Effects on assigning a lease for a business

Insights - 29/04/2019

The majority of landlords grant leases for one main reason – to obtain a steady income stream in the way of rent. A good tenant will be able to provide this, but a lot of careful consideration often (and should) goes into deciding whether a tenant is of a ‘good financial standing’. In order to protect themselves, landlords can (and should) carry out credit checks and request references to determine whether further protection relating to the performance of that tenant is wanted.  This might be in the form of a rent deposit, a guarantee or both depending on all the circumstances.  In this article, we consider in more detail the impact of taking a guarantee and, in particular, what happens with that guarantee on an assignment of an existing lease.

What do guarantors do?

A guarantor guarantees the tenant’s performance of its obligations under the lease by entering into a contractual agreement with the landlord.  This creates, if you like, a second bite at the cherry approach should the tenant not perform its obligations under the lease.  If the tenant does not pay rent, for example, then the landlord can pursue the guarantor for that payment.  Essentially a guarantor is only liable if the tenant does not perform. It is, therefore, imperative that the party standing as guarantor has the financial strength to back up what it will be doing.  It is also important that guarantee provisions in the lease are drafted carefully, with both the landlord and guarantor being advised of the implications of those provisions. For example if the tenant’s covenants in the lease are void or unenforceable, then the guarantee will also be unenforceable. Or, if the lease is varied then there is the risk that the guarantor will be released from all liability under its guarantee unless it consents to the variation.

What happens when the tenant wishes to assign its lease?

It could be argued that a landlord has less control in this situation than on the original grant of the lease as the tenant (within reason and in accordance with the terms of the lease) is free to assign the lease to whomever it wishes. The landlord must also comply with the requirements of the lease in dealing with an assignment and, more often than not, will be required to act ‘reasonably’ when consenting to an assignment. The main concern for the landlord is to make sure its steady income stream is not interrupted. Most leases will look to do this by stating that the assignee is a ‘person of standing acceptable to the landlord’.  The assignee can be asked to give a guarantee or rent deposit to lend weight to this. The current tenant can also be required to enter into an authorised guarantee agreement (AGA). An AGA is a guarantee given by the outgoing tenant guaranteeing that the assignee will observe and perform the tenant obligations in the lease.  As before, it is fundamental that when an AGA is entered into, the provisions are drafted to ensure the guarantor under that document is not released or discharged from its liabilities.

Co-operative Group Food Ltd v A & A Shah Properties Ltd and others [2019]

The lease in this case had been assigned.  The licence consenting to the assignment contained an AGA in its schedule. The original guarantor of the previous tenant was also a party to the licence, extending its guarantee towards the then incoming tenant (now the current tenant in this scenario). Perhaps unusually, both the previous tenant (the party that had given the guarantee contained in the AGA) and the current tenant had gone into administration. The landlord sought rent under the guarantee provisions in the AGA.

The licence contained the following provisions:

  • A clause stating that the ‘schedule formed part of the licence and was to have effect as if set out in full in the body of the licence’.
  • Clause 4.1 confirmed that the previous tenant and the guarantor of that previous tenant were ‘to observe and perform the obligations set out in the AGA immediately after completion of the assignment’.
  • Clause 4.2 confirmed the guarantor of the previous tenant had consented to the previous tenant entering into the licence and that that guarantor also requested the consent granted by the licence. The clause contained wording stating that the guarantor agreed ‘its guarantee and other obligations under the lease would remain fully effective and … extended and applied to the covenants given by and the obligations on the Tenant’s part under the licence’ (here the tenant being the previous tenant)

In the appeal the judge had to decide whether these clauses arose under a sub-guarantee or under a direct guarantee so determining whether or not they were void.

Judgement

It was held that clause 4.1 was a direct guarantee and, therefore, void. The reason being that both the previous tenant and the guarantor had covenanted to observe the tenant obligations under the AGA. The obligations under the AGA were guarantees of the current tenant’s obligations so that made the guarantor’s obligations a direct guarantee of the current tenant, so rendering it void in favour of the original guarantor.

Clause 4.2 was a sub-guarantee, so valid and enforceable against both the previous tenant and its original guarantor. The schedule was included in the licence, making the terms of the schedule capable of having a direct contractual effect. The obligation of the previous tenant in the licence would be an obligation covered by the guarantee in the provisions of clause 4.2. The original guarantor was still liable, as it was guaranteeing the obligations of the previous tenant as had been intended. There was in effect a guarantee of a guarantee, which is permissible.

Comment

It is difficult to know how courts will interpret an ambiguous or unclear guarantee clause but the usual approach has always been in favour of the guarantor. It was certainly a close call for the landlord in the Co-operative case.

In order to avoid having any guarantee given rendered void by a landlord should consider:

  • Reviewing and seeking advice when a licence to assign is being drafted with particular importance being placed on what any guarantor will be bound by and against whom
  • Ensure the guarantor provides consent to all variations and alterations made to the lease and property so as ensure any guarantee obligations continue.

To discuss this further or any other commercial property requirements, please contact Aranja Thamotharampillai, Solicitor in the Commercial Property Team on 01737 854 527 or by email on [email protected]. For more information on Commercial Property please click here.  

 

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Although correct at the time of publication, the contents of this newsletter/blog are intended for general information purposes only and shall not be deemed to be, or constitute, legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article. Please contact us for the latest legal position.