Assignments of leases to guarantors: Well that’s settled then…

The eagerly anticipated appeal to the Court of Appeal in the case of EMI Group Limited v O & H Q1 Limited, which was due to be heard this month and promised to confirm whether assignments of leases to guarantors really are void, will no longer proceed as the parties have reached settlement on confidential terms.

Background

HMV was granted a lease of commercial premises, guaranteed by EMI Group Limited. When HMV went into administration in 2014, the landlord granted consent to the assignment of its lease to EMI Group Limited (its guarantor).

EMI Group sought a declaration from the High Court that although the legal interest in the tenancy was vested in it following the assignment, the tenant’s covenants in the lease were void.

In the High Court

The case came before Deputy Judge Amanda Tipples QC in March last year, who decided that any assignment of a lease granted after 1 January 1996 by a tenant to its guarantor is (and always has been) void.

The case goes to the crux of the Landlord and Tenant (Covenants) Act 1996, which was to ensure tenants and guarantors are not unreasonably encumbered with liabilities on leasehold properties which they have assigned. It does so by providing that on an assignment, (a) the tenant is released from covenants under the lease and (b) the guarantor is released to the same extent as the tenant. Anything which has the effect of making either the tenant or the guarantor bound by ongoing lease covenants after an assignment is void as it would frustrate the operation of the Act.

The Judge found that on an assignment by T1 to G1: (1) T1 is released from the tenant covenants, (2) G1 is therefore released from the tenant covenants, but (3) as from the assignment, G1 becomes immediately bound by the tenant covenants again, this time as T2. Accordingly, G1 is never actually released from the covenants, which frustrates the operation of the Act, rendering the transaction void.

Implications

The settlement of the EMI case means that the High Court decision is good law, but remains untested. This is frustrating: even a positive affirmation of the decision by the Court of Appeal would have given practitioners greater confidence that this is indeed the law, rather than a decision which may be overturned in the future. Perhaps even more frustrating is that the decision does seem perfectly consistent with the 1996 Act.

The decision is also consistent with the previous case of K/S Victoria Street v House of Fraser, where the Court of Appeal ruled that repeat guarantees are void, ie a tenant’s guarantor cannot also guarantee the assignee of the lease.

The principles underlying EMI and K/S Victoria Street are deceptively simple:

1. repeat guarantees are void; and
2. a tenant cannot assign its lease to its guarantor.

However, in practice the decisions are ‘unattractively limiting and commercially unrealistic’, as acknowledged by Amanda Tipples QC in EMI (which she considered ‘neither here nor there’). As it is not uncommon for tenants to assign leases to guarantors, the EMI decision has significant consequences for landlords and tenants. There may be perfectly legitimate commercial reasons why intra-group transfers are desirable or, as in EMI, why a landlord may wish a lease to be assigned from a tenant in administration to its solvent guarantor.

The uncertainty and complications arising from the EMI decision are also of retrospective effect: past assignments of leases to guarantors must be treated as though they never happened. In circumstances where the transaction has been registered at the Land Registry, arguably the guarantor holds the legal estate on bare trust for the previous tenant.

Careful consideration will need to be given to resolve the tension between what is now good law and commercial practice. All we can say for certain is that we shall have to wait for another case before learning what a higher court makes of all this.