The Court of Appeal has recently considered the law surrounding guarantees on commercial lease assignments.
When leases are assigned by a commercial tenant, both the tenant and any guarantor are released from future liability under the lease.
The law allows landlords to require tenants to give a guarantee that the new tenant will pay the rent and perform the lease covenants. This is called an ‘Authorised Guarantee Agreement’ (AGA). This has the effect of keeping the old tenant ‘on the hook’ during the time the new tenant holds the lease.
A controversial Court of Appeal decision last year in the Good Harvest case held that guarantors cannot be kept on the hook in the same way that tenants can. Even if they volunteer to do so.
This can cause problems for landlords. Two examples of where an issue might arise are as follows:
- The lease is held by a subsidiary company and the lease is guaranteed by the parent company. The tenant assigns the lease to another subsidiary company. The parent company will not be able to provide a guarantee for the new tenant, even voluntarily.
- The lease is held by a company and the lease is guaranteed by two of the company’s directors. The directors set up a new company to purchase the assets of the company and take over the lease. Again, the owners will not be able to provide a guarantee for the new company, even voluntarily.
In both cases, the landlord will be able to take an AGA from the tenant assigning the leases, but the strength of such a guarantee will always be in doubt..
The parties the landlord will want to be able to keep on the hook are the parent company and the company directors as the strength of their guarantees will in all likelihood be greater than the old tenant.
The Court of Appeal recently considered these issues in the case of K/S Victoria v House of Fraser. In its decision given on 27 July 2011, the Court of Appeal upheld the Good Harvest decision, but managed to find a loophole that will allow landlords to keep guarantors on the hook.
The loophole found by the Court of Appeal in the House of Fraser case allows guarantors to sub-guarantee an AGA. That is to say, if a tenant assigns the lease, and provides a guarantee to the landlord for the new tenant, the guarantor can guarantee the tenant’s guarantee.
The decision is a welcome and important one for landlords and tenants because it establishes that a guarantor can now be kept on the hook on an assignment. This gives landlords a way of keeping the same covenant strength they had before the assignment. This extra comfort for landlords will give tenants more flexibility in situations where they may not otherwise have been permitted to assign their lease.
For further information please contact Ed Pitt (edward.pitt@gregglatchams.com tel. 0117 906 9466).
