AGAs and GAGAs Where do we go from here? · AGAs and GAGAs Where do we go from here? ... The Law Commissioners in their report dealt with the position of guarantors in two paragraphs

© Louisa Nye, December 2015

1

AGAs and GAGAs

Where do we go from here?

This paper provides a review of the law in relation to authorised guarantee agreements (“AGAs”) and guarantors’ liabilities under the Landlord and Tenant (Covenants) Act 1995 (“the 1995 Act”) in the light of the High Court’s decision in Good Harvest Partnership LLP v Centaur Services Ltd [2010] Ch 426 and the Court of Appeal’s decision in K/S Victoria Street v House of Fraser [2011] EWCA Civ 904. I also consider the subsequent case law and the indications from the Courts as to the way guarantee covenants contrary to section 25 of the 1995 Act will be dealt with. This paper addresses the law in force as at 2 December 2015. The purpose of the 1995 Act - I want to break free Prior to the 1995 Act any landlord or tenant who entered into a lease was prima facie liable for the duration of the term. The contractual liability of the tenant would therefore continue after the term had been assigned. The consequence of this was that tenants could be left in a situation where they had assigned the term, their assignee fell into rent arrears or caused the premises to fall into disrepair, and many years later the original tenant would find themselves facing a substantial claim for arrears or damages.

The Law Commission therefore sought to address this mischief and published a White Paper in 1988: Landlord & Tenant Law: Privity of Contract and Estate.1 The intention of the Law Commissioners was to remedy the unfairness towards tenants. Essentially the issue was how to address the continuing liability which meant that the tenant could face an unexpected and ‘unfair’ claim.

The landlord was seen by the Law Commission as being adequately protected as there would still be a tenant who could be pursued, and landlords had a multiplicity of remedies.

The Law Commissioners in their report dealt with the position of guarantors in two paragraphs only.2 They essentially stated that where the liability of the tenant was to be cancelled under their recommendations, any liabilities that had been undertaken in parallel by a guarantor should also be terminated. Similarly if a tenant was to be partially released from their liabilities, then the guarantor should be released to the same extent. Further, they were of the view that this effect should be automatic.

Following the White Paper there was lobbying on behalf of landlords to try and avoid a position where landlords lost all of their “multiplicity of remedies”. Compromises were achieved on some issues namely:

Section 19(1A) of the Landlord and Tenant Act 1927

The release of landlords’ obligations on assignment

The ability to require an authorised guarantee agreement from the tenant

1 (1988) Law Com No. 174 2 Paragraphs 4.54 and 4.55


2

The relevant provisions of the 1995 Act – Bohemian Rhapsody

As far as guarantors are concerned there are four principle sections in the 1995 Act with which to be concerned: sections 5, 16, 24 and 25. For ease of reference I set these out in full.

5.— Tenant released from covenants on assignment of tenancy.

(1) This section applies where a tenant assigns premises demised to him under a tenancy.

(2) If the tenant assigns the whole of the premises demised to him, he—

(a) is released from the tenant covenants of the tenancy, and

(b) ceases to be entitled to the benefit of the landlord covenants of the tenancy,

as from the assignment.

(My emphasis added)

Section 5 ensures the Law Commissioners’ primary objective: where there is an assignment of premises then the tenant is released from the tenant covenants.

Section 16 provides for AGAs:

16.— Tenant guaranteeing performance of covenant by assignee.

(1) Where on an assignment a tenant is to any extent released from a tenant covenant of a tenancy by virtue of this Act (“the relevant covenant”), nothing in this Act (and in particular section 25) shall preclude him from entering into an authorised guarantee agreement with respect to the performance of that covenant by the assignee.

(2) For the purposes of this section an agreement is an authorised guarantee agreement if—

(a) under it the tenant guarantees the performance of the relevant covenant to any extent by the assignee; and

(b) it is entered into in the circumstances set out in subsection (3); and

(c) its provisions conform with subsections (4) and (5).

(3) Those circumstances are as follows—

(a) by virtue of a covenant against assignment (whether absolute or qualified) the assignment cannot be effected without the consent of the landlord under the tenancy or some other person;

(b) any such consent is given subject to a condition (lawfully imposed) that the tenant is to enter into an agreement guaranteeing the performance of the covenant by the assignee; and

(c) the agreement is entered into by the tenant in pursuance of that condition.

