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Wednesday, 26 October 2011

Lease Guarantees: Spot the Title Defect! Can a Tenant Assign to its Guarantor?

If you are a tenant who has entered into a lease and your obligations have been underwritten by a guarantor, can you at a later date assign your lease to your guarantor?

My recent post on lease guarantees tells how this summer saw the Court of Appeal hand down the most important decision in commercial landlord and tenant law for years in K/S Victoria Street -v- House of Fraser (Stores Management) Limited [2011] EWCA Civ 90.

The decision has been welcomed because it has resolved the question of whether a tenant’s guarantor can guarantee a tenant’s AGA – it can. This issue had never been completely clear under the 1995 Act and was thrown into doubt altogether by comments made by the judge in last year’s Good Harvest decision.

Incidentally, if you are new to these terms or want a reminder, please see my previous post on this for a brief explanation.

However, just as a judicial aside (technically referred to as an obiter statement) caused uncertainty about guaranteeing AGAs in Good Harvest, a similar thing has happened in K/S Victoria Street, only this time the obiter statement is about whether a tenant can assign its lease to its guarantor.

The written judgement, in a section dealing with the anti-avoidance provisions of the 1995 Act (section 25), says “it would appear to mean that the lease could not be assigned to the guarantor even where both tenant and guarantor wanted it”.

So an assignment of a lease by a tenant to its guarantor would appear to be void.

There may be instances where a tenant wants to assign its lease to its guarantor, for example as part of a group corporate reorganisation where the parent company which gave the guarantee wants to assume responsibility for the property.

This may not happen often, and it might be possible to contrive a way of dealing with this that does not fall foul of the anti-avoidance provisions of the 1995 Act, perhaps by providing for some sort of contractual release of the guarantor a few days before the assignment to it.

But there may already be some cases where leases have been assigned by tenants to their guarantors.

And that’s the most troubling part of the obiter statement.

What does it mean where such assignments have already taken place? Good title will not have been given, even though the transfer might have been registered at the Land Registry. Clearly this would raise a serious defective title issue, the implications of which would need to be thought through on individual cases.

It has the potential to cast doubt on the valuation of some portfolios.

It is unfortunate that, having successfully provided clarity on the AGA question, and put to rest the doubts caused by defective legislation, the Court of Appeal has inadvertently created another area of uncertainty.

We need clarification on this point; or do we have to wait for more litigation to clear it up?

Photo by spaceamoeba via Flickr

Tuesday, 18 October 2011

Lease Break Clauses: Want An Option to Quit Part of Your Premises? Why Does the Law Get In the Way?

Do you want a break clause that relates to only part of the premises included in your lease?

This is not as straightforward as it seems; legal technicalities can get in the way.

Although it appears from the history of cases that it is possible to have a break clause that only relates to part of the premises, the matter is by no means certain and, for landlord’s break clauses, is not possible at all unless the lease is contracted out of the Landlord and Tenant Act 1954 (1954 Act) - for more about that see my post More Food for Thought for Landlords.

If the property is divided up into distinct parts from the outset, for example separate floors, if the tenant wants the flexibility of being able to get out of one or more floors individually before the term ends, the safest way of dealing with this is to grant separate leases of each floor and include break clauses in those leases.

That works well for a landlord who wants a break clause too, provided each lease is contracted out of the 1954 Act.

If the premises are not obviously comprised of separate parts at the outset, but the tenant wants the flexibility of being able to get out of part of them at a later date, then rather than a break clause, the safest course of action may be instead to grant an option to surrender part only of the premises.

There is an interesting article in the current edition of the Conveyancer & Property Lawyer* by the precedents editor of that journal, Emma Slessenger, on how you might go about doing this from a legal point of view, which discusses the technicalities further.

There are procedural complications that have to be worked around, such as the need to authorise the surrender in advance by a warning notice and statutory declaration. The detail of this is outside the scope of this blogpost.

Although the premises might not comprise separate parts at the outset, you need to describe carefully the part to which the surrender option relates by reference to an accurate lease plan drawn to scale.

