Guarantees are a common feature in commercial leases. A guarantor will guarantee a tenant’s obligations under a lease, for example the payment of rent. This provides security to the landlord and can help to maintain continuity of rental income regardless of the default or insolvency of the tenant. However, problems can arise with enforcement of guarantees where the obligations being guaranteed have been changed without the guarantor’s consent. This issue was highlighted in the recent case of Topland Portfolio No.1 Ltd v Smiths News Trading Ltd [2013] EWHC 1445 (Ch) in which the guarantor was held to be released from its obligations under a guarantee due to the landlord’s failure to obtain the guarantor’s consent to a variation of the lease.
The facts of the case are as follows: the landlord (L) entered into a lease with the tenant (T), with a guarantee by the tenant’s parent company (G) in 1981. The lease provided that T could not undertake any alterations to the property without the consent of L. In 1987 L granted a licence for alterations to T who then made significant alterations to the premises. When T later entered administration L sought to enforce the guarantee against G. However, as G had not consented to the licence for alterations, the court held that G was released from its obligations under the guarantee.
The case provides a useful reminder that a landlord must take care to ensure that a guarantor’s consent is obtained when a lease is varied. The basic rule is that consent must be obtained unless it can be shown by the landlord that the variations are insubstantial or cannot result in prejudice or damage to the guarantor. It is irrelevant whether or not the guarantor actually suffers prejudice or damage.
The landlord in this case put forward a number of arguments against releasing the guarantor from liability. These were all rejected by the court but they provide a useful illustration of the some of the issues that may arise, and how a landlord might release a guarantor inadvertently.
- The alteration works carried out under the licence could not be taken into account in rent reviews and accordingly did not increase the financial burden on the guarantor.
The guarantee did not merely guarantee the obligation to pay rent; it covered all of the tenant’s obligations including its repairing obligation. The works were substantial and even if they could not increase the rent, they could increase the burden of the repairing obligation. Therefore, consent was required. It is important to remember that any increase in the burden on the guarantor is likely to result in release of the guarantor from their entire obligations under the guarantee.
- The guarantor was the parent company of the tenant and in the years following the alteration works no comment or complaint was made. Accordingly, the landlord argued that the guarantor had knowledge of the alterations and gave consent through conduct.
In the majority of cases a guarantor is likely to be connected to the debtor. Commonly it will be a parent company or, for smaller companies, a shareholder or director. In such cases, consent to a variation must still be obtained separately from the guarantor. The doctrine of separate legal personality means that it is irrelevant that a guarantor might have knowledge of the variation, or that they may have actively requested the variation in another capacity, for example as a director of the debtor. Consent must be actively given; it requires a positive action from the guarantor.
- The lease contained a provision that the landlord could ‘forbear’ to enforce the negative covenant against alterations to the premises. Therefore the allowance of alterations was contemplated under the lease and did not represent a change in the obligations that the guarantor had agreed to.
The specifics of this argument are unique to this particular case. It was rejected because the licence for alterations represented a sufficiently significant change that the Court held it should be correctly classed as a variation rather than forbearance. It is often the case that a guarantee will contain a clause that states that the guarantor consents to future variations to the agreement between the creditor and the debtor. There is case law that holds that such clauses can be effective. However, these clauses should be treated with care. If the variation that occurs is so significant that it changes the fundamental nature of the obligation, or has the effect of creating a completely new obligation, then a guarantor will be released regardless of the consent clause. The best advice is that to avoid doubt, the guarantor’s consent to any variation should always be sought.
The basic rule is clear, therefore, that a guarantor’s consent should be sought to any changes to the underlying obligation. However, cases continue to be raised where a landlord has failed to obtain consent and the guarantor is seeking to escape liability. One particular area of risk is where a new landlord has acquired leased subjects. That landlord may be unaware that a variation of underlying obligations has taken place at some point in the past, without consent being sought. The consequences of failing to obtain a guarantor’s consent are significant, so this underlines the importance of addressing this issue as part of any due diligence exercise in the context of an acquisition.