Search the site


Locked In: tennant liability can continue after sale of lease

publication date: Sep 22, 2009
Download Print
Bonita BackhouseThe decision of the Court of Appeal in a recent case has highlighted an important issue for tenants in the current market. The decision has clarified the point that a tenant who has assigned (sold) his lease could still remain liable to the landlord if the lease he assigned is disclaimed. Disclaimer is a procedure which can be used when a business becomes insolvent or an individual becomes bankrupt. There are complicated legal reasons for this remaining liability, which we will explore in this article.

In practical terms, this residual contingent liability is of increasing importance to tenants in a difficult market where there are an increasing number of insolvencies or bankruptcies. In addition, the residual liability can range from an obligation to take the lease for the amount of time remaining, to paying unpaid rents or other sums due under the lease.


BACKGROUND

Since the Landlord and Tenant (Covenants) Act 1995 a tenant who assigns a lease is usually required to enter into an authorised guarantee agreement (AGA). This is the case for all leases entered into from and including 1 January 1996 (unless the lease was dated after this date but entered into pursuant to an agreement for lease dated before 1 January 1996).

The landlord’s consent to an assignment will usually be required. A lease will contain a list of conditions which have to be met, depending upon the proposed assignee, prior to the consent being given. If these conditions are not met, the landlord can reasonably withhold his consent. Some modern leases also permit the landlord to exercise a general discretion even if the detailed conditions are met. Typical conditions are that the tenant enters into an AGA and that the landlord considers the assignee has the ability to pay the rent under the lease and perform the covenants contained in the lease.

The AGA is a guarantee by the tenant that the assignee will comply with its obligations when it takes on the lease and is made directly with the landlord. The guarantee lasts (subject to certain exceptions) until the leasehold interest is assigned once again.


This is more easily explained by an example:

Tenant 1 (T1) is the tenant under a lease. He assigns the lease to Tenant 2 (T2). T1 enters into an AGA with the landlord for the length of time that T2 is the tenant. When T2 assigns the lease to T3, T1 no longer has any liability. Instead T2 then enters into an AGA with the landlord for the length of time that T3 remains the tenant.


TERMS OF AN AGA

An AGA is a common document in commercial property. Most commercial leases contain the form of AGA when the lease is first agreed between the landlord and the tenant. Therefore, the terms of the AGA are negotiated at the same time as the terms of the lease. Whilst this is usually the case for higher value leases, it is not always true and sometimes the AGA is agreed when the tenant comes to assign.

Whilst the AGA can be negotiated between the parties, it usually contains certain standard provisions. Going back to our example, these include an obligation by T1 that it will observe and perform the tenant covenants under the lease if T2 does not perform them. For example, if T1 fails to keep the property in repair then the landlord is likely to carry out the repairs himself and recover the cost from T1 in accordance with the terms of the AGA.

The AGA will also include an obligation to pay the rent or other sums under the lease if T2 does not pay those sums. More importantly, it usually contains an obligation to take a new lease if the lease is disclaimed whilst T2 is the tenant. The new lease will be on the same terms as the old lease and at the same rent as that which is currently being paid. If a rent review was due at the time the lease was disclaimed, or set for a time after the lease was disclaimed, then the review would usually be put into the new lease which T1 would have to take.


agaDisclaimer

Disclaimer is a right of a liquidator or trustee in bankruptcy. Going back to our example again, if T2 became insolvent, then the liquidator or trustee in bankruptcy could disclaim the lease. This means that all the rights and liabilities that the insolvent tenant has with regards to the lease come to an end on the date of disclaimer. Therefore, between the landlord and T2 there is no longer any legal or contractual relationship which means T2 is no longer liable for the covenants under the lease or to pay any sums under the lease.


Recent case


The recent Court of Appeal case of Doleman v Shaw (2009) regarding the lease of a retail premises in Chichester, West Sussex (see panel), has brought the issue of the liability of a past tenant when a lease is disclaimed into sharp focus. The decision in this case made it clear that even if the lease is disclaimed, and therefore liability has come to an end, T1 will still be liable under an AGA to its previous landlord.

In some respects, this is not new law, because a previous case had made it clear that a disclaimer does not affect the obligation of third parties to the landlord, only the obligation of the tenant whose lease is being disclaimed. The reason why this case has come to attention is that it is the first case that has been decided since the Landlord and Tenant (Covenants) Act 1995. Continuing with our example, T1 had argued in court that it could not be liable because in the AGA it contracted to be only liable “for the period during which the assignee is bound by the tenant covenants in the lease”. In addition, the AGA stated that if the lease was disclaimed the landlord could require T1 to take a new lease for the remainder of the term provided the landlord gave notice to T1 within a certain time.

The Court of Appeal decided that the previous law remained unchanged. The AGA still remained in place irrespective of the fact that T2 was no longer liable for the tenant covenants or any sums of money because the lease had been disclaimed. The landlord’s right to ask T1 to either pay sums, perform covenants or take a new lease remained under the AGA. Interestingly a guarantee that the landlord had from a party connected to T2 lapsed when the lease was disclaimed, largely due to the wording of that guarantee.

It is important because many tenants will be in the position of T1 in our example. They will have assigned leases and have entered into AGAs with the landlord on the assignment. They are still bound by the AGA because T2 is still the tenant.

In addition, there will be many tenants who have negotiated leases (although they have not yet assigned them) where the form of AGA has already been agreed. This form will include an obligation to take a new lease upon disclaimer.

Due to the current economic climate, there will be many tenants who have their obligations guaranteed under an AGA, who may become insolvent. Even before they become insolvent, it is likely that they will stop performing the covenants under the lease, not just payment of sums but other obligations such as property repairs.

These are leases which are likely to be disclaimed and, going back to our example, T1 who originally assigned the lease to them may well be asked to take on those obligations. Even if T1 is not asked to take on a new lease, he will still be obliged to pay out sums of money.

The Court’s decision was clear – the only way to avoid this scenario would be to have specific wording in the AGA to confirm that the AGA will come to an end on the disclaimer of the lease. Unfortunately, the AGA is a document whose main purpose is to protect the landlord against insolvency and disclaimer. For this reason, the objectives of the landlord and the tenant are diametrically opposed. It is insolvency and disclaimer which are the very risks a landlord wants to protect itself against with an AGA.


Summary

In the current economic conditions, we are likely to see more situations where tenants become insolvent and leases are disclaimed. It is likely that more landlords are going to ask previous tenants to undertake lease obligations under AGAs. Whilst a tenant who is assigning a lease may now try to protect himself by specific wording in an AGA, it is unlikely that this will be accepted by the landlord because he wants protection against disclaimer. Unfortunately, many leases will also have had the form of AGA agreed at the time they were negotiated and trying to negotiate them will be almost impossible. The tenant should take good advice as to the extent and nature of it’s obligations both when they enter into a lease and on an assignment.


RECENT CASE STUDY

Doleman v Shaw [2009] EWCA Civ 283; [2009] WLR (D) 115 CA : Mummery, Stanley Burnton, Elias LJJ: 1 April 2009


On a true construction of s 178(4) of the Insolvency Act 1986, on the disclaimer of a lease by a liquidator, although the company ceased to be bound by the tenant covenants so far as its own obligations were concerned, it was treated as still bound so far as third party obligations were concerned. The Court of Appeal so held in dismissing the appeal of the defendant, Gabriella Anne Shaw, from the decision of Judge Barratt QC sitting in the Chichester County Court dated 20 August 2008 entering judgment for the claimant, Hazel Doleman, in the sum of £16,921 87 on her claim for arrears of rent and insurance rent in respect of retail premises in Petersfield, Hampshire