There are other practicalities to consider too.

If the premises were not capable of being let on separate leases from the outset, what will need to be done to make them into separate units if part of the premises is surrendered?

Who will be responsible for carrying out any works required to make the premises suitable for separate occupation?

Do any rights need to be granted and reserved between the two distinct units being created by the surrender of part?

How will dilapidations be dealt with in relation to the surrendered premises?

The lease of the part being retained may need to be varied, for example to deal with things like rent reduction pro rata to reflect the reduced size; rights and reservations; treatment of any separation works on future rents reviews; and maybe even a change to the permitted use provisions.

The tenant should also make sure that the lease provides for any rent paid in advance for the surrendered part to be reimbursed on the surrender date, as there is no common law right to apportion that rent.

And having said all this, is it really safe legally to allow in advance for a surrender of part?

Not entirely! There is an argument that you cannot agree in advance to surrender part only of premises included in a lease, because the mechanism for doing so under the 1954 Act only refers to surrendering a “tenancy”, which some commentators believe has to mean the whole tenancy.

One way round that might be for the tenant to surrender the whole lease and take a lease back of the part it wants to retain.

In view of these uncertainties, the safest thing of all is probably to avoid part break clauses or part surrenders altogether if you can.

Unfortunately this is another example of the law getting in the way of apparently straightforward commercial objectives.

For more about break clauses generally, here is a link to my other posts.

*[2011] 75 Conv Issue 4 pp264-267

Photo by stevelyon via Flickr

Tuesday, 11 October 2011

Lease Break Clause Strategy

Break clauses – drafting new ones and operating old ones – are still a hot topic for property professionals as individuals and companies look to get out of property they no longer want, or can no longer afford.

A tenant’s need to get out of property because of downsizing, downshifting or just trying to stay solvent will more often than not be equally matched by a landlord’s desire to keep the tenant tied to terms that might have been agreed in the boom years, but which no one else would be willing or able to sign up to today.

If you are a tenant, when you operate your break clause, you have to get it right because time after time the courts have shown themselves unwilling to bend over backwards to rescue a tenant from the consequences of a mistake that on the face of it appears to be a mere technicality, but which can result in the tenant not being able to escape its lease for the duration of the term.

Getting it wrong can be the most expensive mistake a tenant can make.

I have posted several times on this blog about break clauses, but as the topic remains as relevant now as it ever was, it might be useful for you to have a strategic reminder and links to the relevant posts.

For the most common mistakes made by tenants operating break clauses and examples of the conditions that sometimes have to be complied with, see What Can Possibly Go Wrong?

It is vital to ensure a break notice is served on the right person, and if you are a landlord that your managing agents respond in the right way (or better still, don't respond), see Don’t Get Caught in the Landlord’s Web.

If you do get it wrong, there might still be time to remedy the situation, see If You Get it Wrong, You’ll Get it Right Next Time.

And whatever you do, make sure you get your own name right, see Get Your Own Name Right!

The break right might be personal to the original tenant only, and so of no use to subsequent tenants, see This Time it’s Personal!

You might be obliged to give “vacant possession” as a condition of breaking the lease; for a discussion of what that means see Pretty Vacant.

Then again, you might serve the notice and get everything right, but then you change your mind and want to stay at the premises after all. What then? See What If You Change Your Mind?

And if you’re negotiating a new lease, you will want a simple and effective break clause without any onerous conditions, see What Should You Agree in a New Lease?

There are special considerations to think about if you want to have the ability to get out of only part of your premises, see Want an Option to Quit Part of Your Premises? Why Does the Law Get in the Way?

It’s not just tenants who want break clauses, landlords do too sometimes.

How can break clauses be effective for landlords? See When is a Landlord’s Break Clause Effective?

For a more complicated example of how a break clause can go wrong for a landlord, where there are issues of “estoppel” and renewal rights, see More Food for Thought For Landlords.

Given the times we live in, I suspect there will be many more tales of break clause bungling in the months to come.

