Guarantees on lease assignment: implications for landlords and their lenders

This guide considers the implications of a recent case for landlords and their lenders. For the implications for tenants, please see our separate Out-Law guide.

What is an authorised guarantee agreement?

Authorised guarantee agreements (AGAs) were created by the Landlord and Tenant (Covenants) Act, and their content is strictly regulated by statute.

Tenants and their guarantors are automatically released from liability to the landlord when a lease is lawfully assigned to a third party. Landlords can, however, require outgoing tenants to enter into AGAs guaranteeing the liabilities of the new tenant under a lease. There are no provisions allowing guarantors to do so as well.

The Landlord and Tenant (Covenants) Act applies to leases granted on or after 1 January 1996, unless the lease was granted under an agreement or court order made before that date. It includes anti-avoidance provisions which invalidate contractual provisions designed to work around it.

Recent case law

There were heated debates about the validity of guarantees of leasehold liabilities following the High Court's decision in the Good Harvest case in 2010 that a guarantee of an assignee given by the outgoing tenant's guarantor was void. This was considered again later that same year in a case between landlord K/S Victoria Street and House of Fraser (Store Management) Ltd.

In January 2006 K/S Victoria Street agreed to the sale and leaseback of a property in Wolverhampton to a company in the House of Fraser group. Under the agreement, the store management company was to take a lease guaranteed by the group holding company. The Agreement for Lease also required it to assign the lease to another group company by April 2006, but no assignment ever took place. In March 2010, the landlord brought proceedings against all three of the House of Fraser companies seeking to enforce the assignment.

House of Fraser relied on the Good Harvest decision to argue that the agreement was unenforceable. The High Court agreed, deciding that the guarantee to be given by the parent company as the outgoing guarantor in respect of the new tenant's liabilities under the lease was invalid. It also doubted whether sub-guarantees - that is, guarantees by outgoing guarantors in respect of outgoing tenants' liabilities under AGAs - were effective. The decision caused difficulties for landlords and tenants, and meant that in many cases groups of companies could no longer make assignments between themselves.

The Court of Appeal clarified the law and upheld the validity of sub-guarantees. The decision confirms that:

• an outgoing tenant's guarantor can guarantee an outgoing tenant's liabilities under an AGA – but not the liabilities of the incoming tenant to which the lease was assigned;
• once released from liability by an assignment, guarantors can provide fresh guarantees in respect of subsequent assignees.

Grant of a lease

For landlords, the decision restores the widely accepted position - that a guarantor can guarantee an outgoing tenant's liability under an AGA. This has the indirect effect of guaranteeing the obligations of the new tenant, and addresses most of the difficulties arising from the Good Harvest decision.

It is less usual to require a guarantor to guarantee the new tenant's obligations directly, unless the assignment is between companies who are part of the same group, so confirmation that this is invalid will rarely cause problems. Nonetheless, some landlords have gone down this route in the past - in which case, such guarantees are invalid.

Assignment of a lease

A guarantor must not be asked to guarantee the obligations of an assignee directly. A landlord should not accept such a guarantee if it is offered independently, because it is invalid.

A guarantor can be asked to guarantee an outgoing tenant's obligations under an AGA if it is reasonable to do so, or if the lease so provides.

There is a suggestion that a tenant may not be able to assign its lease to its guarantor. It may be advisable to avoid this situation until the position is clarified.

Intra-group assignments

The Court of Appeal confirmed that an outgoing tenant's guarantor cannot directly guarantee the liabilities of the incoming tenant when a lease is assigned.

This has important consequences for alienation provisions which allow the landlord to control the assignment by a tenant of its lease. Corporate tenants often request provisions in leases which will allow assignments between companies in the same group without the landlord's permission. Landlords often agree to these arrangements, subject to a condition that the tenant's guarantor continues to guarantee the incoming tenant's liabilities under the lease. The decisions in the Good Harvest and K/S Victoria Street cases prevent this because:

• it will be impossible to obtain a further guarantee from the same guarantor for the incoming tenant;
• the Landlord and Tenant (Covenants) Act provides that it is only possible to obtain an AGA from an outgoing tenant, for which the outgoing guarantor can then be a guarantor, if the lease prevents the tenant from assigning the premises without the landlord's consent.

This means that it would be a good idea to prevent assignments between companies in the same group without the landlord's consent in order to obtain a sub-guarantee from an existing guarantor. Alternatively, landlords will need to impose some other form of control – for example, a financial test – to ensure that the new tenant is suitable.

Note too that the Court of Appeal did not say whether landlords can contract with the same guarantor through a string of intra-group assignments using a string of guarantees and sub-guarantees, or more complex arrangements, in order to obtain a fresh guarantee from an outgoing guarantor.

Implications if you are buying or lending against investment property

The position is significantly improved by this decision. Up until now there had been a working assumption that guarantors could have no further liability whatsoever following assignment of a lease. Generally, this problem has now been resolved.

However, you still need to look out for:

• a guarantor directly guaranteeing the obligations of a new tenant after an assignment directly – this is definitely void;
• evidence that an assignment to a guarantor has taken place – this is potentially void;
• provisions for intra-group assignments that cause problems – see above.