UK: 'Strange New Beasts In The Forest' - The Impact Of Virtual Assignments On The Landlord And Tenant Relationship

Last Updated: 25 March 2010
Article by Catherine McCann

Virtual assignments are a relatively new concept. Until recently their impact on the landlord and tenant relationship has been uncertain but the Court of Appeal in Clarence House Limited v National Westminster Bank Plc [2009] confirmed that virtual assignments do NOT amount to a breach of standard alienation covenants prohibiting assignment without consent, sharing or parting with possession or entering into declarations of trust in relation to premises.

What is a virtual assignment?

A virtual assignment is an arrangement under which a tenant agrees to transfer the economic benefits and burdens of a lease to a third party without effecting a legal assignment of the lease. A virtual assignment is useful to a tenant because it can also be used to transfer property management responsibilities to a third party and remove lease liabilities from the balance sheet - and so achieves the same economic result as an assignment without altering the underlying legal relationship between the parties. To date, such arrangements have principally been used in large real estate transactions or group re-structures. As one of the Court of Appeal judges commented, such arrangements are indeed 'strange new beasts in the forest'.

The facts of the case

National Westminster Bank Plc ('the tenant') was granted a lease by Clarence House Limited ('the landlord') and subsequently underlet the whole of the premises to William M Mercer Ltd ('the undertenant'). The tenant then 'virtually assigned' their lease to New Liberty Holdings Ltd ('the virtual assignee').

The material provisions of the virtual assignment included:

- the transfer of all economic benefits and burdens of the lease to the virtual assignee;

- an obligation on the virtual assignee to pay rent to the landlord and to observe and perform the tenant's covenants in the lease and to keep the tenant indemnified against liability for all rent, costs, liabilities and claims; and

- the appointment of the virtual assignee as the tenant's agent in all dealings connected with the premises including the collection of rent from the undertenant.

The virtual assignment did not transfer any proprietary, contractual or occupational right in relation to the premises. The landlord subsequently issued a claim for a declaration that the virtual assignment was in breach of the standard alienation provisions in the lease because it constituted one or more of the following:-

- a declaration of trust as between the tenant and the virtual assignee;

- an assignment between the same parties, without consent; and/or

- an arrangement under which possession of the premises was either shared or had been parted with

The Court of Appeal decision

1. Declaration of trust

It was held that although the virtual assignment was similar to a declaration of trust, it was a contractual arrangement under which the virtual assignee had been appointed as the tenant's agent and had acquired the economic benefits and burdens of the lease. It did not create a trust.

2. Sharing possession or occupation

It was held that possession was to be given its ordinary meaning ie the right to exclude all others from the premises. At the time of the virtual assignment the undertenant was in occupation of the premises and the virtual assignment did not alter this position. Since the tenant was not in occupation, it could not be said to have parted with or shared possession of the premises with the virtual assignee.

3. Assigning the premises

It was held that in the absence of any context showing that a covenant against assignment is to have an extended meaning, it only covers a legal assignment, not an equitable assignment, and as such the relevant covenant could not have been breached by anything other than a legal assignment – which the parties agreed had not taken place.

Impact for landlords and tenants

Tenants can use virtual assignments (unless there is an express prohibition in the lease) to avoid onerous alienation covenants. Such arrangements can be used to release lease liabilities from the balance sheet so that capital can be invested elsewhere. Since there is no need to obtain landlord's consent, virtual assignments will continue to be useful for large corporate tenants wanting to transfer a property portfolio, or as part of a group restructure.

From a landlord's perspective, it would appear that virtual assignments are 'with us' for better or for worse – they do not appear to impact on the landlord and tenant relationship (in that both parties remain liable to observe their obligations under the lease) but they do allow tenants to dispose of leases in a way which is outside the landlord's control ie the landlord loses the ability to assess the covenant strength of the proposed assignee.

Landlords may also be concerned about undertenant rent being diverted to a third party and the indirect effect this could have on a tenant's covenant strength (although it should be noted that the landlord's right to request payment of rent by an undertenant direct to the landlord, if the tenant is in arrears, would be unaffected).

Some commentators have suggested that the alienation covenants in leases could be drafted so as to expressly prohibit virtual assignments. Such an approach will need to be carefully considered as the relevant wording could be seen as an onerous provision at rent review - although to date such an argument has not reached the courts.

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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