void under the anti-avoidance provisions contained in section 25 of the Act. However, the Court went further in its interpretation of section 25 and considered a point that was not in issue, Lord Neuberger commenting, “It would also appear to mean that the lease could not be assigned to the guarantor, even where both tenant and guarantor wanted it.” This was the point which fell to be considered in EMI.

The present case concerned an HMV shop in Worcester. The original landlord granted HMV a 25 year lease in 1996 and EMI provided a guarantee. HMV went into administration in 2013 and in 2014 HMV assigned the lease to EMI, with the consent of the landlord. EMI then contacted the landlord to argue, relying on the interpretation of the Act given in K/S Victoria Street, that the tenant covenants in the lease were unenforceable against EMI, but that the assignment was still valid. EMI issued its claim, seeking a declaration from the Court to this effect, and the landlord, O&H, issued a counterclaim for alternative declarations. The preliminary issue before the Court was whether the Court should declare that:

• (as sought by EMI) the lease was vested in EMI but that by operation of law the tenant covenants were void and could not be enforced against EMI
• (as sought by O&H) the lease was vested in EMI and that the tenant covenants were valid and enforceable against EMI, or
• (as sought by O&H in the alternative) the assignment was void and of no effect, with the result that the assignment could be treated as never having happened, so that EMI would remain liable as guarantor.

The Court went for the last of these, holding that the whole thrust of the Act is that tenants should be released upon assignment (and their guarantors to the same extent) and that there should be no immediate re-assumption or renewal of their liabilities. An assignment by T1 to G would mean that, at the very moment G obtains its release as guarantor, it becomes T2 and thereby bound by all the tenant covenants in the lease. G would obtain no real release at all, thereby frustrating the operation of the Act. Therefore, G is absolutely precluded from becoming T2.

Comment

The ambitious interpretation sought by EMI would have meant that the landlord would be put in a position where no one would have been “on the hook” for rent or any other covenants for the residue of the lease term, and it is welcome that EMI’s adventurous interpretation did not prevail. Of the two interpretations put forward by O&H, the Court went for the more rigid one, an uncompromising interpretation of the Act which further restricts the ability of parties to contract as they wish. In an insolvency situation such as this, it is easy to see how an assignment to a guarantor could be considered beneficial: the guarantor gains physical control of the premises (for which it is ultimately liable anyway) and may have improved VAT recovery as future rent demands can be addressed to it; the landlord retains the financial covenant of the only party able to pay the rent and gains a solvent tenant; the insolvent tenant with no further use for the premises obtains an orderly exit.

The Court has ruled that this is not possible. The range of options available to a tenant or guarantor in an intra-group reorganisation or insolvency situation for unlocking a tricky lease situation is more restricted. Landlords must be vigilant in spotting future assignment proposals which could be regarded as void. It is likely that many assignments of the type which took place between HMV and EMI will have taken place over the years; landlords, prospective landlords and their lenders should take steps to identify them and consider the possible consequences if such assignments (and any onward assignments or sublettings) are to be treated as void.