Can a tenant assign their commercial lease to their guarantor?

The Landlord and Tenant (Covenants) Act 1995 (LTCA 1995) was primarily enacted to reform the law relating to transmission of covenants on assignment of tenancies. It aimed to create a fairer balance between landlords and tenants by ending the potentially indefinite liability of original tenants under privity of contract.

Direct guarantees and AGAs

When granting a new commercial lease – or consenting to assignment (transfer) of an existing lease to a new incoming tenant (Assignee) – one of the critical considerations for landlords is the creditworthiness of the incoming tenant: does this tenant have sufficient financial resources, and covenant strength, to comply with the lease terms as they fall due? Can they prove it?

Often – particularly where the proposed tenant / assignee is a newly-incorporated limited company (perhaps a special purpose vehicle set up with the sole intent of taking this lease) – they will not be able to provide sufficient references or other evidence to satisfy the landlord. In such circumstances, it is quite common for the landlord to request that the tenant be backed by one, or several, personal guarantors. In the case of brand-new leases, the guarantors will more often than not be the directors of the tenant company. On assignment, often it is the outgoing tenant who will guarantee performance of the incoming tenant by way of an Authorised Guarantee Agreement (AGA).

Release of covenants

The statutory provisions governing guarantees (direct guarantees and AGAs) are set out in LTCA 1995. These provisions:

• relate to all “new tenancies” (those granted on or after 1^st January 1996); and
• relate to all covenants in a lease – given by both landlords and tenants – whether express, implied, or imposed by law.

There is no automatic release from landlord’s covenants in a lease upon a transfer of the reversionary title (freehold / headlease). The limited ways in which a landlord can obtain a release from the landlord covenants are:

• by obtaining an express release from the tenant, by deed;
• under the procedure for statutory release contained in the LTCA 1995; or
• by using contractual provisions to limit liability.

The statutory release process is rarely used in practice because of the strict time limits for compliance, and because many landlords consider it is not a good idea to place tenants on notice that they have continuing liability. An alternative is to incorporate an Avonridge clause in the lease at the time of grant (a contractual provision to protect the original landlord from being held liable for breaches committed by subsequent reversioners).

Where a property is sold subject to leases, the landlord’s solicitor should seek an indemnity clause in the contract and transfer deed, creating contractual protection against any future liability arising from the buyer’s (new reversioner’s) breaches of the lease covenants.

However, the statutory provisions confirm that a tenant who assigns a lease will automatically be released from the tenant’s covenants in the lease on assignment and will no longer be entitled to the benefit of the landlord’s covenants.

Prohibition on guarantor assignments

If a tenant wishes to assign (transfer) its lease to the same person(s) who are their named guarantor(s), things can get complicated.

As above, when a lease is assigned, the outgoing tenant is released from their covenants. However, the landlord can require the outgoing tenant to enter into an AGA so as to guarantee the performance of its immediate assignee.

The complication? If the assignee is the current guarantor, a circularity arises. The guarantor is already liable for the current tenant's obligations. Upon assignment to them:

• the outgoing tenant would be released from the lease covenants;
• the landlord would typically want the outgoing tenant to enter into an AGA guaranteeing the new tenant (the former guarantor); but
• the former guarantor is also released from their guarantee upon assignment, because their guarantee was tied to the outgoing tenant's liability.

An attempt to assign a lease from tenant to guarantor is typically void under the LTCA 1995 as such an assignment is often deemed an illegal attempt to avoid the statutory release process and constitutes a prohibited “re-assumption of liability”, as confirmed in K/S Victoria Street v House of Fraser.

But what if all parties want to effect the assignment, notwithstanding the legislation?

• The risk to the landlord is that the assignment may be void or ineffective, meaning the original tenant remains the tenant under the lease, potentially creating confusion over who is actually bound by the covenants (especially problematic if the original tenant is wound up after the assignment, if the lease was its only asset), and the guarantor’s obligations may be inadvertently discharged in the process, leaving the landlord with reduced security and difficulty enforcing.
• For the tenant, the main risk is that they may not have achieved the release they anticipated, leaving them with continued liability and exposure to claims.
• The assignee may be left in a position where they have paid consideration and taken occupation, but not actually acquired a valid leasehold interest, leaving themselves in a vulnerable position and with potentially wasted costs (legal fees, stamp duty, any premium paid, fit out costs, etc.). Any formerly accrued rights will be lost. Additionally, if the assignee later needs to serve notices (e.g. a break notice) or respond to notices received from the landlord (e.g. a hostile Section 25 Notice under the Landlord and Tenant Act 1954 where the landlord is opposing a statutory renewal lease) under the lease, they may find that said notices are deemed invalid, since not served by the correct persons.

It is also worth noting that while all parties may have been in agreement, if the landlord later transfers their freehold reversion to A N Other, the subsequent landlord – or their legal advisors – may identify the issue and exploit it; the same can be said for tenant and assignee.

Practical solutions

The LTCA contains anti-avoidance provisions, so parties seeking to transfer a lease from tenant to guarantor should not do so without taking specialist advice.

One solution which is often suggested is to surrender the lease altogether and enter into a new tenancy agreement. However, the parties should not do so without advices from legal and tax practitioners and should avoid tripartite agreements, instead documenting everything separately.

While there is nothing in the LTCA 1995 expressly prohibiting this workaround, the legislation is widely drafted and complex. A surrender and grant could be detrimental to the landlord, who loses the ability to obtain an AGA, and who enters into a brand-new agreement which is separate and distinct from the previous tenancy. New tenants would need to consider potential stamp duty land tax liability.

It is likely that a Supreme Court decision will be needed to obtain further clarity on potential solutions in the future. In the interim, all parties should exercise caution!

How we can help

Our specialist Commercial Property Department are able to offer advice and support with lease assignments, guarantor arrangements and resolving issues arising under the LTCA 1995. This article is not intended to constitute legal advice. If you require advice on a specific matter or transaction, please contact us for a no-obligation quotation.