(4) An agreement is not an authorised guarantee agreement to the extent that it purports—

(a) to impose on the tenant any requirement to guarantee in any way the performance of the relevant covenant by any person other than the assignee; or


3

(b) to impose on the tenant any liability, restriction or other requirement (of whatever nature) in relation to any time after the assignee is released from that covenant by virtue of this Act.

(5) Subject to subsection (4), an authorised guarantee agreement may—

(a) impose on the tenant any liability as sole or principal debtor in respect of any obligation owed by the assignee under the relevant covenant;

(b) impose on the tenant liabilities as guarantor in respect of the assignee's performance of that covenant which are no more onerous than those to which he would be subject in the event of his being liable as sole or principal debtor in respect of any obligation owed by the assignee under that covenant;

(c) require the tenant, in the event of the tenancy assigned by him being disclaimed, to enter into a new tenancy of the premises comprised in the assignment—

(i) whose term expires not later than the term of the tenancy assigned by the tenant, and

(ii) whose tenant covenants are no more onerous than those of that tenancy;

(d) make provision incidental or supplementary to any provision made by virtue of any of paragraphs (a) to (c).

(6) Where a person (“the former tenant”) is to any extent released from a covenant of a tenancy by virtue of section 11(2) as from an assignment and the assignor under the assignment enters into an authorised guarantee agreement with the landlord with respect to the performance of that covenant by the assignee under the assignment—

(a) the landlord may require the former tenant to enter into an agreement under which he guarantees, on terms corresponding to those of that authorised guarantee agreement, the performance of that covenant by the assignee under the assignment; and

(b) if its provisions conform with subsections (4) and (5), any such agreement shall be an authorised guarantee agreement for the purposes of this section; and

(c) in the application of this section in relation to any such agreement—

(i) subsections (2)(b) and (c) and (3) shall be omitted, and

(ii) any reference to the tenant or to the assignee shall be read as a reference to the former tenant or to the assignee under the assignment.

(7) For the purposes of subsection (1) it is immaterial that—

(a) the tenant has already made an authorised guarantee agreement in respect of a previous assignment by him of the tenancy referred to in that subsection, it having been subsequently revested in him following a disclaimer on behalf of the previous assignee, or

(b) the tenancy referred to in that subsection is a new tenancy entered into by the tenant in pursuance of an authorised guarantee agreement;

and in any such case subsections (2) to (5) shall apply accordingly.

(8) It is hereby declared that the rules of law relating to guarantees (and in particular those relating to the release of sureties) are, subject to its terms, applicable in relation to any authorised guarantee agreement as in relation to any other guarantee agreement.

(My emphasis added)


4

Section 24 provides for the position in relation to guarantors:

24.— Effects of release from liability under, or loss of benefit of, covenant.

(1) Any release of a person from a covenant by virtue of this Act does not affect any liability of his arising from a breach of the covenant occurring before the release.

(2) Where—

(a) by virtue of this Act a tenant is released from a tenant covenant of a tenancy, and

(b) immediately before the release another person is bound by a covenant of the tenancy imposing any liability or penalty in the event of a failure to comply with that tenant covenant,

then, as from the release of the tenant, that other person is released from the covenant mentioned in paragraph (b) to the same extent as the tenant is released from that tenant covenant.

(3) Where a person bound by a landlord or tenant covenant of a tenancy—

(a) assigns the whole or part of his interest in the premises demised by the tenancy, but

(b) is not released by virtue of this Act from the covenant (with the result that subsection (1) does not apply),

the assignment does not affect any liability of his arising from a breach of the covenant occurring before the assignment.

(4) Where by virtue of this Act a person ceases to be entitled to the benefit of a covenant, this does not affect any rights of his arising from a breach of the covenant occurring before he ceases to be so entitled.

(My emphasis added)

Section 25 sets out the anti-avoidance provisions, which were intended to prevent landlords from circumventing the effects of the 1995 Act:

25.— Agreement void if it restricts operation of the Act.

(1) Any agreement relating to a tenancy, is void to the extent that—

(a) it would apart from this section have effect to exclude, modify or otherwise frustrate the operation of any provision of this Act, or

(b) it provides for—

(i) the termination or surrender of the tenancy, or

(ii) the imposition on the tenant of any penalty, disability or liability,

in the event of the operation of any provision of this Act, or


5

(c) it provides for any of the matters referred to in paragraph (b)(i) or (ii) and does so (whether expressly or otherwise) in connection with, or in consequence of, the operation of any provision of this Act.

