Occupational leases, as the providers of income stream to the freeholder, are so often the nub of the value of a commercial property for the lender. The existence of a guarantor for a tenant’s lease obligations is often crucial to that income stream, and thus the value of the freehold, particularly where the tenant itself is not a strong covenant.
Several cases have emphasized the desirability of ensuring that any guarantor signs up to any material variation of the lease to ensure that the guarantor is not wholly released from the lease obligations. Checking that guarantors are still on the hook is a fundamental part of the reviewing and reporting process for a bank’s solicitors.
Landlord and Tenant (Covenants) Act 1995
The recent High Court decision in EMI Group Ltd v O & H Q1 Ltd [2016] EWHC 529 (Ch) introduced a new twist to guarantors’ obligations. The property in question was the HMV store on the edge of Worcester’s Crowngate centre. The Deputy High Court Judge held that an assignment of the lease by the tenant HMV UK Limited to its guarantor EMI Group Ltd was void because it fell foul of section 24(2) of the Landlord and Tenant (Covenants) Act 1995. That section was intended to release guarantors on assignments by tenants to third parties, but the court decided that it had a wider effect, rendering void an assignment to the guarantor itself, as it would involve a continuation of the guarantor’s liability under the lease (albeit now arising in the guarantor’s capacity as lessee) beyond the moment of its statutory release. Contracting out of section 24(2) is void under section 25 of the same Act. The court saw the very act of assigning the lease to the guarantor as such a contracting out. The decision was astonishing as it unwound a transaction all three parties (landlord, tenant and guarantor) had agreed and signed up to.
As a result, the solicitor’s due diligence exercise must now include checks that there have been no assignments of any occupational lease, at any time, to a previous guarantor, as any such assignment, or subsequent assignments, may not be worth the paper they are written on. The City of London Law Society Certificate of Title has been changed to require the certifying solicitor to confirm that any lease “is not now and has not been previously vested in any guarantor of a previous tenant”.
The effect of the Worcester store case was that the purported assignment was void, with the result that the lease remained vested in the original tenant, and that EMI Group Ltd remained bound as original lease guarantor, and had not been released from its obligations under that guarantee.
The guarantor was therefore still liable, albeit not in the way intended. The decision however has a number of unwelcome ramifications. Subsequent assignments by the guarantor would be void, leaving the freeholder without recourse to anybody if the original tenant and guarantor were then wound up. Underleases created out of the void assignment are also at risk.
We wait to see if the decision will be challenged in a higher court but in any event the 1995 Act – the principal statute governing landlord and tenant relationships in all leases granted from 1996 - is crying out for legislative change to resolve this and other quirks and confusions.
