03 July 2017
Guarantees on lease assignment: what landlords need to know
What is an AGA?
Under the Landlord and Tenant (Covenants) Act 1995 (the Act), tenants and guarantors under leases granted after 1 January 1996 are automatically released from liability to the landlord when a lease is lawfully assigned to a third party. However landlords can require outgoing tenants to enter into authorised guarantee agreements (AGAs) guaranteeing the liabilities of the incoming tenant. AGAs cannot bind the outgoing tenant to guarantee the liabilities of the incoming tenant’s successors. This means that the outgoing tenant has some certainty that its liability will continue only for so long as the incoming tenant is the tenant under the lease.
Recent litigation involving AGAs
There have been several important court decisions which show that the impact of the Act has been much wider than had first been thought. These cases concern in particular the role played by a party which guaranteed the performance of the outgoing tenant’s obligations under the lease. The following principles have been established:
- An agreement by the outgoing tenant’s guarantor to guarantee the liabilities of the incoming tenant is void.
- However once it is released from liability on an assignment, a guarantor of the outgoing tenant can guarantee the liabilities of the incoming tenant’s successors in title.
- A tenant cannot assign its lease to its own guarantor.
- Although it is not beyond doubt, it appears that an outgoing tenant's guarantor can guarantee an outgoing tenant's liabilities to the incoming tenant under the AGA. In other words, the guarantor may be able to guarantee the outgoing tenant’s own guarantee of the incoming tenant’s liabilities. This is known as a sub-guarantee.
- The Court of Appeal has suggested that the outgoing tenant’s guarantor may also be able to guarantee the performance of the incoming tenant by having the outgoing tenant assign the lease to an intermediary entity, and then simultaneously assigning the lease to the incoming tenant. However this solution is not without risk, because transactions whose purpose is to circumvent the Act are void.
There are a number of consequences to the recent AGA litigation. Perhaps most importantly, the parties cannot agree to contract out of the Act. This means that arrangements that are prohibited by the Act will be void, even if the parties enter into them freely. The Act thus seriously interferes with the parties’ right to reach whatever commercial agreement they wish to. One area where the consequences are felt is where there is a tenant which may not be financially stable, but which is part of a much larger corporate group. Formerly, the group comprising the tenant would be able to restructure its business by assigning the lease from one shell company to another, with the performance of both companies guaranteed by the parent company. That arrangement is no longer possible. Restricting the ability of a corporate group to structure itself as it needs to, will itself have many undesirable consequences, which may include encountering funding difficulties. If the Act raises obstacles to the tenant assigning its lease that could have an adverse impact on the capital value of the landlord’s interest.
In recognition of these problems, the Property Litigation Association has produced a briefing note to the Secretary of State for Communities and Local Government which proposes amending the Act to, amongst other things, permit sub guarantees, and (in some circumstances) parental guarantees in intra-group assignments, but in the meantime landlords, tenants and guarantors must ensure that they take proper legal advice before assigning a lease which is subject to the Act.