Property Litigation

Assignment to Guarantor held to be Void

The case of EMI Group Limited v O&H Q1 Limited (2016) EWCH 529 (Ch) considers an important question relating to the operation of the Landlord and Tenant (Covenants) Act 1995, namely whether an original tenant can validly assign its lease to its existing guarantor. The answer given by the Court is that any such purported assignment is void.

The Landlord and Tenant (Covenants) Act 1995 came into force a little over 20 years ago. Many of its provisions followed the recommendations of the Law Commission. The Covenants Act was intended to address the unfair situation where a tenant or third party such as a guarantor found itself facing liabilities due to the default of a subsequent tenant, often many years after it had assigned its interest in the property.  Hence the  Covenants Act was intended to make provision for persons bound by covenants of a tenancy to be released on the assignment of that tenancy.

There have been a number of recent cases which have considered the provisions of the Act, and transactions which were relatively commonplace have been held to fall foul of the Act. The courts are favouring certainty over commercial expediency.

In Good Harvest Partnership LLP v Centaur Services Ltd (2010) Ch 426,  it was held that the Covenants Act precludes the original guarantor from becoming the guarantor of an assignee from the original tenant.  This led to the somewhat surprising result that a parent company could not voluntarily continue to act as guarantor where one of its subsidiaries assigned a lease to another subsidiary. In K/S Victoria Street v House of Fraser (Stores Management) Ltd (2012) Ch 497, CA, the Court of Appeal affirmed the Good Harvest decision.

In the EMI case, the Court had to consider whether the tenant could assign its lease to its guarantor. The facts of the case were that HMV UK Limited was the tenant of a long lease of retail premises in Worcester, guaranteed by EMI.  In January 2013 HMV, having changed its name to Record Shop 1 Limited, went into administration. There followed discussions about the future of the premises and about EMI taking an overriding lease as it was obliged to do pursuant to the Deed of Guarantee.  However, it was agreed that the simpler and more cost effective route was for the Administrators of Record Shop 1 Limited to assign the lease to EMI. A Licence to Assign and a Deed of Assignment were entered into in November 2014.

Shortly after the assignment, in December 2014, EMI’s solicitors submitted that although the assignment was valid, the tenant’s covenants in the lease could not be enforced against EMI. EMI said that as they were the guarantor immediately prior to the assignment, they should have been released from the tenant covenants and any attempt to immediately re-impose liability would breach the Covenants Act.

The matter came before the Court in December 2015. Judge Amanda Tipples QC had to decide whether EMI as guarantor could take an assignment of the lease, thus assuming liability for the tenant covenants.

The Court considered Lord Neuberger’s judgment in K/S Victoria and in particular his comments about the extent to which a guarantor can freely offer to guarantee a subsequent tenant without falling foul of the Covenants Act. It was recognised that on one view a guarantee freely offered could be said not to frustrate the provisions of the Covenants Act. However, the Court of Appeal dismissed this view preferring certainty.  Lord Neuberger considered that the subjective intention of the parties should not be the test.  The better view was to consider the objective effect of the transaction so that it made no difference if the subsequent guarantee was freely volunteered. Such a transaction would still breach the Covenants Act as the guarantor would remain bound by the tenant covenants post assignment. Lord Neuberger considered that this objective approach would give greater certainty avoiding the problem of investigating, perhaps many years later and by different parties, whether a guarantee had been required by the landlord or had been freely given.

During the course of his Judgment in K/S Victoria Lord Neuberger made an obiter comment that the impact of his judgment appeared to mean that a lease could not be assigned to the guarantor even where both the tenant and the guarantor wanted it. It was this obiter comment which EMI relied on but with an interesting twist.  EMI said that the assignment itself was valid, but the tenant covenants could not be enforced against EMI. The Tenant Covenants remained  in suspense for so long as EMI remained tenant.  Accordingly, EMI was not bound to pay the rent, although if it failed to do so, the lease could be forfeited.

Kirk Reynolds QC for O&H submitted that EMI’s position created a “Frankenstein’s Monster” of a lease which was absurd and unworkable. Either the assignment was valid or it was not. Mr Reynolds submitted that the assignment to EMI did not breach the Covenants Act. By taking an assignment of the lease, EMI were being released from their liability as guarantor of the original tenant as required by the Covenants Act but EMI then re-assumed liability wearing a different hat – namely as tenant.  The liability was re-assumed by virtue of section 3 of the Covenants Act.

Mr Reynolds submitted that if an assignment of the lease to the guarantor did fall foul of the Covenants Act as alleged by EMI, then the assignment itself was void. EMI would then remain liable pursuant to the guarantee including an obligation to take an overriding lease.

Judge Tipples concluded that the whole thrust of the act is that there should be no re-assumption or renewal of liabilities on assignment, whether on the tenant or the guarantor.  An assignment by the original tenant to its guarantor would mean that the guarantor reassumes liability for the tenant covenants and thus falls foul of the Covenants Act.  The guarantor is therefore absolutely precluded from becoming the assignee on an assignment by the tenant, whose covenants he is guaranteeing.

The Judge concluded that the assignment to the guarantor was itself rendered void.  Rather than picking and choosing which parts of the lease survive the assignment as suggested by EMI, she supported  Lord Neuberger’s obiter statement in K/S Victoria that such an assignment could not take place. This meant that EMI remained bound under the Deed of Guarantee.