UK: Group Assignments – The "Obvious Solution"

The recent Court of Appeal decision in Tindall Cobham 1 Limited & Others v Adda Hotels (An Unlimited Company) and Others [2014] EWHC 2637 (Ch) ("Tindall Cobham") has been welcomed by concerned landlords following the previous case of K/S Victoria Street v House of Fraser (Stores Management) Limited and others [2011] EWCA Civ 904 ("K/S Victoria").

In K/S Victoria, the Court of Appeal held that any agreement requiring a current tenant's guarantor to guarantee the obligations of an incoming tenant (an assignee) would be void under Section 25 of the Landlord and Tenant (Covenants) Act 1995 ("the LTCA"). Many leases which were granted before K/S Victoria would have contained such a provision as in this case. Until Tindall Cobham, it was unclear how the Courts would deal with such a provision.

This decision from the Court of Appeal shows that the Courts will interpret leases affected by Section 25 of the LTCA in a practical and commercial way and not merely render entire clauses void.

Facts

Adda Hotels and Puckrup Hall Hotel Limited ("the Tenants") were subsidiaries of Hilton Worldwide Inc. The Tenants had leasehold interests of ten UK Hotels under a lease whereby Tindall Cobham 1 Limited ("the Landlord") was landlord and Hilton Worldwide Inc. ("the Guarantor") acted as guarantor. The leases contained covenants that the Tenants were not to assign the Property to a group company without the prior written consent of the Landlord, save that if (i) the Tenants provided the Landlord with notice of the assignment within 10 working days of completion ("the first condition") and that (ii) on assignment, the Guarantor (and any other guarantor of the Tenants) provided a guarantee of the assignees' performance under the leases ("the second condition"), the Landlord's consent would be deemed given.

The Tenants assigned the leases to group companies (albeit shell companies) without the consent of the Landlord. As the leases were granted after 1 January 1996, the Tenants and the Guarantor would have been automatically released from future liability under the lease unless the assignment was an excluded assignment (if made by operation of law or in breach of the lease covenants). The Tenants first argued that these were non-excluded assignments.

The Tenants and the Guarantor considered that there was no need to obtain the Landlord's prior written consent as the second condition was void as it offended Section 25 of the LTCA. This is because it sought to keep the Guarantor "on the hook" when the Tenants were to be released from their liabilities. The Tenants therefore merely gave the Landlord notice in accordance with the first condition.

Decision of the High Court

The Landlord applied to Court for a declaration that these assignments were unlawful as they were in breach of the leases (and therefore excluded assignments so that the Tenants and the Guarantor would remain "on the hook" with regard to liability under the leases).

The Landlord's case was that the second condition should be read as meaning that a replacement guarantor should stand in the place of the Guarantor or that the Landlord was entitled to refuse consent (should the second condition be removed and no replacement guarantor be offered). The Court agreed with this submission and said that consent should have still been requested in any event.

The Landlord was granted summary judgment. The Tenants were found to be in breach of the leases and the assignments found to be excluded. The Tenants and the Guarantor would therefore not be released from their liabilities under the leases.

The Tenants and the Guarantor appealed as to the interpretation of the second condition (and the requirement to procure a replacement guarantor) and as to the effect of Section 25 of the LTCA. In the interim before the appeal was heard, it was agreed that the assignments were unlawful due to the lack of request for consent.

Decision of the Court of Appeal

The Court of Appeal dismissed the Tenants' and the Guarantor's appeal but overruled the High Court decision as to the interpretation of the second condition (i.e. the requirement for a replacement guarantor). As a result, in order to give effect to Section 25 of the LTCA, both the first condition and the second condition were to be treated as void. The covenant would therefore become a simple qualified covenant against assignment and subject to the usual requirement to act reasonably under Section 19(1) of the Landlord and Tenant Act 1927 – this was the "obvious solution".

Had the Court of Appeal ordered that the second condition was to be removed but the first condition was to remain, the Landlord would have been obligated to give consent following the Tenants giving notice of the assignment. This would provide the Tenants with an unintended and unfair advantage over the Landlord.

Similarly, the Court of Appeal were reluctant to interpret the clause in a way that the Tenants were required to procure a replacement guarantor (as the Landlord had argued), as Lord Justice Patten considered that this would be a "significant re-formulation of the clause".

Section 25 of the LTCA indicates that an agreement will only be void "to the extent that" it offended the LTCA. The Court therefore considered the covenant in the context of the whole of the leases and did not feel it necessary to disregard more of the clause than absolutely required in order to give effect to the LTCA nor add additional obligations to provide a replacement guarantor.

Conclusion

Each case going forward will turn on its own facts and the particular wording of the lease. However the decision will give confidence to both landlords and tenants that the Courts will not try to reinvent the meaning of an entire agreement and will try to find the most commercially practical result for both parties.

The decision may have an effect on future drafting in so far as tenants may be required to find replacement guarantors of equivalent standing. This is particularly difficult in a group of companies where the parent of good financial standing acts as the first guarantor but there is no other new and substitute company within the group of equivalent standing to act as a replacement guarantor on an assignment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.