Good Harvest - bad news for everyone

06/09/10

Over the last few years tenant insolvencies have become increasingly common. With their tenants gone, landlords are struggling to relet their empty properties and are looking for someone else to pay the rent until things start to pick up again. There may be a rent deposit or a bank guarantee, but this will only last for a few months. Alternatively there might be a parent guarantee, but if your tenant is insolvent there is a good chance that its parent will not be far behind. The other option is to go after former tenants and the guarantors of former tenants, but the high court decision in the Good Harvest case earlier this year has cast some doubt over how far you can enforce against the guarantors of former tenants. As this is often where the greatest covenant strength lies the decision has caused much upset.

Old leases and new leases

To understand the case it is helpful to understand the background law, and in particular the difference between "old" and "new" leases.

Leases granted before the first of January 1996 are known as "old" leases while the majority of leases granted since this date are "new" leases. A landlord with an old lease is in a much stronger position than a landlord with a new lease when it comes to enforcing against his former tenants and their guarantors. The original tenant under an old lease remains liable right through until the lease comes to an end. The lease could have been granted thirty years ago to a tenant who assigned just a few years later but that original tenant can still be required to pay the rent and comply with the tenant covenants. If the original tenant had a guarantor then, depending on the wording of the guarantee, the landlord can almost certainly pursue the guarantor as well. If the lease was assigned several times during its term it's very likely that the landlord will have insisted that each tenant was obliged to comply with the tenant's covenants throughout the whole of the term of the lease. The same will be true of any guarantors of those tenants. This means that a landlord with an old lease can try and get the rent paid by anyone who was ever tenant under the lease and also by anyone who ever guaranteed any of those tenants.

All of this changed from the beginning of 1996 with the coming into force of the Landlord and Tenant (Covenants) Act 1995 (the "1995 Act"). Parliament decided that landlords had all of the advantages and that it was very unfair to expect a tenant, or his guarantor, to remain liable for a property which he occupied for a couple of years several decades ago. A tenant under a new lease, and any guarantor of that tenant's interest, are both automatically released from liability as soon as the lease is assigned. This applies to the original tenant and also to any subsequent tenant; any attempt to agree that the release will not apply is void.

Authorised guarantee agreements

The only exception to this release is that a landlord may require that when the lease is assigned the current tenant provides an authorised guarantee agreement ("AGA"). This is beneficial to tenants as well as landlords as without this option a good tenant may find his landlord very resistant to any assignment of the lease. Being able to require an AGA means that the landlord can keep the good tenant on the hook.

There's not really anything special about an AGA: it's simply a guarantee by the tenant of the assignee's obligations. However, the AGA automatically comes to an end if the assignee assigns the lease again and the landlord is not able to require any further or other guarantee from this tenant. Any attempt to do so will be void.

Guarantors and AGAs

Unfortunately, whilst the 1995 Act is very clear with regards to tenants giving AGAs, it is almost entirely silent with regards to guarantors and AGAs, meaning that the law about what a guarantor can and cannot be required to do has always been unclear. This is significant as landlords make a decision to grant a lease based on the complete financial package of tenant and guarantor. If the purpose of the AGA provisions in the 1995 Act are to allow the landlord to maintain this covenant on an assignment of the lease it wants to be able to maintain the whole package.

There are two ways in which this package could be preserved:

• the guarantor could be required to enter into an AGA on assignment, directly guaranteeing the obligations of the assignee; or

• the guarantor could be required to guarantee the tenant's obligations in the AGA that the tenant gives (often known as a sub-guarantee).

There is nothing in the 1995 Act to indicate whether either of these options is legally acceptable, but since 1996 it has been standard practice to require either or both of a direct guarantee and a sub-guarantee from the guarantors of tenants when the lease is assigned.

The Good Harvest Case

The case of Good Harvest Partnership LLP v Centaur Services Limited has now provided us with some answers, though it has also left us with several questions.

In this case, the tenant, Chiron, was granted a lease. The lease was guaranteed by Centaur and the assignment provisions stated that the landlord could require, as a condition of consent to any assignment, that both its tenant and guarantor enter into an AGA.

Chiron assigned the lease and Chiron and Centaur both entered into an AGA, as required, under which they each directly covenanted with the landlord that the assignee would pay the rent and perform the tenant's covenants. The assignee stopped paying rent and the landlord sought to recover rent from Centaur pursuant to its obligation in the AGA. Centaur refused to pay on the basis that the AGA was void and unenforceable under the 1995 Act. The High Court agreed with Centaur.