(2) To the extent that an agreement relating to a tenancy constitutes a covenant (whether absolute or qualified) against the assignment, or parting with the possession, of the premises demised by the tenancy or any part of them—

(a) the agreement is not void by virtue of subsection (1) by reason only of the fact that as such the covenant prohibits or restricts any such assignment or parting with possession; but

(b) paragraph (a) above does not otherwise affect the operation of that subsection in relation to the agreement (and in particular does not preclude its application to the agreement to the extent that it purports to regulate the giving of, or the making of any application for, consent to any such assignment or parting with possession).

(3) In accordance with section 16(1) nothing in this section applies to any agreement to the extent that it is an authorised guarantee agreement; but (without prejudice to the generality of subsection (1) above) an agreement is void to the extent that it is one falling within section 16(4)(a) or (b).

(4) This section applies to an agreement relating to a tenancy whether or not the agreement is—

(a) contained in the instrument creating the tenancy; or

(b) made before the creation of the tenancy.

(My emphasis added)

The 1995 Act therefore represented a considerable change to the pre-existing law. In Wallis Fashion Group v CGU (2001) 81 P&CR 28 Neuberger J (as he then was) stated that the 1995 Act represented a “sea-change” in the law.

It is clear that the 1995 Act operates on its terms as a comprehensive approach to avoid the continuation of tenants’ primary liabilities at the end of the term, to avoid any attempt to circumvent this by making any agreement that purports to do so void, but by giving landlords AGAs as an exception under specific circumstances. As is always the case a clear and comprehensive approach on paper has become more complex and problematic in practice and has led to what are arguably unintended consequences.


6

Good Harvest Partnership LLP v Centaur Services Ltd [2010] EWHC 330 Ch – Another One Bites the Dust In Good Harvest Newey J had to consider whether a guarantor could be a party to an authorised guarantee agreement. The defendant (“G”) was the guarantor of the tenant (“T1”) under the lease. The lease was assigned to a new tenant (“T2”). As a condition of the grant of the licence to assign T1 and G entered into an agreement that was described as an authorised guarantee agreement. T2 did not pay the rent and therefore the landlord brought an action against G to seek to recover the rent arrears. G opposed that claim on the ground, inter alia, that the guarantee agreement was void and unenforceable by reason of section 25 of the 1995 Act. Newey J found that G had an absolute defence to the claim for rent. It was held that the 1995 Act precluded a guarantor from being required to give a further guarantee in respect of an assignee. G could not be T2’s guarantor. This was because if a guarantor were required to enter into a further guarantee then this would frustrate the operation of the 1995 Act, as it would impose obligations on the guarantor equivalent to those which should have been released by section 24(2). The guarantee agreement was therefore invalidated by section 25 insofar as it purported to impose liability on G. Points of particular note in the reasoning3 of the judge are:

The comment in London Diocesan Fund v Phithwa (Avonridge Property Co Ltd) [20055] 1 WLR 3956 at para [14] that section 25 is a “comprehensive anti-avoidance provision” is noted.

Parliament intended section 24 to relieve the guarantor of any liability he might otherwise have had in respect of the guarantee he had given.

If the guarantor were required to enter into a further guarantee, this would as a matter of language fairly be said to “frustrate the operation of…the Act“. Section 25 is to be interpreted generously.

Section 16 represents an exception to the general prohibition. If (subject to section 16) the Act precludes tenants from giving guarantees for assignees, it is difficult to see why guarantors should not be likewise barred.

Had Parliament intended a tenant’s guarantor to be able to guarantee the obligations of an assignee it could have been expected to say so explicitly.

There is no equivalent to section 16 for guarantors. Also there is no indication in the section that an AGA can include a guarantee from anyone other than a tenant [NB K/S Victoria – discussed below]

If a tenant’s guarantor could be required to give a guarantee for T2 there seems to be nothing to limit the guarantor’s exposure. Newey J noted “… for a landlord to be able to call on a tenant’s guarantor to give a guarantee for assignees other than the first could drive the proverbial “coach and horse” through the legislation”.

3 The full reasoning is at paragraph 22 of the judgement. It is exceptionally clear and well worth a read.


7

Newey J did not consider it by any means clear that the 1995 Act permits a guarantor to sub-guarantee a tenants obligations under an AGA. [NB K/S Victoria – discussed below]

The 1995 Act is plainly designed to impose restrictions on freedom of contract: the question is how far those restrictions go.

