Lease assignments under the microscope

The first article of this three-part series highlighted how alienation provisions in a lease can provide a tenant with options to react and adapt to change. Here, Tom Merrick delves deeper into a tenant assigning its lease and reflects on some important points that need to be considered. Assigning a lease is the legal process whereby a tenant (assignor) transfers its lease to a buyer (assignee). The assignee effectively steps into the shoes of the assignor and takes on its lease obligations. A tenant is free to assign its lease unless the lease prohibits or restricts it. The lease would need to be analysed to establish what is permitted and on what terms.  Why should a landlord be concerned? Who a tenant assigns to needs to be handled with caution as it could have an adverse impact on a landlord’s interests. A landlord would want to carry out due diligence on the proposed assignee to determine, among other things, whether it is capable of performing under the lease. What is the assignment process? It is likely to be a requirement under the lease that landlord’s consent is obtained. If the lease permits the tenant to assign with landlord’s consent, it is implied that landlord’s consent cannot be unreasonably withheld (section 19(1) of the Landlord and Tenant Act 1927) if not expressly provided for in the lease.  A tenant will need to submit an application for consent to the landlord in accordance with the lease. A tenant should provide the landlord with as full a pack of information as possible when applying for consent to avoid the landlord having grounds for delaying its decision.  Typically, a landlord would want financial information on the assignee (ideally accounts for the last three years), trade, bank or other references (as appropriate) and details of any specific terms agreed, such as the assignor contributing towards the rent post-assignment (as the landlord is entitled to be told the true nature of the transaction) in order to consider an application.  If the assignee is a new company, there will be limited information available so a landlord will want additional security to mitigate against resulting risks. Details of any additional financial security on offer (such as a rent deposit or additional guarantee) could therefore be disclosed upfront to help speed up the process. Duties imposed on landlords  Section 1(3) of the Landlord and Tenant Act 1988 requires landlords to respond to an application within a reasonable time (except where it is reasonable not to do so) and to serve written notice of its decision specifying, if applicable, any conditions or, if the consent is withheld, the reasons for withholding it. The landlord holds the burden of proof as to whether it is acting reasonably.  The landlord’s duty under section 1 of the 1988 Act will be engaged when a “written application” is “served” on “the person who may consent”. Under section 5(2), an application is served if it is served as provided in the lease (the notice provisions would need to be checked carefully) or (if the lease makes no provision) it is served in accordance with section 23 of the 1927 Act.  Case law has determined that consent cannot be refused on grounds that have nothing whatever to do with the relationship of landlord and tenant in regard to the subject matter of the lease. A landlord does not also need to prove that the conclusions which led them to refuse consent are justifiable so long as those conclusions might be reached by a reasonable person in the circumstances.  What is a “reasonable” time to respond? It will depend on the circumstances. It will generally be measured in terms of days or weeks, rather than months. If the application is urgent, this should be made clear in the application, as this may be relevant in determining what constitutes reasonable time for the landlord to respond (E.ON UK plc v Gilesports Ltd [2012] EWHC 2172 (Ch); [2012] 3 EGLR 23). A landlord must also pass on an application to anyone else (such as a superior landlord or mortgagee) whose consent is needed under the lease (section 2 of the 1988 Act). A failure by a landlord to give consent within a reasonable time would constitute an unreasonable withholding of consent under the 1988 Act.  Reasonable circumstances and conditions  In respect of “new” leases (typically granted after 1 January 1996), section 19(1A) of the 1927 Act allows the landlord and the tenant to agree circumstances in which the landlord may withhold consent and/or impose conditions on the consent and set these out in the lease.  