UK: Be Wary Of Guarantees

Last Updated: 20 May 2008
Article by Madeleine James

In the current market, investment landlords will be doing all they can to ensure that potential tenants have full and sufficient covenant strength, as well as vetting proposed assignees and sub-tenants.  We are likely to see heads of terms containing belts, braces and more.  Landlords will be demanding guarantees from parent companies, from directors, from outgoing tenants on an assignment, from the guarantors of outgoing tenants and from anyone else they can get "on the hook". 

Cases concerning the efficacy of guarantees are bound to become more widespread.  The recent Powerhouse1 case has certainly focused people's minds on the giving and accepting of guarantees as the judgment appeared to allow some scope to permit a guarantor who is solvent to escape the liability which it validly accepted when agreeing to enter into the guarantee.

But this positive development (from a guarantor's perspective) should not distract from the basics about guarantees which any company or individual needs to be aware of if that company or individual is a tenant or proposes to act as guarantor to a tenant in a lease.  In short, there is potential liability for which they could be responsible and which may endure for a longer period than they first realise.

For example, there are some particular points to note in relation to underlettings and a guarantor of an undertenant:

  • In the case of a tenant's guarantor, liability subsists usually until the end of the term or until the tenant is released from the tenant covenants in the lease by virtue of the Landlord and Tenant (Covenants) Act 1995.  However, covenants given by an undertenant to a superior landlord in a licence to underlet, in which that undertenant covenants to observe and perform the covenants etc for the duration of the headlease (i.e. not just his own underlease) are not unheard of.  In such a case, the 1995 Act does not assist and, if the undertenant covenants in this way, the guarantor remains on the hook for the duration of the headlease as well.

In addition, lease assignments can lead to long-lasting guarantee obligations for the assignor.  Where a post-1995 Act lease is assigned, the assignor may become a guarantor by virtue of entering into an "authorised guarantee agreement" (AGA) if required by the lease. 

This fact may come as an unwelcome surprise to the assignor.  It also has important repercussions for the assignee.

  • Once assigned, it is important to note that a clause in the lease providing that the lease may be forfeited on the insolvency of "any surety" of the tenant will mean that the lease is liable to forfeiture not only on the insolvency of any company acting as guarantor to the assignee, but also on the insolvency of the assignor, as it is also classed as "a surety" having entered into the AGA.

  • If that assignor, being the guarantor under the AGA, is insolvent, the landlord may be able to require the existing tenant to provide a replacement surety depending on the terms of the lease in question.  If the landlord is entitled to a replacement it will likely insist upon it.

Anyone wishing to take an assignment of an existing lease needs to be sure of who they are dealing with; taking an assignment from a company that is about to become insolvent may mean that, if the worst happens, an application for relief from forfeiture may have to be made and/or a replacement surety found to placate the landlord.

Commercial Lease Code

With this in mind, tenants and anyone proposing to act as a guarantor to a tenant are urged to be wary of some of the pitfalls.

In negotiations with landlords, they should bear in mind the provisions of the Commercial Lease Code2 which is helpful to them on the issue of AGAs.

The overall objective of the Code is to promote fairness between the parties, and many of the largest institutional landlords in the country are supposedly supporters of the use of the Code (and are signatories to it).

One of the provisions of the Code is that, on an assignment,

"...Authorised Guarantee Agreements should not be required as a condition of the assignment, unless at the date of the assignment the proposed assignee, when assessed together with any proposed guarantor:

  • Is of a lower financial standing than the assignor (and its guarantor); or

  • Is resident or registered overseas ..."

Therefore, tenants should not automatically submit to the requirement to enter into an AGA on an assignment of their lease.

The problem with the Code is that many landlords and their solicitors pay it no more than lip service.  They will try to ensure that provision of an AGA is a condition of giving consent to the assignment, as has been the custom since the Landlord and Tenant (Covenants) Act 1995 was introduced.

It's fair to say that what the Code says is, in our experience, almost universally ignored by landlords, so tenants and their advisors need to be vigilant about this issue at the heads of terms stage and argue against the provision of an AGA as far as they can.

Footnotes

1. Prudential Assurance Company Limited v PRG Powerhouse Ltd (2007)

2. The Code for Leasing Business Premises in England and Wales 2007

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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