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The AGA saga: the Court of Appeal on lease guarantees

28 July 2011

Good news for commercial landlords as the Court of Appeal endorses 'parallel guarantees' - where the contractual guarantor for the old tenant guarantees that tenant's authorised guarantee agreement for the new tenant.

This is a standard arrangement in institutional leases, although there has always been some doubt about whether it worked.

Unfortunately, the court also ruled that lease guarantors cannot directly guarantee successive tenants. This will be a blow to landlords who have taken such guarantees, perhaps following an intra-group assignment.

How will this affect transactions?

  • 'Parallel guarantee' arrangements, common in institutional leases, have been strongly endorsed. Although strictly the court's comments on this issue are not part of the binding decision, they will be highly influential and, in the absence of an appeal to the Supreme Court, landlords should be able to rest easy and rely on them.
  • Greater use of rent deposits and bank guarantees where a guarantee cannot be 'recycled'. Both of these have their drawbacks, being limited in amount and the latter limited in time. Neither enables the landlord to force the grant of a fresh lease following the disclaimer of the original on the tenant's liquidation.
  • More demands for a stronger company to be the tenant or a co-tenant, particularly where there is the possibility of group re-organisation in the future. This was mooted when the new privity regime first came into force in 1996, but has not been widely used. Will the ban on direct guarantees for successive tenants strengthen the landlords' hand in the present tenant-friendly market? The forthcoming changes to accounting for leases may also militate against the joint tenancy model.
  • Intra-group assignment clauses where the incoming tenant has to provide a security package of the same strength as the existing one should not (depending on the precise drafting) be a problem. The strong parent company contractual guarantor for subsidiary 1 will remain in the picture guaranteeing the authorised guarantee agreement of subsidiary 1 for subsidiary 2. However, if there is more than one intra-group assignment, things get trickier.

What should landlords do?

Audit your portfolio – do you have guarantees which are now not worth the paper they are written on? In institutional leases the most common problem is likely to be where the tenant has made an intra-group assignment. The parent company which has guaranteed the first subsidiary often agrees to guarantee the second. This second guarantee is now worthless and the landlord may only be able to look to a weak and unsupported tenant.

Rent reviews – it is a common requirement that on an intra-group assignment the security package for the assignee must be equal to that existing for the assignor. A tenant who is guaranteed by the best company in its group might argue for a reduction at rent review because the clause might effectively prevent such an assignment. However, rent reviews are normally of a hypothetical lease being granted at the review date between a willing landlord and a willing tenant, not the actual parties. The landlord can argue that a willing tenant, being aware of the law, would not place itself in this position and therefore the provision does not have an adverse impact on rent review, even if the actual tenant is in a difficult position. (These clauses were introduced when the 1995 Act came into force to prevent tenants with a good covenant from assigning to a weak group company which promptly assigns to a third party, leaving the landlord only with an AGA from the weak group company.)

What should guarantors do?

Look carefully at any demand to make a payment or take up a fresh lease under a guarantee. If you guaranteed successive tenants, the second guarantee is void.

What is not affected?

The Court of Appeal decision does not undermine the validity and effectiveness of:

  • In post-1995 leases, contractual guarantees where the guarantor has not guaranteed the previous tenant;
  • Authorised guarantee agreements given by the former tenant;
  • In pre-1996 leases, contractual guarantees, whether or not the guarantor guaranteed the previous tenant;
  • Original tenant liability (usually recreated with successive assignees) in pre-1996 leases.

How did we get there?

The Landlord and Tenant (Covenants) Act 1995 introduced a new regime of tenant liability for leases granted on or after 1 January 1996. Instead of remaining liable throughout the term, on lawful assignment the outgoing tenant is now automatically released. There is a wide anti-avoidance provision to prevent the purposes of the Act from being frustrated.

The only exception to automatic tenant release which the Act allows is the authorised guarantee agreement (AGA). This is a limited form of statutory guarantee by the outgoing tenant for its immediate successor.

The Act does not deal fully with the position of contractual guarantors. Although the Act says that they are automatically released “to the same extent” as the tenant they are guaranteeing, it has not been clear whether the contractual guarantor can be required to stand behind the outgoing tenant’s AGA (a 'parallel' or sub-guarantee).

It was only in 2010 that the courts first looked at this issue in the now notorious case of Good Harvest. In that case the original tenant was supported by a contractual guarantor. Under the lease it was a condition of the landlord’s consent to assign that both the tenant and its guarantor would have to give AGAs for the assignee. In due course the lease was assigned and the outgoing tenant and its contractual guarantor gave AGAs. The current tenant defaulted on the rent and the landlord claimed against the contractual guarantor.

The High Court held that the contractual guarantor for the outgoing tenant could not give a direct guarantee for the assignee. It was released from its obligations under the guarantee "to the same extent" as the tenant was released from the tenant covenants (ie completely), but there was no statutory exception akin to the AGA for guarantors, so they could not be asked to give a direct guarantee for the assignee.

The same point arose in the case of K/S Victoria Street v House of Fraser. There, for SDLT saving reasons, a sale and leaseback agreement provided for the grant of the lease to a dormant company with a guarantee from the parent. The agreement required the lease to be assigned to another group company, again with the parent guarantee, within a certain period. When it was not, the landlord sought specific performance of the agreement. The Court of Appeal has confirmed the first instance judgment that the requirement for the second guarantee from the parent company fell foul of the 1995 Act and was void. The obligation to give the guarantee could be severed from the obligation to assign and the landlord could (and in the unusual commercial circumstances was keen to) insist on the assignment taking place.

In the first instance decision, as in Good Harvest, the judge had been doubtful about the effectiveness of parallel guarantees. The Court of Appeal's ringing endorsement of them is a very welcome relief to landlords.

Source: K/S Victoria Street v House of Fraser [2011] EWCA Civ 904