Where such an agreement has been reached, the landlord will not be unreasonably withholding consent or imposing an unreasonable condition if it acts in accordance with that agreement. However, the landlord is not precluded from withholding consent where reasonable, or from granting consent subject to any other reasonable condition because such a circumstance or condition is not the subject of an agreement under section 19(1A). A landlord and tenant may agree that it would be reasonable for consent to be withheld if: there are arrears of rents due; there is an unremedied tenant breach of covenant; the assignment would cause a detriment to the landlord’s reversion or impact on the landlord’s tenant mix; or in the landlord’s reasonable opinion, the assignee is not of sufficient financial standing to comply with the tenant’s obligations in the lease. Typical conditions could require: direct covenants from the assignee; an authorised guarantee agreement (AGA) from the assignor (for a “new lease”); a satisfactory assignee guarantor; and  an assignee rent deposit. AGAs and GAGAs If a lease is an “old lease”, landlords can look to any former tenants to be liable for a breach by the current tenant. With regard to “new leases”, in most cases, tenants (and their guarantors) are automatically released from liability to the landlord when a lease is lawfully assigned (section 5(2) of the Landlord and Tenant Covenants Act 1995). This is where an AGA comes into play. An AGA is a legal mechanism created by statute which allows a landlord of a new lease to seek redress from the assignor if an assignee defaults (so the assignor remains on the hook). Whether the landlord can insist on an AGA will depend on the terms of the lease, or, if the lease is silent, on whether it is reasonable in the circumstances. In an AGA, an assignor will guarantee the performance of the tenant covenants by the assignee (section 16(2) of the 1995 Act). The terms may also require the assignor to take a new lease from the landlord if the assigned lease is later disclaimed. The guarantee usually lasts until the assignee itself assigns the lease (unless it is an excluded assignment (under section 11 of the 1995 Act)) or otherwise until the end of the lease. An AGA cannot include liability in respect of a successor in title of the assignee. The actions of a landlord could inadvertently result in the early discharge of an AGA, an example being the material variation of a lease without the guarantor being a party to it, so landlords need to be wary of this. Some leading cases on AGAs have determined that: an AGA entered into by an assignor’s guarantor to guarantee the assignee’s obligations is void under section 25 of the 1995 Act (Good Harvest Partnership LLP v Centaur Services Ltd [2010] EWHC 330 (Ch); [2010] 1 EGLR 29 and confirmed in K/S Victoria Street v House of Fraser (Stores Management) Ltd [2010] EWHC 3006 (Ch)). an assignment by an assignee to its guarantor is void by virtue of section 25(1) of the 1995 Act as it frustrates the purpose of that Act (EMI Group Ltd v O&H Q1 Ltd [2016] EWHC 529 (Ch); [2016] EGLR 26). The lease remains vested in the assignee and the guarantor remains bound by its guarantee. The logic of the EMI case strongly suggests that an assignment from T1 to T1 and T2, or (common in dealings with partnership property) from T1 and T2 to T2 and T3, is also void. an assignee’s guarantor may validly guarantee the performance, by that assignee, of its obligations under an AGA (known as a GAGA). What if a tenant assigns in breach of the lease?  It is still an effective assignment at law. The legal estate transfers to the assignee, leaving the landlord with a claim for breach of the lease. There could be a claim in damages as well as remedies under the lease (including the right to forfeit). In the case of a new lease, the assignment would be an excluded assignment and the assignor would not be released from the tenant covenants under section 5 of the 1995 Act. Treat assignments with caution Understanding the assignment process and the potential liabilities is essential for both landlords and tenants. Landlords need to ensure that they satisfy their duties when dealing with applications for consent and assignors need to understand that assigning a lease may not be the end of the matter in terms of ongoing liabilities which could come back to bite. Any future financial planning would need to factor this in. Key case: unreasonable refusal of consent In International Drilling Fluids Ltd v Louisville Investments (Uxbridge) Ltd [1986] Ch 513, a landlord was held to have unreasonably refused consent to an assignment of a tenant’s office premises to an assignee that wanted to use it as serviced offices (offices being the permitted use under the lease) on the ground that the value of its reversion would be diminished. One of the principles laid down in the case was that where the benefit to the landlord from its refusal is unreasonably disproportionate to the detriment to the tenant, a refusal of consent may be unreasonable. Typical legal documents on an assignment: Sale contract (between assignor and assignee). Deed of assignment/transfer deed (between assignor and assignee).  Licence to assign (documenting consent) and AGA (between landlord (and any superior landlord, if applicable), assignor and assignee and any applicable guarantor). Rent deposit deed (between landlord and assignee if the assignee is to provide a rent deposit as a condition of the landlord consenting to the assignment). Tom Merrick is a managing associate in the real estate team at Lewis Silkin Read part 1: Flexible lease solutions – alienation and beyond Read part 3: An overview of underlettings Photo © Justin Case/Unsplash