Newey J accepted that the Act could sometimes operate in apparently arbitrary (or at least uncommercial) ways.

Newey J expressly noted that the 1995 Act would present problems in the common case where a parent company or director gave a guarantee for a tenant. A parent company would not be able to guarantee successive subsidiaries if they are tenants. It was noted that the 1995 Act would prevent the parent company from guaranteeing the second subsidiary however much it wished to and however commercially desirable that was. K/S Victoria Street v House of Fraser (Stores Management) Ltd [2011] EWCA Civ 904 – It’s a Kind of Magic The decision in K/S Victoria has been much criticised. It is important to look carefully at the judgement to see what was decided and what was not decided. There were also several comments made by Lord Neuberger which while arguably obiter are quite rightly accepted as the received wisdom in relation to the 1995 Act. The facts of the case were as follows: The claimant acquired the freehold of a department store (Beatties) and granted a lease back to the first defendant (T1). The third defendant (G) acted as surety for the first defendant. Under clause 3.5 of the agreement the first defendant agreed to assign the lease to a group company of the surety, and that if such a company were not chosen by a certain date the assignment should be to the second defendant (T2). The third defendant agreed to enter into a deed of guarantee of the second defendant (assignee T2)’s liabilities. No assignment of the lease took place. The lease remained vested in the first defendant (T1). The first defendant was not worth anything. So in due course the claimant demanded that the assignment take place pursuant to clause 3.5. The defendants refused. The claimant therefore brought a claim for specific performance. The defendants defended on the ground that the clause was void and unenforceable because it contravened section 25 of the 1995 Act (relying on Good Harvest). The Court of Appeal had to determine whether clause 3.5 was valid and whether the reasoning in Good Harvest was correct. The Court of Appeal held that the reasoning in Good Harvest was correct subject to one important exception – there was nothing to prevent the assignor’s guarantor from guaranteeing the assignor’s AGA (i.e. entering into a sub-guarantee). (This is where the colloquial term GAGA has been introduced by practitioners.)


8

The argument that was put to the Court of Appeal was as follows:

On an assignment of the lease T1 would be released from all further liability under the lease by virtue of section 5(1).

This meant that section 24(2) was satisfied: G as another person who is bound by the covenants of the lease.

It is the effect and intention of section 24(2) that as from the release of the tenant, the guarantor should also be released from its liabilities under the lease.

Any provision which stipulates in advance that the guarantor had to re-assume precisely the same liability as a term of the assignment would therefore “frustrate the operation” of section 24(2)(b).

Clause 3.5 was therefore rendered void by section 25(1)(a) as it would “frustrate the operation” of section 24(2)(b).

The Court of Appeal found that that argument was correct, at paragraph [21]:

“If a landlord could (a) when granting a tenancy, impose an obligation on the tenant’s guarantor to guarantee the liability of the assignee in the event of an assignment, and (b) on an assignment by a tenant, enforce that obligation, it would, as a matter of ordinary language “frustrate” the operation of section 24(2).”

The Court of Appeal also made clear that the same reasoning would apply in relation to a similar contractual arrangement contained in a later document (e.g. a renewal agreement).4 An important point that was raised by the claimant was that the parties in this case had no intention of evading the provisions of the 1995 Act. The Court of Appeal held that it is the objective effect of the provision in question, and not the subjective reasons for its existence, which determine its validity under the Act. If a subjective element were introduced this would lead to uncertainty. The above would be sufficient, but there were further arguments put to the Court in relation to Good Harvest and Newey J’s decision that G cannot be a party to an AGA or sub-guarantee an AGA. The Court of Appeal did not agree with Newey J on these points. The further reasoning and principles were as follows: (a) Assignment to guarantor

Adopting their interpretation of section 25(1) (as set out above) appeared to mean that the lease could not be assigned to the guarantor, even where both the tenant and guarantor wanted that outcome.5

(b) GAGAs

Section 24(2), on any assignment, only requires the guarantor of the assignor to be released “to the same extent as the tenant”.

4 Paragraph 24 5 In UK Leasing (see below) Morgan J described the comment regarding an assignment from the tenant to

the guarantor in K/S Victoria as being “obiter” and “somewhat tentative”.


