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08 September 2020

We’re all going GAGA under AGAs

EMI records, under the guise of Def Jam, previously distributed the music of Lady Gaga.

That association ended some time ago but in the recent High Court case of EMI Group Limited v the Prudential Assurance Company Limited, EMI were faced with another kind of GAGA (a guarantee of an authorised guarantee agreement (AGA)).

In an attempt to avoid liability under that guarantee EMI’s legal team used a series of arguments which for the most part focused on the drafting in the lease and subsequent licence to assign.

Those arguments (spoiler alert!) failed, but the case confirms that a guarantee of an AGA is lawful and usefully summarises the courts approach to contractual interpretation. It also has something to say about the doctrine of severance and a guarantor’s liability where its principal has been dissolved.

The facts

The case concerned a lease of 360 / 366 Oxford Street / Stratford Place London W1. The lease was granted to HMV UK Limited (HMV) in 2000 and EMI Group Limited (EMI) guaranteed the tenant’s obligations under the lease.

In 2011 HMV assigned the lease to Forever 21 (UK) Limited (Forever 21) and its American parent company Forever 21 Inc guaranteed the new tenant’s obligations.

In the licence to assign HMV provided a guarantee which was expressed to be an AGA for the purposes of section 16 of the Landlord and Tenant (Covenants) Act 1995 (1995 Act). EMI, by clause 8 of the licence, consented to the terms of the licence and confirmed its obligations under the lease continued until it was released by law. By paragraph 5.2 of the first schedule to the lease EMI covenanted with the landlord that the ‘Principal’ (see below) will observe and perform its obligations under the AGA. Therefore in effect EMI sub-guaranteed HMV’s AGA obligations (the GAGA).

In January 2013 HMV went into administration and was dissolved in October 2015. In June 2019 Forever 21 failed to pay the rent and service charge, and in September 2019 Forever 21 Inc sought chapter 11 bankruptcy protection in the state of Delaware. Forever 21 went into administration on the following day.

Therefore EMI were the last man standing and the current landlord, the Prudential, claimed outstanding rent and service charges from EMI who responded by disputing the validity of the GAGA.

Legal background

The judge (Penelope Reed QC – sitting as a deputy judge of the High Court) set out in her judgement the relevant provisions of the 1995 Act and confirmed the following:

  • section 5 (2) provides that a tenant is released on assignment;
  • section 24 (2) provides that any guarantor will also be released on assignment to the same extent that the outgoing tenant is released; and
  • section 25 is a comprehensive anti-avoidance provision so that any agreement relating to a tenancy will be void to the extent it would have the effect of excluding, modifying or otherwise frustrating the operation of the 1995 Act.

The judge emphasised that the only exception to the effect of section 5(2) is the ability for the landlord to require an outgoing tenant to enter into an AGA pursuant to section 16 of the 1995 Act.

The judge went on to refer to the Court of Appeal‘s obiter statement (that is a statement not forming part of the court’s decision) in K/S Victoria Street V House of Fraser (Stores Management) Limited that there is no reason why an outgoing tenant’s guarantor cannot guarantee that tenant’s obligations under an AGA (that is provide a GAGA). This is because, by virtue of section 24 (2), on any assignment a guarantor of the assignor is only required to be released to the same extent as that assignor.

What cannot happen is for the outgoing tenant’s guarantor to guarantee the liabilities of the incoming tenant and / or any subsequent assignee’s other than via a GAGA. This GAGA is in respect of the outgoing tenant’s AGA which in turn guarantees the immediate incoming tenant’s obligations under the lease for its period of ownership only.

Summary of EMI’s arguments

Argument 1

EMI’s primary argument was that the drafting of the GAGA and the underlying guarantee fell afoul of the anti-avoidance provisions in section 25 and therefore the GAGA was void under that section.

As mentioned above, by paragraph 5.2 of the first schedule to the lease EMI covenanted with the landlord that the Principal will observe and perform its obligations under the AGA.

The lease defined the Principal as:

‘the person who is or is to become the tenant and whose obligations under this lease and any authorised guarantee agreement the guarantor has been required by the landlord to guarantee but shall not include any successor in title’.

Counsel for EMI argued that the words ‘or is to become the tenant’ must refer to future tenants and therefore EMI were required to guarantee a future tenant which is not permitted by the 1995 Act.

