Further lease guarantees from the same guarantor are unenforceable

15/02/10

A recent high court decision has established that, for "new" leases (generally those granted from 1996 onwards), a guarantor of the tenant's interest cannot be required to give any further guarantee in respect of any assignees of the lease. Furthermore, even if the guarantor willingly offers a guarantee of the assignee's obligations, such guarantee will be unenforceable. This acts a severe restriction on the parties' freedom to contract and will no doubt result in numerous unenforceable guarantees. While this sounds like good news for tenants it is likely to have a negative impact on the deals that landlords are willing to do, both at lease grant and on assignment. This note sets out the background law, provides commentary on the decision and picks up on some reasons as to why this is not really a good decision for anyone.

Background law

If you are the original tenant under a lease which was granted before 1996 you will be liable under that lease until it comes to an end. Even if you assigned the lease just a few years into the term and the lease has been assigned many times since then, the landlord can always come back to you if the current tenant fails to pay up or repair the property.

Authorised guarantee agreements

One of the effects of the Landlord and Tenant (Covenants) Act 1995 (the "Act") was to remedy this for all "new" leases. When a tenant assigns his lease he is automatically released from all future liability under it. In addition, if the tenant has a guarantor, the guarantor is also automatically released at this point. This is very different from the position under an old lease where liability will continue.

However, the Act does allow the landlord to require, as a condition of assignment, that the tenant provide an authorised guarantee agreement (or "AGA"). There's not really anything special about an AGA: it's just a guarantee by the tenant of the assignee's obligations. However, it will automatically come to an end if the assignee assigns the lease again and the landlord is not able to require any further guarantee from this tenant. The Act contains anti-avoidance provisions so that any attempt by the landlord to require any additional or greater guarantee from the tenant will be unenforceable.

Can guarantors be required to enter into authorised guarantee agreements?

There has always been some doubt as to whether the tenant's guarantor can also be required to enter into the AGA. The Act does not make any provision in this regard, but certain provisions do seem to envisage the possibility of the guarantor guaranteeing the AGA. You often see leases with assignment provisions which require that an AGA be given by both the tenant and the guarantor in the event of an assignment, but it has not been entirely clear that this provision is enforceable and some property lawyers were of the view that if a guarantor resisted this at the point of assignment a landlord would not be able to withhold his consent on this basis. However, most commentators were reasonably comfortable that if the guarantor nonetheless entered into the AGA, this would be binding on him: it was the question of whether he could be required to give an AGA that was really in doubt, not whether the AGA would be enforceable if he in fact chose to be party to it.

The decision: Good Harvest Partnership LLP v Centaur Services Limited

The recent High Court decision in Good Harvest Partnership LLP v Centaur Services Limited [2010] EWHC 330 (ch) confirms that a guarantor cannot be obliged under the terms of a lease to enter in an AGA.

However, this decision also goes a step further and says that if, in spite of the obligation being non-binding, the guarantor nonetheless does guarantee the AGA, this guarantee is unenforceable, despite it having been given willingly.

Taking this a step further: if the guarantor cannot willingly be party to an AGA where the lease requires him to be party to it, presumably he cannot be party to it where this lease does not require this but he nonetheless wants to offer it for good commercial reasons. As an AGA is really just like any other guarantee what this case therefore seems to be saying is that a guarantor who has guaranteed the provisions of a particular lease is not permitted by law to provide any further guarantee in respect of this lease. Similarly a tenant may only provide one AGA and, no matter how much he wants to or it is commercially sensible for him to do so, is not permitted by law to provide any further or alternative guarantee.

Restriction on freedom to contract

Whilst the judgment is not terribly clear, and the comments are obiter, the judge in the Good Harvest case acknowledged that this restriction on freedom of contract was the purpose of the legislation. To take an example alluded to in the case, a strict interpretation of the decision may lead to the following situation: the original tenant is a property holding shell company. The lease is guaranteed by the UK parent. As a part of a group restructuring the tenant assigns to a sister company, which is also a shell company. The landlord does not require an AGA from the outgoing tenant (who is a very weak covenant) but agrees to the assignment on the basis that the parent company provides a further guarantee in respect of the new tenant's obligations (which for all practical purposes comes to exactly the same thing as him being party to the AGA). The parent company expected to provide this guarantee and in fact offered to do so when the landlord was approached for consent to assign. On the basis of the Good Harvest decision this further guarantee may be unenforceable.

Why is this a bad decision for everyone?

On a first reading this appears to be a bad decision for landlords but a great decision for those parties who cannot now be held to the guarantees they have given. This may be true looking back, but looking forward it is a dreadful decision for everyone as it restricts the freedom of parties to do a commercially sensible deal.

When a group wishes to restructure its property holding and approaches the landlord for consent to assign from one shell company to another the landlord will be able to reasonably refuse consent unless a guarantor is provided other than the current guarantor. Where this is the only company of substance within the group this may cause serious problems and effectively prevent the group restructuring from going ahead.

When new leases are granted landlords will also be far more likely to insist that the company which would previously have been the guarantor actually takes the lease in its own name so that when the lease is assigned he can require an AGA from this entity.

It is not yet known whether this decision will be appealed. However, even if it is not, there will hopefully be a decision on appeal from the next case in which a guarantor refuses to pay up under a non-binding guarantee that it willingly gave.

Further information

If you have questions about any of the matters raised in this note we would be happy to discuss these with you. We would particularly be interested to hear from any landlords who believe that the guarantees they have been given are non-enforceable in the light of this case.