9

Accordingly if, where section 16(2) applies, the landlord is entitled to require the assignor to re-assume liability under an AGA it does not appear inconsistent to require the guarantor to guarantee the liability of the tenant under the AGA. The guarantor is released to precisely the same extent as the assigning tenant.

This conclusion appears to comply with commercial sense. (c) Co-guarantor under the AGA?

It may well be that the guarantor could simply act as a co-guarantor under the AGA. However, the Court of Appeal found that that was an issue which they should not determine.6

(d) Further assignments

If a tenancy that is granted to T and guaranteed by G is assigned, and it is then assigned back to T, there is nothing to prevent the guarantor’s renewed guarantee or the tenant’s renewed assumption of liability under the tenancy.

The Court of Appeal therefore left open points (a) and (c), but decided points (b) and (d). The Court of Appeal did not deal with the situation where there are a series of assignments and G becomes guarantor for T3 (or T4 etc.). However, given the comments in relation to (d), further assignments such an arrangement would appear to be valid. In terms of summarising the case I can do no better than refer to paragraph [53] of the Court of Appeal’s decision:

“Reverting to the general effect of the 1995 Act on existing guarantors, our conclusion, as explained above is that the effect of sections 24 and 25 is that: (i) an existing or contracting guarantor of a tenant cannot validly be required to commit himself in advance to guarantee the liability of a future assignee, (ii) subject to (iii) and (iv), a guarantor of an assignor cannot validly guarantee the liability of the assignor's assignee, (iii) such a guarantor can validly do so by being party to an AGA which otherwise complies with section 16 , and (iv) such a guarantor can in any event validly guarantee the liability of an assignee on a further assignment. We would hope that those responsible for drafting leases are aware of these conclusions, and that, as a result, the 1995 Act should not lead to many practical difficulties of the sort discussed above.”

The final comment is of particular note.

6 It can also be noted that Good Harvest was a co-guarantors case. It is difficult to see how the Court of

Appeal can approve the reasoning, while also finding that this point is in issue.


10

Subsequent case law – We Will Rock You A helpful summary of the principles to be derived from Good Harvest and K/S Victoria was set out in the judgment of Morgan J in UK Leasing Brighton Limited v Topland Neptune Limited [2015] EWHC 53 (Ch) at paragraph 19:

“19 It is not necessary to refer to the detailed facts of Victoria Street , save to say that it concerned the operation of the 1995 Act in relation to an agreement that an existing guarantor of the tenant's obligations should enter into a further guarantee in relation to an assignee of the tenancy. The reasoning of the Court of Appeal is fairly intricate and I will attempt to extract the relevant propositions established by that case, as follows: (1) a term of the lease, or of an agreement relating to the lease, which stipulates in advance that a tenant's guarantor must re-assume the liability of a guarantor in relation to the assignee, as a term of an assignment by the tenant, would “frustrate” the operation of the statutory provision ( section 24(2) ) which would otherwise serve to release the guarantor and is therefore void under section 25(1)(a) : [20] – [24] and [34]; (2) the first instance decision in Good Harvest was correct; (3) the correct interpretation of the Good Harvest decision was (subject to a later qualification) that section 25(1) invalidated any agreement which involved a guarantor of the assignor guaranteeing the assignor's assignee: [34] and [44]; (4) this interpretation gave the 1995 Act an unattractively limiting and commercially unrealistic effect but was nonetheless the law: [36]; (5) there was no distinction between a guarantee freely offered by the guarantor and a guarantee insisted upon by the landlord: [40] – [43]; (6) there was no distinction as to the effect of the 1995 Act on an agreement to give a guarantee and a guarantee actually given: [43]; (7) the qualification referred to in (3) above was that if the assignor gave an AGA in relation to the assignee, the guarantor of the assignor (whilst it was the tenant) could also give a guarantee in relation to the assignor's liability under that AGA : [46] – [48]; (8) if a tenant assigns and the tenant and the tenant's guarantor are thereupon released, there is nothing to stop that guarantor becoming a guarantor again on a subsequent assignment: [51]; (9) the proposition in (8) above applies not only where the subsequent assignee is a new party but also where the subsequent assignee is an earlier tenant whose liabilities were guaranteed by that guarantor: [51].”

In the cases that have followed K/S Victoria the Courts have attempted to adopt a commercially sensible approach, while also applying the law as set out in the 1995 Act and interpreted by the Court of Appeal.