In response, counsel for Prudential argued that the words ‘is or is to become’ meant only HMV (or if an AGA is being provided prior to an assignment, the person who will become the tenant).

In deciding between these competing interpretations the judge relied on the following principles derived from previous cases relating to contractual interpretation:

  • the court should look at the ordinary and natural meaning of the words used against the relevant factual matrix taking into account the document as a whole;
  • while the court should always construe a contract with regard to the commercial consequences of any rival interpretations, it should not prevent the court from giving effect to the clear words used by the parties. (See Arnold v. Britton (2015) being a prime example of the court not departing from the ordinary, natural meaning of the words to avoid unfortunate commercial consequences);
  • while it has been held that guarantees should be construed strictly with the benefit of any doubt given to the guarantor, that is very much a rule of construction which should only be resorted to if the words cannot be fairly construed in their context;
  • the principle that a construction should be reached which will validate the provision (see Egon Zehnder V Tillman (2020)) is based on the common sense proposition that the parties did not mean to enter into an unlawful contract but it cannot save a provision which cannot be construed in that valid way without ignoring the normal rules of construction; and
  • it may be possible to sever offending words (see below).Applying these principles, the judge found that the most obvious reading of the words referred to above is that for the purposes of EMI’s GAGA they refer to just one person i.e. the original tenant HMV and not subsequent assignees of the lease.

Counsel for the Prudential also argued that if the wording of the GAGA went beyond what was permitted by the 1995 Act then those words could be severed by virtue of the common law doctrine of severance, the provisions of section 25 of the 1995 Act which applies to invalidate provisions to the extent they offend the provisions of that Act or by virtue of the express severance clause which had been included in the lease.

The judge agreed that if she had reached a different conclusion regarding the definition of the Principal she would have had no difficulty In severing the words ‘or is to become’ in that definition using the provisions of section 25.

Argument 2

EMI also argued that the particular AGA guarantee wording offended the 1995 Act because the guarantor covenanted that the Principal will pay the rents and observe the tenant’s covenants ‘while’ the Principal is bound by the tenant’s covenants.

This drafting allowed for the possibility of an AGA given by T1 which could be extinguished when T2 assigned to T3 but would be reignited if T3 assigned the lease back to T2. This possibility offends section 16 (4) of the Act as it seeks to impose under the AGA liability on the part of the tenant after the assignee is released and therefore the AGA did not comply with the Act and the GAGA was in turn void.

The judge did not agree. She held that the word ‘while’ was clearly intended to mean a single period when the tenant is bound by the covenants and does not contemplate a future and unlikely assignment back to the tenant.

Argument 3

EMI also suggested that ‘to the same extent’ in section 24 (2) of the 1995 Act meant that the conditions to the imposition of an AGA and a GAGA had to be the same. In this case an AGA could only be required where it was reasonable for the landlord to require one whereas the imposition of a GAGA was absolute.

The judge cited the analysis of Lord Neuberger in K/S Victoria Street. She concluded from that analysis in holding a GAGA is lawful that the focus of the Act is on the fact that the guarantor will be released when the tenant (giving the AGA) is released and not on the terms which require the AGA to be entered into in the first place.

Therefore the conditions relating to the imposition of an AGA / GAGA do not have to be the same.

Argument 4

Finally counsel for EMI referred to the fact that under the lease, EMI’s liability only existed ‘while the Principal is bound’. HMV had been dissolved, no longer had existence and therefore cannot be bound so that in turn EMI were no longer liable.

Paragraph 2.4 of schedule 1 to the lease provided that the liability of the guarantor was not to be affected by the Principal being dissolved or otherwise ceasing to exist. This provision seemed to answer the point (against EMI) but counsel for EMI argued that this paragraph only applied to other provisions in the guarantee clause whereby the landlord could require the guarantor to take a new lease following certain trigger events.

However the judge rejected that argument and found that the above provision of the lease was clear in providing that the dissolution will not affect the liabilities of the guarantor.

Conclusion

We now have clear guidance that entering into a GAGA is lawful. It is however important that the drafting of the underlying AGA complies with section 16 of the 1995 Act and in particular the liabilities thereunder must not extend beyond the period of ownership of the incoming tenant so that any GAGA Is in turn compliant.

No doubt counsel for EMI kept a poker face (ahem!) when trying to make the above arguments but ultimately those arguments did not succeed.

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