Can a tenant's guarantor be obliged to give a direct covenant to the landlord guaranteeing the assignee's obligations?

Unless and until someone takes the same issue to a higher court and the Good Harvest decision is overturned, the answer is no. The reasoning for this is that while the 1995 Act makes provision for any AGA given by a tenant to be automatically released when the lease is next assigned, there is no equivalent release in respect of an AGA given by a guarantor. This means that an AGA given by a guarantor could continue indefinitely which frustrates the operation of the Act and must therefore be void.

If a tenant's guarantor voluntarily offers a direct guarantee of the assignee's obligations, is this guarantee valid?

This is particularly relevant in a situation where the assignment forms part of a group restructuring, with the lease being assigned from one subsidiary company to another. The answer to this question is uncertain. The judge in the Good Harvest case commented that Parliament clearly intended that a tenant would not be allowed to give any guarantee other than an AGA and that there was no reason why tenant's guarantors should not be likewise barred. He reasoned that if Parliament had intended a tenant's guarantor to be able to guarantee the obligations of an assignee it could be expected to have said so explicitly. Whether or not this reasoning will be upheld remains to be seen; we can only hope not as it really doesn't do anyone any favours, and will simply result in landlords refusing to consent to intra-group assignments.

Can a tenant's guarantor be obliged to provide a sub-guarantee (a guarantee of the tenant's obligations under the AGA)?

Again, the position is unclear and the judge in the Good Harvest case expressed doubts about the enforceability of such a guarantee, but he didn't actually have to decide this point. However, the better view must be that such guarantees are valid. The judge's reasoning as to why a direct AGA was invalid was that there was no release mechanism for it. However, a guarantee of the tenant's obligations in an AGA can only last as long as the AGA itself lasts so this argument doesn't apply. There are also several sections in the 1995 Act which talk about the position of a guarantor who has guaranteed an AGA, so the draftsman clearly envisaged that this was a possibility.

Practical implications

Practically speaking, where does this leave us?

Landlords need to be aware that there is a risk that any existing lease guarantee they have from the guarantor of a former tenant is potentially unenforceable, particularly where it is a direct guarantee and even if it was given voluntarily on an intra-group assignment.

That said, there are some practitioners who do not accept that any part of the Good Harvest decision is correct and are still drafting leases which require the guarantor to give a direct AGA on assignment. As the law stands, this requirement is unenforceable. However, if the same point is taken to a higher court on appeal there is a chance that the Good Harvest decision will be overturned and such obligations will then become valid.

Despite the judge's doubts, the majority of firms are of the view that sub-guarantees are enforceable. Leases that require a guarantor to guarantee the AGA given by a tenant will continue to be standard, but landlords should be warned that there is some uncertainty as to their validity.

When the lease is granted landlords should think very carefully about which company it's being granted to. If a landlord can be sure that on assignment he is going to maintain the combined covenant strength of the tenant and the guarantor it doesn't matter which of these companies is the tenant. However, as there is doubt over whether the guarantor will remain bound the landlord may want to insist that the parent company actually takes the lease as tenant, rather than guaranteeing it.

Landlords may also want to consider including restrictions on intra-group assignments. Before the Good Harvest decision a landlord would have been happy to allow one subsidiary to assign to another where the parent company guarantor was remaining in place. However, as there's some doubt about whether the parent company's guarantee of the new tenant's obligations will be enforceable landlords may prefer to prevent these assignments altogether.

From the other perspective, guarantors of former tenants should seek legal advice before paying up under any guarantee as the guarantee may be void. In addition, guarantors who have already paid out under a guarantee which the Good Harvest case has now held to be invalid may like to consider whether they can claim repayment from the landlord on the basis that they paid under a mistake of law.

Conclusion

In conclusion, 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, this guarantee may be unenforceable. This acts a severe restriction on the parties' freedom to contract and no doubt means there are numerous unenforceable guarantees. While it sounds like good news for guarantors it is having a negative impact on the deals that landlords are willing to do, both at lease grant and on assignment. Let's hope that someone challenges the decision soon!

Further information

If you have questions about any of the matters raised in this note we would be happy to discuss these with you. Please contact Hugh Blaza on 01235 836603 or at hugh.blaza@bsdr.com