UK: Leasehold Guarantees

Last Updated: 11 November 2016
Article by Rosie Gibb and Rebecca Thomas

When a landlord lets a property to a tenant its main concerns are that the rent is paid and the premises are maintained. While most solvent tenants will make sure that these things are done, if a tenant gets into financial difficulties a landlord will want to ensure that these costs are covered.

There are various types of security which a landlord may seek to put in place when a lease is granted, including rent deposits (see our separate note for more on these), bank guarantees, director guarantees and parent/group company guarantees. This note focuses on parent/group company guarantees.

ADVANTAGES AND RISKS OF GUARANTEES

A guarantee is usually an attractive option for the tenant as it does not require any upfront cash sum. From a landlord's perspective it has the advantage that the guarantee company can be required to step into the shoes of the tenant and will be liable for compliance with all lease covenants.

However, parent guarantees are only of any use if the tenant has a parent/group company of good covenant strength. The landlord generally needs to resort to its security when the tenant is in financial difficulties; one problem with a parent guarantee is that if the tenant is in financial difficulties the guarantee company may not be far behind.

From a tenant's perspective, providing a parent guarantee can be problematic if the tenant is subsequently sold out of the group: obtaining the release of parents guarantees, particularly where the tenant holds numerous properties, can complicate and delay the sale of the tenant company.

STANDARD PROVISIONS OF A GUARANTEE

The guarantee provisions are often contained in a separate schedule within the lease. The provisions will usually include the following key points:

What Is Guaranteed?

The guarantor will promise to pay the rent and also to step in and perform the tenant's covenants if the tenant fails to do so. In addition, the provisions will often specify that the guarantee extends to the tenant's obligations contained in documents other than the lease (e.g. a licence for alterations).

When Does The Guarantor's Liability End?

Unless the guarantee specifies otherwise, a guarantor will be liable throughout the term of the leases unless the tenant's own liability is released (see the section on Authorised Guarantee Agreements below). If a tenant has security of tenure and the guarantor is to remain bound during a period of holding over the guarantee provisions must state this, otherwise the guarantor's liability will end when the contractual term ends.

Sometimes a guarantee is being provided only because the tenant is a new company with no trading history; in this case it may be appropriate to include provisions which allow the guarantee to come to an end when the tenant is able to produce accounts which meet specified criteria.

What Won't Release The Guarantor?

In the absence of express provisions, it is easy for a landlord to unintentionally release a guarantor. The guarantee should therefore set out the circumstances in which the guarantor will not be released – for example because of a delay in the landlord enforcing against the tenant, because of a refusal to accept rent from the tenant where this may prejudice a right to forfeit, because the tenant ceases to exist or the tenant's structure changes, or because the lease is forfeit or surrendered in part.

Variations To The Lease

In the absence of wording the contrary, a guarantor will be released by any variation to the lease, save where this is very clearly insubstantial and non-prejudicial. However, where the guarantor has consented to a variation he will generally be bound by it. The guarantee provisions will therefore usually include both a provision stating that the guarantor remains liable following a variation and also obliging the guarantor to join in and give its consent to any other document entered into by the tenant in connection with the lease.

Obligation To Take A New Lease

If the lease is forfeit (terminated early by the landlord because of a default on the part of the tenant) the law is unclear as to whether the guarantor's obligations also fall away. As it is arguable that they do, the guarantee should be drafted to ensure that the guarantor remains liable. The guarantee provisions will usually include an obligation on the guarantor to either take a new lease (on the same terms as the one which has been terminated) or to make an appropriate payment (equal to a pre-agreed number of months' rent) in lieu of this.

If a tenant becomes insolvent, its liquidator has the power to disclaim the lease (i.e. bring the lease obligations to an end). While this disclaimer does not end the guarantor's liability, it creates an unsatisfactory situation for both the landlord (who has a vacant property which can only be re-let subject to the ongoing rights of the guarantor) and the guarantor (who has liability for payment of rent and performance of covenants but cannot take possession of the property or assign the lease). It is therefore normal to include equivalent provisions in the event of disclaimer, with an obligation on the guarantor to either take a new lease or to make an appropriate payment in lieu.

Restrictions On The Guarantor

The landlord will want to know that the guarantor is not going to enforce its rights against the tenant while money is still owed by the tenant to the landlord. It is therefore usual to include restrictions on the guarantor which prevent it from making any kind of a claim or taking or enforcing any security in competition with the landlord.

