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The AGA Saga Continues: K/S Victoria Street v House of Fraser

28 January 2011

Last year’s High Court decision in Good Harvest v Centaur Services that a guarantor cannot give direct guarantees for successive tenants aroused much interest and comment.

Now a further case, following that decision, has provided more insights into this tricky area.

Recap

The Landlord and Tenant (Covenants) Act 1995 provides for automatic release of tenants under post-1995 leases on lawful assignment. The only exception to that rule is that the outgoing tenant can be required to give an authorised guarantee agreement (AGA) for its immediate successor. Contractual guarantors for tenants are released “to the same extent” as the tenant they guarantee. One of the Act’s major loose ends is that it does not clearly state whether the contractual guarantor for the outgoing tenant can be kept on the hook during the AGA.

What did Good Harvest not decide?

  • That only a former tenant can give an AGA (a technical point about labels, which is undoubtedly correct); and
  • That the contractual guarantor of an outgoing tenant cannot be required to give a direct guarantee for the assignee. This is what we expected a court to decide.

The judge made some interesting comments on related situations. However, they are only comments, not binding decisions.

  • Not only can a landlord not compel the contractual guarantor of an outgoing tenant to give a direct guarantee for the assignee, but the contractual guarantor cannot volunteer an effective direct guarantee either. If correct, this can cause significant practical problems, particularly in group reorganisations.
  • The judge doubted whether the parallel or sub guarantee arrangement (where the outgoing tenant’s contractual guarantor stands behind the AGA) works either. This comment has caused much alarm, as it is the arrangement most commonly seen in institutional leases. However, the judge did not have to decide this point, so parallel guarantees live to fight another day, although landlords should remember that there has always been a question mark over them.

And now read on

In the latest case, the agreement provided for the lease to be granted to the tenant with a guarantee from the parent company. Unusually, the agreement then required the tenant to assign the lease to another group company with a further guarantee from the parent. The tenant did not do so and the landlord sought to enforce the agreement.

The judge followed the Good Harvest decision. As a fellow High Court judge, it was not technically binding on him, and he expressed some reservations, but it was strongly persuasive and he thought he ought to follow it. So we now have two cases, albeit both only first instance decisions, which say that the same guarantor cannot give direct guarantees for successive tenants.

Practical implications

The judge had to consider the practical implications of his decision: did it mean that the assignment could not take place at all or that it could take place but without the guarantee?

The judge decided that the obligation to give the invalid guarantee could be severed from the obligation to assign. The tenant could assign to the group company without any contractual guarantee, despite the fact that this would produce a very different commercial result from the one the parties had intended. Usually the landlord would not want it at all. However, in this case the initial tenant company is dormant and has no other assets. The parent company, having been a strong covenant at the beginning, now has a negative value. Only the assignee is a good covenant and it may be preferable to have it as a tenant even without a guarantee.

However, this is a useful point for tenants whose leases allow intra-group assignments without consent provided that the parent company gives successive guarantees (the clause would need to be in specific, rather than generic, terms). Depending on the exact drafting of the clause, they may be able to assign without the guarantee.

Bouncing’ leases

The tenant in the case had argued that an order of specific performance would be pointless because the lease allowed it to reassign to the original tenant without consent. The judge did not find this a good enough reason, and he warned the tenant against doing so. Under the terms of the lease, an intra-group assignment would only be permitted with a parent company guarantee. So, the judge had ruled that on the first assignment from A to B the parent company could not be required to give a guarantee, but on a second assignment (back to A), the landlord could demand one. There would be no successive guarantees, and bringing back a party who has been a guarantor at some earlier time in the life of the lease is not forbidden. If correct, this supports the arrangement which is occasionally seen where intra group assignments are only permitted if the lease is first ‘bounced’ through the original (blue chip) tenant (ie lease to A, assignment to group company B, reassignment to A, assignment to group company C etc). This is to ensure that the strong covenant of the original tenant remains available – whether as tenant or AGA – while the lease is owned by its group.

At a later hearing, the court found that, on the particular drafting the lease could not be reassigned to the original tenant unless the tenant met the cumulative financial requirements of the assignment clause. Being free to assign without consent did not dispense with the need to comply with these.

Parallel guarantees again

The judge in the latest case echoed the comments in Good Harvest, doubting whether parallel guarantees actually work. These may show which way the judicial wind is blowing, but are not actually decisive of the issue.

Source: Good Harvest Partnership LLP v Centaur Services Ltd [2010] EWHC 330 (Ch), K/S Victoria Street v House of Fraser (Stores Management) Ltd and ors [2010] EWHC 1120 (Ch), EWHC 3344 (Ch)

Postscript, 28 July 2011:
The Good Harvest v Centaur Services decision that was upheld in last year's first instance decision of K/S Victoria Street v House of Fraser (Stores Management) Ltd has now been affirmed by the Court of Appeal.  The Court of Appeal has confirmed that a guarantor for an outgoing tenant cannot guarantee the obligations of an assignee (although it can guarantee the obligations of alternate, as opposed to successive, assignees). This will come as bad news for landlords who have taken on such guarantees, for example following an intra-group assignment. In addition, the Court of Appeal has endorsed the use of "sub-" or "parallel" guarantees, which means that a contractual guarantor can guarantee the original tenant's obligations to the landlord in respect of an assignee under an authorised guarantee agreement (AGA). A more detailed analysis can be found in the article entitled The AGA Saga: the Court of Appeal on lease guarantees.