11

Taking the cases in chronological order: In Pavilion Property Trustees v Permira Advisers [2014] EWHC 145 (Ch) Morgan J was asked to grant declaratory relief in relation to the meaning and effect of a “poorly drafted” guarantee. The agreement in question purported to impose liability on the guarantor in respect of a future assignee, contrary to Good Harvest. The claimants sought a declaration that the offending parts of the agreement could be severed. The judge was highly critical of the case as it had been presented to him. He held that the declarations sought by the claimant should not be granted in the terms sought. More importantly, Morgan J considered how severance could operate so that the entire agreement was not invalid. He noted at paragraph [21] that section 25 of the 1995 Act contemplates severance as it uses the words “to the extent that” in a number of places. It would therefore be possible to sever the provision that sought to impose liability in respect of the next assignee, but leave the remainder of the guarantee as a valid and enforceable agreement. He referred at paragraph [20] to the Latin maxim “verba ita sunt intelligenda ut res magis valeat quam pereat”. More easily understood in the English – “validate if possible”. In Tindall Cobham Limited v Adda Hotels [2014] EWCA Civ 1215 the parties were again agreed that the specific clause in question fell afoul of section 25 and the decision in Good Harvest. The question for the Court of Appeal was how to sever the offending provisions. There were 10 leases of hotels. Those leases were assigned to nine companies. This was as part of a corporate restructure. The assignments were made without seeking prior consent, which was contrary to the leases. It was accepted that the assignments were unlawful and therefore under section 11 of the 1995 Act those assignments were ineffective to release the original tenants and their guarantors from their liabilities under the leases. It became common ground at the hearing that a request for consent must precede any assignment of the leases in question. An issue remained as to whether a similar assignment to other associated companies in the group would have the effect of releasing the tenants’ covenants. Clause 3.14.6 of the leases required the guarantor to enter into an agreement guaranteeing the obligations of the assignee: this was clearly contrary to Good Harvest. The claimants issued proceedings seeking a declaration that the assignments were unlawful and an order for the re-assignment of the leases to the original tenants. The Court of Appeal considered the “validate if possible” principle. At paragraph [30] they noted that the principle was derived from statutory interpretation, and was not devised as a means for avoiding the consequences of legislation being applied to a contract. It was also considered, at paragraph [31], that it is not possible to apply the maxim in order to create an interpretation of the contract or other instrument which cannot be justified under the ordinary principles of construction.


12

At paragraph [32] the Court of Appeal held:

“The starting point must therefore be to construe clause 3.14.6 in its proper contractual context in order to decide whether there are in fact realistic alternative constructions of the relevant words that may require the application of the “validate if possible” principle.”

The fundamental question which the Court had to consider was how far section 25 should be regarded as avoiding contractual provisions. At paragraphs [45] to [47] the Court of Appeal held as follows:

“45… [Counsel] made the point that legislation which operates to avoid the whole or a part of a contract may produce consequences in terms of the legal position which the parties are left with that may be both capricious and uncommercial. I accept that. Any alteration of the contract will necessarily change the parties' legal relationship from what they intended it to be and the actual impact upon them in terms of the remaining balance of liabilities and obligations may be fortuitous. But that should not be regarded as an invitation to assume that such will necessarily be the case, still less to attribute to Parliament an intention that the legislation should be interpreted and applied in that way when other alternatives are available. 46 Although the words “void to the extent that” indicate that Parliament did not intend to invalidate more of the relevant agreement than was necessary to safeguard the objectives of the Act in the context of the particular assignment under consideration, those words do not in my view preclude the Court from taking a balanced approach to invalidation which, whilst neutralising the offending parts of the contract, does not leave it emasculated and unworkable. The judge was referred in argument to the principles of severance under which the Court can enforce a contract containing provisions that are either illegal or against public policy provided that the unobjectionable provisions are severable. It seems to be generally accepted that the Court will not sever the terms of a contract for this purpose unless the unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording that remains; the remaining terms are supported by adequate consideration; and the removal of the unenforceable provisions does not alter the character of the contract: see Sadler v Imperial Life Assurance Co of Canada [1988] IRLR 388 at p. 393. 47 Neither party to this appeal relies upon the principles of severance as of direct application to what we have to decide. We are not concerned with whether the Court is able to sever an illegal contract on these common law principles because s.25 makes it clear in terms that it operates only to invalidate limited parts of the relevant agreement. The rules of severance are not therefore of much assistance even by analogy to a determination of how much of the contract the Court is required to treat as invalid or unenforceable for the purpose of s.25 . But in carrying out that exercise I can see nothing in s.25(1) which prevents the Court from looking at the structure of the agreement in an objective and common sense way.”