WHEN CAN A CLAIM BE MADE UNDER A GUARANTEE?

The limitation period for a guarantee is usually 12 years from the date on which the cause of action accrues (often the date that the default takes place). This means that a landlord has 12 years to sue the guarantor for losses suffered. However, there is an important exception to this in relation to rent arrears: an action for damages in respect of rent arrears must be brought within six years from the date that the arrears become due.

The majority of a leasehold guarantees are not "on demand" guarantees. This means that the landlord does not have to make a formal demand on the guarantor for liability under the guarantee to be triggered. The advantage of this is that liability arises automatically; however, it also means that the six-year limitation period for non-payment of rent starts to run from the date on which rent was due from the tenant under the lease.

ASSIGNMENT AND AUTHORISED GUARANTEE AGREEMENTS (AGAs)

As at the grant of a lease, when a tenant wishes to assigns its lease a landlord's main concerns will be getting the rent paid an ensuring that the property is maintained. The landlord already knows that he is happy with the covenant strength of the current tenant/guarantor package, so if he knows that this covenant will be preserved on assignment he is more likely to consent to the assignment.

An AGA is a special type of guarantee, given by a tenant when it assigns its lease. AGAs are only relevant to "new leases", mainly those granted on or after 1 January 1996 (with some exceptions). Under an "old lease" (granted before that date) the original tenant, and usually his guarantor, remains bound by the tenant covenants throughout the term of the lease (no matter how many times it is assigned) – so if the current tenant doesn't pay his rent the landlord can instead demand this from the original tenant. This is known as privity of contract.

The Landlord and Tenant (Covenants) Act 1995 (the "Act") got rid of privity of contract for all new leases, meaning that landlords no longer have an automatic right to make a claim against the original tenant. However, to compensate for this, the Act introduced the AGA. An AGA is a guarantee by the tenant of the assignee's obligations (and it takes much the same form as any other guarantee) but it can only continue until the lease is assigned again: at this point the AGA simply falls away.

Guarantors And Authorised Guarantee Agreements

The Act makes it clear that when the tenant's liabilities fall away on assignment, the liabilities of the guarantor also fall away. However, it is less clear from the Act when, if at all, the guarantor may remain liable. The decisions in the Good Harvest (2010) and K/S Victoria Street (2011) cases have provided some clarification on this, but have left us with a situation which causes significant problems when groups of companies wish to restructure.

Within a group of companies it is common to have a property holding company, which takes the lease as tenant, and a parent company (where the covenant strength sits), which acts as a guarantor. Over time the group may wish to reorganise, transferring their leases into an alternative holding company whilst still maintaining the parent company guarantee (or assigning the lease to the guarantor).

However, although the tenant and the landlord are perfectly happy, from a commercial perspective, for the lease to be assigned to a different group company, with the guarantor willingly giving a direct guarantee of the assignee's obligations, the Act prevents him from doing so: any guarantee given in this situation is void and unenforceable.

What is permitted is a sub-guarantee of the AGA: when the original tenant assigns the lease and gives an AGA the guarantor can guarantee the tenant's obligations under the AGA. This will often be acceptable to landlord (as the covenant strength is preserved) but if the group subsequently wishes to carry out a further restructuring neither the original tenant nor the guarantor is permitted to give any kind of a guarantee of the new tenant's obligations.

Making A Claim Under An Aga

When a landlord wishes to make a claim under an AGA it cannot do so in respect of any fixed charge (rent, service charge and liquidated sums payable in respect of a breach of covenant) unless he serves a notice within six months of the date on which the sum became due, informing the former tenant that the sum is due and stating the amount of any interest payable.

Where the total liability has not been determined (for example, where an amount of service charge is payable on account with a subsequent balancing charge) a notice must still be served within six months of the sum falling due which states that the liability may increase. A further notice specifying the total amount must then be served within three months of the liability being fixed.

CONCLUSION

Guarantees offer a popular and effective form of security with advantages for both landlords and tenants. However, it is essential that they are carefully drafted to ensure that the guarantor is not unintentionally released from liability while the tenant's obligations are ongoing. Landlords also need to ensure that they are aware of the timings for making a claim under a guarantee and that they understand the limitations of Authorised Guarantee Agreements.

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.

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