Virtually an assignment

"Virtual" assignments of leases are often used in portfolio transactions, corporate deals and other arrangements transferring responsibility without any intention to affect the contractual position between landlords and tenants.

15 December 2009

"Virtual" assignments of leases are often used in portfolio transactions, corporate deals and other arrangements transferring responsibility without any intention to affect the contractual position between landlords and tenants. To the consternation of those relying on these types of arrangement, this state of affairs was shaken somewhat in January this year, when, in the case of Clarence House Limited v National Westminster Bank Plc [2009] EWHC 77 (Ch)) the High Court decided that by entering into a "virtual assignment" of leasehold premises, the tenant was in breach of standard form alienation covenants in the lease. An appeal, heard in July ([2009] EXCA Civ 1311) has unanimously overturned this decision. The Court of Appeal has held that a Virtual Assignment did not breach the alienation covenants.

The Virtual Assignment
Clarence House Limited are the current landlords of property let to National Westminster Bank Plc. In 2001, NatWest underlet the whole of the premises.

In June 2005, NatWest entered into a Virtual Assignment with New Liberty Property Holdings Limited, in terms of a master agreement between NatWest's parent company and New Liberty. The Virtual Assignment transferred all the economic benefits and burdens of NatWest's leasehold interests. NatWest also granted a power of attorney to New Liberty to act on its behalf. 

NatWest did not inform their landlord, nor seek consent to the arrangement. Once the landlord discovered the position, and having concerns about the covenant strength, the landlord issued proceedings against NatWest.

Sharing or parting with possession
Various arguments were made on behalf of the landlord. The alleged breaches were some or all of:

  • underletting without landlord's consent;
  • assignment without landlord's consent;
  • execution of a declaration of trust; and/or
  • sharing or parting with possession.

Three of these arguments were rejected. The virtual assignment did not constitute a subletting, nor was it a breach of the covenant in the lease not to assign, which was to be given its standard meaning, namely, not to assign the legal interest.  It was also affirmed that there was no assignment since there was no contractual obligation to assign, nor any possibility for New Liberty to enforce an assignment since there was no consent from the landlord.

Neither did the Court agree that there was a declaration of trust created. This was based on the fact that there was no use of language that pointed to the relationship between the parties having been formed as a trust. It was clearly a contractual arrangement. 

However, in the matter of sharing or parting with possession, the High Court decided that NatWest had shared or parted with possession, on the basis that there was sharing of control (and therefore some possession). Reference was made to section 205(1)(xix) of the Law of Property Act 1925, which defines possession as including "receipt of rents and profits or the right to receive the same, if any" in support of this decision. 

Transfer of economic benefit not tantamount to parting with possession
The High Court described the effect of a Virtual Assignment as "..all the economic benefits and burdens of the relevant lease…are transferred..". The Court of Appeal had to consider whether or not this amounted to parting with or sharing possession.  It analysed the contractual arrangements between NatWest and New Liberty and compared the analysis of Virtual Assignments in the case Abbey National PLC v Commissioners of Revenue and Customs [2006] EWCA Civ 886, where it was held that the status of the tenant remained the same, and there was no effect on the landlord/tenant relationship, notwithstanding the Virtual Assignment to a third party.

Other "possession" cases were considered, including Lam Kee Ying [1975] A.C. 257 and Akici v LR Butlin Ltd [2005] EWCA Civ 1296, where possession was linked with allowing a third party into physical occupation to the exclusion of one's own occupation. Applied to this case, any question of parting with or sharing occupation was irrelevant, as NatWest had not been in occupation at any material time.

The Court of Appeal applied the wider definition of possession and held there was an aspect of physical control involved when possession was analysed. The ordinary and normal sense of the word "assignment" included a right to exclude others, and this was the meaning given to the phrase in this case. NatWest had already divested themselves of possession by the underlease. The Virtual Assignment could not alter the position as regards possession, and the fact that NatWest were no longer in possession led to the conclusion that they were therefore not capable of parting with or sharing possession.

The right to receive rents was interpreted as a contractual arrangement. New Liberty were obliged to collect rent from the undertenant and pay rent to the landlord. There was nothing in the agreement that permitted New Liberty to recover any non-payment by the undertenant, from NatWest, nor was there any obligation to pay any monies collected from the undertenant, to NatWest. In addition, New Liberty indemnified NatWest against any liability for any breaches of covenants in the lease. An express assignment of the rent cannot of itself amount to sharing or parting with possession.

The Court of Appeal concluded that the Virtual Assignment could not transfer any legal estate in the premises.

The decision will no doubt bring comfort to tenants who have been using these arrangements. At the same time landlords' interests are preserved with Virtual Assignments not altering the landlord/tenant relationship.

The Court of Appeal stated that there had been no breach of the covenant not to assign without landlord's consent. One of the reasons in support of this was the absence of a reference to equitable assignments in the sub-clauses that specified what events would be a breach of the alienation clauses. It may be the case that some landlords adopt a stricter approach in the wording of alienation provisions in leases to ensure they are aware of dealings with the leases and to avoid having such arrangements forced upon them. This may be an important measure to prevent the landlord inheriting financial covenant issues since the tenant he has contracted with may have assigned the right to a source of income. Any decision to further restrict alienation rights however must be balanced against the view taken of overly restrictive lease provisions when it comes to rent review.

The Court of Appeal's decision in the case of Clarence House Limited v National Westminster Bank Plc can be viewed at the British and Irish Legal Information Institute's website.