UK: More Trouble With Assignments And Guarantees - Parties Must Face The Music

Last Updated: 8 July 2016
Article by Edward Cooper

EMI Group Ltd v O & H Q1 Ltd [2016] EWHC 529 (Ch)

The High Court has confirmed that a completely voluntary assignment of a lease from a tenant to its existing guarantor will be void under statute. Such an assignment will be unenforceable and the parties will be returned to the positions they were in prior to the assignment. The decision in this case follows similar results in previous cases, often in scenarios where all parties concerned had strong commercial reasons to ensure that the transaction succeeded. Although the statutory limitations on such transactions were intended to prevent injustice, these cases provide increasing evidence that the freedom of parties to contract for legitimate commercial purposes has been severely curtailed.

The facts

This case concerned a lease of retail premises dated 26 September 1996, granted to the well-known entertainment store HMV ("HMV") for a term expiring in February 2021. On the day the lease was completed, the claimant ("EMI") agreed to guarantee HMV's performance of its covenants in the lease. However, HMV fell into administration in January 2013.

In November 2014, the defendant, as landlord of the premises (the "Landlord") consented to the assignment of the lease from HMV to EMI. This arrangement appeared to benefit all concerned. HMV was no longer able to comply with the terms of the lease, EMI was already on the hook pursuant to the guarantee, and the Landlord wanted a secure tenant.

Following the assignment of the lease to EMI, EMI's solicitors wrote to the Landlord to contend that, although the assignment had been valid, the covenants in the lease were unenforceable against EMI. The Landlord's solicitors disputed this, claiming that the lease was enforceable against EMI. In the alternative, the Landlord argued that if it was wrong, the whole assignment must be void, resulting in the restoration of EMI as HMV's guarantor.

The Law

Having been completed after 1 January 1996, the lease was a "new tenancy" to which the Landlord and Tenant (Covenants) Act 1995 (the "Act") applied. One of the principal purposes of the Act was to ensure an original tenant of a lease could be released from liability, following an assignment of its interest. To ensure that the Act would be effective, anti-avoidance provisions were included, to hold void any agreement if it would restrict the operation of the Act. The provisions therefore apply to a party that is bound by a tenant's covenants, even if it is not the tenant itself, such as a tenant's guarantor.

The Court of Appeal recently reviewed the effect of the anti-avoidance provisions in the Act in the K/S Victoria Street case. This case concerned an agreement to assign a lease from one tenant to another, where the original tenant's guarantor would remain the guarantor of the new tenant. Since the value of the new tenant's covenant was weak, the importance of the guarantee was paramount for the landlord. However, as the original guarantor would remain liable for the tenant's covenants after the assignment, it was held that the guarantee would be unenforceable under the Act.

The legal issues

EMI submitted that the K/S Victoria Street decision had direct application to the present facts. In both cases, the original tenant's guarantor would remain liable for the performance of the covenants in the lease before and after the assignment, and the law should draw no distinction between the liability of a tenant and that of a guarantor.

EMI also contended that the result of the unlawful assignment was that it was released from the tenant's covenants in the lease. The lease would continue and the landlord could forfeit it if EMI did not pay rent, but there would be no means to sue EMI in respect of the tenant's covenants.

In response, the Landlord argued that the effect of striking down an assignment, rather than a guarantee, had difficult implications that were not intended when the Act was passed. Furthermore, if EMI's case was correct, the parties would be left with a lease that could not be enforced by a Landlord, and which could not be recognised as a tenancy. As Counsel for the Landlord put it, the result would be a "Frankenstein's monster" of a tenancy.

The decision

Following the reasoning laid out in K/S Victoria Street, the Court held that the assignment of the lease from HMV to its guarantor, EMI, was void. In practical terms, although EMI was released as the guarantor of HMV, it had assumed liability for the tenant's obligations at the very same time. This would frustrate the purpose of the Act and the transaction therefore fell foul of the Act's anti-avoidance mechanisms.

Although the Court preferred EMI's arguments concerning the anti-avoidance mechanism, this was a Pyrrhic victory, as the Court could not accept EMI's submissions concerning the effect of this. The Court held that the obvious conclusion was that the assignment was void. This had the effect of returning the parties to the original position before the assignment, leaving EMI liable for the lease covenants pursuant to its guarantee.

Our comments

In view of the previous case law concerning the Act, the result of this case is perhaps unsurprising. However, the case highlights the fact that the Act has become a serious impediment to parties seeking to conduct lease transactions where the value to the landlord is held in a guarantee of the tenant's covenant. A simple intra-group transfer of a lease from one company to another will cause problems and now we know that an assignment to an existing guarantor will also be struck down. Summing up, the Judge noted "As is clear from K/S Victoria Street, the fact that such a conclusion is unattractively limiting and commercially unrealistic is neither here nor there." Following this line of decisions, The Property Litigation Association is now consulting on proposals to reform the law and many practitioners will hope that the campaign succeeds.

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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