(My emphasis added)

The indication that the Courts will take a sensible approach in severing the offending portions of any agreement is obviously encouraging. Although it should be noted that the Court of Appeal accepted


13

that in certain circumstances section 25(1) would have consequences which may be capricious and uncommercial. UK Leasing Brighton Limited v Topland Neptune Limited [2015] EWHC 53 (Ch) was the sequel to Tindall Cobham. Given the assignments had been in breach of contract, the parties were seeking to get themselves out of the mess they had ended up in. As the assignments had been in breach of contract the original tenant (T1) and guarantor (G) had not been released from their liability (as set out above). All of the parties wanted a result where the leases were re-vested in T1 with a guarantee from G. The simple answer would have been for T2 to assign the term back to T1. However, the 1995 Act created problems in this regard. The landlord’s position was that if there were a direct assignment to T1 any fresh guarantee by G would be avoided by section 25. The tenant favoured T2 assigning to a separate company (Newco), with Newco then assigning to T1 and G entering into a fresh guarantee. Morgan J held at paragraph [33] that a direct assignment by T2 to T1, with T1’s obligations being guaranteed by G was possible. His reasoning was as follows7:

In K/S Victoria the Court of Appeal’s conclusion was premised on the words “to the same extent as the tenant is released from that tenant covenant” in section 24(2).

The critical issue was that the guarantor could only remain liable to the same extent as the tenant.

On the facts of the case, as the original assignment had been unlawful T1 was still liable under the terms of the leases.

On a further assignment to T1, T1 would cease to be bound by the tenants covenants as a result of section 11(2)(b), but would become bound by the tenants covenants under section 3(2)(a).

If G were released from its original obligations under its original guarantee, but entered into a fresh guarantee in relation to the tenant covenants, then G would be released to the same extent as T1 is released.

Section 24(2) therefore takes effect in accordance with its terms and is not frustrated for the purposes of section 25.

The approach appears to be that as long as the tenant’s liabilities and guarantor’s liabilities are coterminous, the 1995 Act can operate in a commercially sensible way. That said, the reasoning is slightly strained and Morgan J stated that he reached this conclusion “after some hesitation”. An interesting comment is that Morgan J expressly said that the “Newco” approach suggested would not have been held to involve a sham:

7 See paragraphs 31 and 32


14

“All the parties to the series of transactions would intend all of the steps in the transaction to have legal effect. The fact that they wished to structure their transaction to have a particular legal effect rather than choosing a different structure with a different legal effect would not have been sufficient to make the transaction (or any part of it) a sham without legal effect.”

All three cases clearly show that the Courts are highly conscious of the need to try and maintain commercial workability, while at the same time acknowledging the, at times, severe effects of section 25(1). Concluding remarks – The Show Must Go On Although the 1995 Act clearly was passed with good intentions, it has led to unforeseen consequences in relation to commercial leases and intergroup arrangements. The intentions behind the 1995 Act were to ensure that a tenant could not be pursued in relation to a tenant covenant many years after an assignment. The view was that liability should only attach to the tenant who was benefitting from the lease. As commercial leases have grown shorter in length (a typical commercial lease now being 10 years with a 5 year break clause, or a 5 year lease) the continuing liability issue has become less of a concern. Instead the 1995 Act has caused arrangements between group companies to become more complex and has presented a legal minefield for transactional lawyers. The focus on the objective effect of the Act means that the most ‘innocent’ of tenant groups can be caught out; although it must be right that parties should not have to conduct a trawl through the negotiating history to determine whether section 25 has effect or not. Ultimately the Courts appear, as far as they are able, to be trying to adopt a commercial approach to the 1995 Act, especially in relation to guarantors. However, the wording of the Act means that commerciality is restricted. Parliament intended to restrict the ability to contract in this area and clients should be advised that the 1995 Act will have this effect, whether that appears fair and commercial or not.

Louisa Nye Landmark Chambers

December 2015

Documents

AGAs and GAGAs Where do we go from here? · AGAs and GAGAs Where do we go from here? ... The Law Commissioners in their report dealt with the position of guarantors in two paragraphs