Good Harvest, Bad News
The High Court held in Good Harvest Partnership LLP v Centaur Services Ltd that a tenant’s guarantor is released on a permitted assignment of a lease and cannot be required to guarantee the assignee’s obligations under the lease. The decision does not create binding precedent and, since an appeal to a higher court has now been settled out of court, the position is left uncertain.
Background
In 1996, the Landlord and Tenant (Covenants) Act 1995 swept away the concept of privity of contract in leases. It provided for tenants to be released automatically on a permitted assignment, subject only to them guaranteeing the assignee under an Authorised Guarantee Agreement (AGA). Any existing guarantor is automatically released at the same time and the 1995 Act does not say that an existing guarantor can be required to join in the AGA or give a fresh guarantee. It is not possible to contract out of the Act.
Landlords have frequently employed two common methods of attempting to keep a tenant's guarantor on the hook following an assignment by the tenant:
- requiring the guarantor to guarantee the obligation of the assignee by a new direct guarantee (in the same way as the tenant guarantees the assignee's obligations under its AGA); and
- requiring the guarantor to guarantee the tenant's obligations under the AGA it gives to the landlord (a sub-guarantee).
Decision
It was option 1 that was considered in Good Harvest and which the court considered was void under the Act. The offending condition on assignment provided that “the Tenant …and its Guarantor…shall enter into an AGA.” The court held that only a former tenant could give an AGA and the contractual guarantor of a former tenant could not be obliged to give a direct guarantee for an assignee. As the Act expressly releases both tenants and contractual guarantors on lawful assignment of the lease, extending their liability frustrated the operation of the Act and fell foul of its anti-avoidance provisions. Furthermore, it was held that a guarantor could not give a guarantee voluntarily in these circumstances either.
The judge, Newey J, also commented that a sub-guarantee of a tenant’s obligations under an AGA would not work either. This comment, although not relevant to the facts, may be treated as persuasive.
No surprise
This decision was not a huge surprise as these lease mechanisms had been treated with caution for a number of years. The case was due to be appealed on 29 June 2010 but it settled on the eve of the hearing which is an unsatisfactory conclusion. It had been hoped that the appeal (which would create a binding legal precedent) would overturn the decision or at least clarify the position in relation to sub-guarantees. Unfortunately we are left with uncertainty in relation to the position of the guarantor for existing leases and it is also difficult to structure new leases where the landlord wants a guarantor to have continuing liability.
Implications
Any guarantee covenants following the method set out in option 1 may now be void and it is also uncertain whether guarantee covenants following option 2 will be valid. Landlords should therefore either ask the guarantor to take the lease in its own name, persuade the tenant to sub-let rather than assigning (neither are universally popular approaches), or seek other forms of security which are outside the 1995 Act.
Group re-organisations may also be problematic if the strongest company in the group has been the assignor’s guarantor, as that company cannot even voluntarily guarantee its assignee, leading to a dilution of the financial strength of the covenant.