I’ll try to keep you posted.

Always take professional advice as soon as possible if you are going to operate a break clause or if you are negotiating a new one.

Friday, 7 October 2011

Lease Guarantees: What Are They Worth Now? How Can They Add Value in Future?

This summer saw the Court of Appeal hand down the most important decision in commercial landlord and tenant law for years in K/S Victoria Street -v- House of Fraser (Stores Management) Limited [2011] EWCA Civ 90.

It would never have made the general headlines, even without a summer dominated by phone hacking and riots, but for property lawyers it is nevertheless a landmark judgement on the workings of the Landlord and Tenant (Covenants) Act 1995 (1995 Act).

I gave a summary of the decision in August in my post Lease Guarantees: Is it the End of the Saga?; but now the dust has settled, and in case it slipped under your summer holiday radar, I’m going to look again at some of the practical implications of this decision.

Why is it so important?

It is often the case that a landlord will be persuaded to grant a lease to a tenant of little value – a “weak covenant” – because the tenant’s obligations will be guaranteed by someone stronger, such as a parent company or a rich individual.

For leases granted since 1996, when the tenant (T) assigns its lease to an assignee (A), it ceases to be responsible for performance of the tenant’s obligations, unless it has given the landlord an authorised guarantee agreement (AGA), which it is nearly always required to do, under which it guarantees the obligations of A. If T by itself is a weak covenant, the AGA is also of little value unless the guarantor (G) can somehow be kept on the hook.

Following the Court of Appeal’s ruling, the law now says:

·         G cannot guarantee the obligations of A

A requirement to do so is void, whether it is contained in a lease, a licence to assign, the assignment itself or a separate guarantee deed. Surprisingly, G cannot even agree to give a direct guarantee of A voluntarily.

·         G can guarantee the obligations of subsequent assignees

So if A assigns the lease to A2, then G can step back into the frame and guarantee the obligations of A2 – even if A2 is the original tenant. But if G guarantees A2, on the next assignment, G could not then guarantee A3 directly, but it could guarantee A4 if there was another assignment. Confused? There’s more on this in the context of group companies below!
·         G can guarantee the obligations of T under an AGA

This is sometimes called a parallel or sub-guarantee, or even a GAGA. Here, G is not guaranteeing A directly, but is instead standing behind T’s guarantee of A in the AGA – which is a subtle difference but one which has some practical consequences.

What should you do now?

Check the leases in your portfolio – where’s the value gone?

Leases which require guarantors to give direct guarantees of assignees will be defective. If any such direct guarantees have been given, even voluntarily, they will not be enforceable and will basically be worthless. On repeated assignments within corporate groups, some guarantees may be effective, whilst others may not be (see below for more on this). What effect will this have on the overall value of your portfolio? This is something you need to discuss with your valuation advisers in tandem with your legal advisers.

Due diligence

When buying investment properties or portfolios; check carefully the position of any guarantors. If any guarantees are defective, take advice on the implications this will have on value and consequently whether an adjustment should be made to the price.

Check your precedents

Make sure that the leases you grant from now on comply with the law, and provide for a guarantor to give a GAGA rather than a direct guarantee of A.

Group companies – intra-group assignments and “leapfrogging”

The rule against guarantors voluntarily providing repeat guarantees will continue to have an impact on intra-group assignments where, for example on successive group reorganisations, the landlord would want the main group company to stand as guarantor for each successive tenant – so in my example, the group company would be G.

The Court has decided that G can validly guarantee the liability of an assignee on a future assignment provided there has been an intervening assignment of the lease during which the guarantor was released from liability as a direct guarantor, but can still have given a GAGA.

So, to keep renewing G’s guarantee (which is where the value lies), G will have to alternate between giving GAGAs and direct guarantees if the lease is assigned several times. I think of this as leapfrogging. On the first assignment to A1, G gives a GAGA. On the next assignment to A2, G gives a direct guarantee of A2. On assignment to A3, G gives a GAGA. On assignment to A4, G gives a direct guarantee of A4. And so on...

