Guarantors' ongoing obligations no longer assured

In the recent case of Good Harvest Partnership LLP v Centaur Services Limited, [2010] EWHC 330 (Ch) the High Court has finally clarified that the Landlord & Tenant (Covenants) Act 1995 (LTCA 1995) prevents a guarantor of a tenant's obligations from being required to give a further direct guarantee in respect of an assignee of the lease.

Guarantee of an assignee's covenants

24th March 2010

In the recent case of Good Harvest Partnership LLP v Centaur Services Limited, [2010] EWHC 330 (Ch) the High Court has finally clarified that the Landlord & Tenant (Covenants) Act 1995 (LTCA 1995) prevents a guarantor of a tenant's obligations from being required to give a further direct guarantee in respect of an assignee of the lease.

Guarantee of an assignee's covenants

A lease for a term of 10 years was granted to Chiron CS Limited in 2001. Centaur Services Limited was a party to the lease as guarantor of Chiron's obligations. The lease entitled the landlord to impose certain conditions when granting licence to assign. The relevant condition in this case was:

"...upon or before any assignment…the Tenant making the application for licence to assign and its Guarantor (if any but not someone who has already given an authorised guarantee agreement) shall enter into an authorised guarantee agreement in a form permitted by law and agreed between the parties"

An authorised guarantee agreement or AGA is a guarantee by an outgoing tenant of its assignee's obligations under a lease. Chiron assigned the lease in 2004 and the licence to assign included a guarantee agreement under which both Chiron and Centaur covenanted to the landlord that the assignee would pay the rent and perform the other tenant covenants in the lease, from the date of assignment until the next lawful assignment of the lease. This constituted a fresh guarantee by Centaur of the assignee's covenants as tenant under the lease rather than a guarantee of Chiron's obligations under an AGA.

The assignee failed to pay two quarterly instalments of the annual rent of £245,000 and the landlord claimed the money from Centaur under the guarantee agreement. Centaur disputed the claim on the grounds that the guarantee agreement was void and unenforceable by virtue of section 25 of LTCA 1995.

The relevant legislative framework

The LTCA 1995 provides that for a 'new lease' (one granted on or after 1 January 1996) a tenant and its guarantor will automatically be released from all tenant covenants under the lease on assignment. This is in contrast to tenants under 'old leases' (granted prior to 1 January 1996) where privity of contract ensures that the original tenant remains bound by the tenant covenants for the duration of the lease, notwithstanding any assignments.

Section 25 of the LTCA contains broad anti-avoidance provisions to ensure that these releases are not circumvented by landlords. Any agreement that excludes, modifies or otherwise frustrates the operation of the LTCA 1995 will be void. Notwithstanding this, the LTCA states that a lease may include an agreement between the parties specifying the conditions under which the landlord can validly refuse consent to the assignment of the lease. It also stipulates various circumstances in which the landlord can require the tenant to guarantee the performance by the assignee of the tenant's covenants in the form of an AGA.

The terms of an AGA are governed by section 16 of the LTCA 1995. AGAs that comply with that section are specifically excluded from the anti-avoidance provisions in section 25.

Although the LTCA 1995 provides for the circumstances in which a tenant may be required to guarantee the performance by the assignee of the tenant covenants, it is completely silent on the following questions:

  • whether a guarantor of the outgoing tenant can be required to guarantee the performance of the outgoing tenant's assignee;
  • whether a guarantor of the outgoing tenant can be required to guarantee the performance of the outgoing tenant's ongoing liability under an AGA.

The High Court Decision

The High Court held that Centaur's guarantee of the assignee's obligations was void and unenforceable. Section 24 of the LTCA 1995 provides for tenants and guarantors to be released from their obligations when the lease is assigned. The judge concluded that the anti-avoidance provisions in section 25 of the LTCA barred Good Harvest's claim against Centaur, by applying the judgement of Lord Nicholls in Avonridge Property Co Ltd v Mashru [2005] UKHL 70 in which he stated:

"Section 25 is of course to be interpreted generously, so as to ensure that the operation of the 1995 Act is not frustrated, either directly or indirectly"

If Centaur was required to enter into a further guarantee when the lease was assigned, this would frustrate the operation of the LCTA 1995. This was because, if valid, it would impose on the guarantor obligations equivalent to those from which section 24 sought to provide release.

The judge commented that the LTCA 1995 was "plainly designed to impose restrictions on freedom of contract" even if this sometimes meant an "uncommercial outcome".

How will this decision affect parties to a lease?

This decision clarifies the law in respect of the question of whether a guarantor of the outgoing tenant can be required to guarantee the performance of the outgoing tenant's assignee  - the subject of debate amongst practitioners for some time.

It is thought that the decision could have a negative impact on both landlords and tenants. 

Landlords are likely to change the way they deal with applications for consent to assign. Landlords are more likely to focus on the covenant strength of the proposed assignee and whether any additional security is required in the form of a direct guarantor, rent deposit or bank guarantee. If there are concerns about the proposed assignee, the landlord may try to insist that a new guarantor takes the lease in its own name rather than rely on a weak tenant/strong surety combination. Landlords may wish to incorporate more rigorous criteria for covenant strength of assignees in their leases in future.

In terms of negotiating new leases, covenants prohibiting inter-group transfers may become more common again. As the decision stands, on assignment to another group company, the parent company guarantor will not be permitted to stand again as guarantor for the new group company assignee.

The decision does not clarify whether a guarantor of the outgoing tenant can be required to guarantee the performance of the outgoing tenant's ongoing liability under an AGA, which remains at large. It remains unclear whether a guarantee of an outgoing tenant's obligations under an AGA (commonly called a sub-guarantee) is void. We think it unlikely that a court would treat such a guarantee in a different manner. It is also unclear whether voluntary arrangements to guarantee performance would also be affected.

When acting for landlords in negotiating new leases, there may be little change in practice except to ensure that the landlord is alerted to the fact that if an outgoing tenant's guarantor provides any form of guarantee it may not be enforceable. However, landlords should be cautious about agreeing to dispense with these provisions in lease negotiations, until the outcome of any appeal of this decision and/or a case directly concerned with the issue of whether the guarantor can be required to guarantee the outgoing tenant's ongoing liability under an AGA is decided. Tenants may be more likely to resist these provisions now, but may be persuaded to concede on the basis that, as such arrangements are currently unenforceable as a result of this decision, neither tenant nor guarantor would be prejudiced, and they can always take the point at a later date, upon an application to assign.

With regard to recovering arrears, it would appear the only guarantees upon which landlords can now rely (in relation to post 1 January 1996 leases) are those given by its current tenant's guarantor or by a former tenant under an AGA.

Although this is unfortunate for landlords, it does mean that former guarantors that have entered into AGAs on assignment may now no longer need to worry about such contingent liabilities coming back to bite. Those former guarantors who may have already paid out under, now invalid, guarantees may be considering whether to attempt to seek reimbursement from the landlord on the ground that the payments were made as a result of a mistake as to the law, in line with the finding in Kleinwort Benson Ltd v Lincoln CC (1998) 3 WLR 1095.

Regardless of this judgement however, where a tenant is in arrears, landlords should still consider protecting their position by giving notice to the guarantor of the former tenant of the sums outstanding, in terms of section 17 of LTCA 1995, so that, if the decision is reversed on appeal, the landlord's right to recover such arrears is not lost.

The decision in Good Harvest Partnership LLP v Centaur Services Ltd is available on the BAILII website.