So G is giving a GAGA for odd numbered assignees and direct guarantees for even numbered assignees.

If at any time an assignment is back to a former tenant, or even the original tenant, you just need to think of them as another assignee to keep track.

Anyone drafting new leases needs to think carefully about how to provide for the guarantor to give either a GAGA or a direct guarantee on each subsequent assignment at the landlord’s option, and then the landlord needs to think carefully about what it must require on each assignment.

In new leases, landlords should not allow intra-group assignments without consent (which often used to be agreed for big corporate occupiers). This is to ensure an AGA will be given, which can then be backed up by a GAGA.

For existing tenants, the decision may present an opportunity to secure the release of a guarantor which the landlord can do nothing to prevent.

Why is a GAGA less valuable than a direct guarantee?

A GAGA, and indeed the AGA itself, is less valuable than a direct guarantee of an assignee because, if a landlord wants to make a claim under a GAGA or an AGA, it first has to serve notice on the former tenant or guarantor within six months of any rent or other fixed charge falling due and the person paying the arrears may be able to claim an overriding lease. This is not the case with direct guarantors.

But in terms of keeping the valuable group company at least on the hook, this is a lot better than nothing, and should enable multiple group reorganisations to go ahead without the need for further security.

Can a tenant assign a lease to its guarantor?

The Court of Appeal threw out a bit of a curve ball in its judgement when, on looking at the anti-avoidance provisions of the 1995 Act (section 25) it said “it would appear to mean that the lease could not be assigned to the guarantor even where both tenant and guarantor wanted it”.

So an assignment of a lease by a tenant to its guarantor would appear to be void. What does this mean where such assignments have already taken place? Good title will not have been given, even though the transfer might have been registered at the Land Registry. Clearly this would raise a serious defective title issue, the implications of which would need to be thought through on individual cases.

What if the assigning tenant is insolvent?

Where a tenant is insolvent (but has a solvent guarantor), the administrator or liquidator is unlikely to be willing to give an AGA. If that is the case, the solvent guarantor cannot give a GAGA, nor can it give a new direct guarantee of the assignee. In that situation, assignees may be required to provide a fresh guarantor of suitable covenant strength or other security, such as a rent deposit or bank guarantee.

So check your portfolio to determine the validity of existing guarantees; and think carefully from now on about making sure guarantees in future really do add value.

Wednesday, 5 October 2011

Landlords – Don’t Give Consent by Mistake

If you’re a landlord, it’s alarmingly easy to end up agreeing to something your tenant has requested by mistake – or for your advisers or agents to do so on your behalf.

Leases will usually stipulate that certain things cannot be done without the landlord’s consent, such as for example assignment, sub-letting, carrying out alterations or changing the use.

Nowadays most leases require that consent to be given in writing.

However, if a landlord or its representatives are careless in their correspondence, including e-mail, then there is a danger that consent is given prematurely, preventing the landlord from later withdrawing that consent or imposing conditions.

Using phrases like “subject to licence”, “subject to contract”, or “consent in principle” do not in themselves stop correspondence from amounting to consent, whether it comes from the landlord, its agents or its solicitors. 

So make sure all correspondence is suitably qualified. For example, if you are acting for a landlord your initial letter and subsequent correspondence should say:

“Please note that we have no authority; express or implied, to give or sign consent on behalf of the landlord.”

When indicating consent in principle, you should also say something along these lines:

“Our client is prepared to consider your application for consent if [set out any conditions] but we must stress that this letter forms no consent in itself and consent will only be given, if those conditions are satisfied, by formal licence/deed.”

Whether you can specify that the consent must be by deed or licence will depend on what the lease says.

But don’t forget, in trying not to say yes, when you might mean no, you might also be under an obligation to be reasonable and to respond within a reasonable time.

There may still be some leases around which do not require consent to be given in writing. You need to be extra careful with these, as just having a conversation might amount to consent.

Life’s full of the inadvertent.

Photo by corykrug via Flickr