Are guarantors off the hook?

In the current economic climate landlords more than ever are having cause to rely upon guarantees when a tenant defaults, including guarantees given by previous tenants and their guarantors in the form of an Authorised Guarantee Agreement (AGA).  As such, the decision of Mr Justice Newey in the case of Good Harvest Partnership LLP v Centaur Services Limited could not have come at a worse time for landlords.  The case considers the question of whether the Landlord and Tenant (Covenants) Act 1995 prevents a party who has guaranteed a tenant's obligations under a lease from being required to give a further guarantee in respect of an assignee of the lease.

The basic facts of the case are straightforward, and are encountered frequently in practice. The claimant was the landlord under a lease dated 5 October 2001 pursuant to which a tenancy for a term of ten years from 16 July 2001 had been granted to a company called Chiron CS Limited. The defendant, Centaur Services Limited, was the guarantor to the lease.

The lease was subsequently assigned in 2004 to a company called Total Home Entertainment Distribution Limited.  As was required under the terms of the lease, both Centaur and Chiron entered into an AGA with the landlord, guaranteeing the performance of the tenant covenants by Total Home for the duration of its interest in the property.  Problems arose when Total Home failed to pay the rent and the landlord looked to Centaur to pay the rent arrears under the terms of the AGA.
 

The landlord, perhaps unsurprisingly, was relatively confident of its position, and accordingly issued an application for summary judgment.  It was this application that Mr Justice Newey dealt with in February of this year, and in which Centaur argued that it was not liable to pay the rent arrears because it was expressly prohibited by section 25 of the Covenants Act from being a party to an AGA in these circumstances, and that the guarantee it had given to the Landlord in the AGA was therefore void.
 

The Covenants Act was introduced in 1995, and was principally aimed at ensuring that a party who had disposed of its interest in a property would not continue to be liable on the tenant covenants for the remainder of the term.

The principal provisions of the Covenants Act for the purposes of this case are:
 

• Section 5: effectively provides that a tenant who assigns his leasehold interest is released from the tenant covenants from the date of the assignment, save in respect of pre-existing breaches.
 

• Section 24: ensures that the guarantor of a tenant is also released from its obligations under the lease at the same time that the tenant is released.
 

• Section 25: a comprehensive anti-avoidance provision, providing that any agreement relating to a tenancy is void to the extent that it would (apart from this section) have the effect of "excluding, modifying or otherwise frustrating" the operation of the Covenants Act.  However, it is expressly provided that an agreement entered into in accordance with section 16 of the Covenants Act will not infringe these anti-avoidance provisions.
 

• Section 16: expressly states that where a tenant is released from a tenant covenant by virtue of the Covenants Act, nothing in the Act will prevent him from entering into an AGA.  The section goes on to explain what constitutes an AGA. 
 

In this case, Mr Justice Newey analysed the relevant provisions of the Covenants Act closely, and confirmed that section 16 expressly creates an exception to the anti-avoidance provisions in section 25 in that it permits a tenant to enter into an AGA.  However, he pointed out that it does not contain any similar exception in relation to a guarantor.  As such, when a tenant is released from the tenant covenants on an assignment, section 24 of the Covenants Act ensures that the guarantor is also released, but the guarantor (unlike the tenant) is effectively prohibited from being a party to any AGA by the anti-avoidance provisions contained in section 25 of the Covenants Act.

This decision is likely to impact in practice in two main ways:
 

1 On future assignments landlords cannot insist that a tenant's guarantor is a party to any AGA, even if the Lease states that this is a pre-condition to an assignment.
 

2 Guarantors of former tenants who have already entered into AGAs when the lease was assigned under which they, in conjunction with the assigning tenant, have guaranteed the obligations of the incoming tenant can now proceed on the basis that they are effectively released from any ongoing liabilities under the AGA.
 

The first situation is possibly less of a problem as, whilst a landlord may no longer have the automatic right to insist upon the tenant's guarantor being a party to the AGA, he will still have the right to scrutinise the covenant strength of any proposed assignee and, insofar as he is not satisfied with the financial status of that assignee, and it is reasonable for him to do so, he can refuse consent to the proposed assignment.  This may actually present tenants with something of a problem, as a landlord who might have been relatively comfortable about the covenant strength of a proposed assignee when supported by an AGA from the current tenant and its guarantor, may feel considerably less comfortable if the AGA is to be given only by the current tenant.  In those circumstances, the landlord may well consider refusing consent, or at the very least asking for a third party guarantee to be provided by the incoming tenant.  Finding a suitable guarantor for such tenants may not be an easy thing, and as such the lease may prove more difficult to assign. 
 

The situation with pre-existing AGAs is likely to prove more difficult. As the assignment will already have taken place, the landlord cannot retrospectively withdraw consent and must instead live with the fact that he now has reduced security, in that he can look only to the current tenant, to any additional guarantors that were taken at the time of the assignment, and to any guarantee given by the previous tenant under the terms of an AGA.  However, the previous tenant's guarantor is no longer in the frame even if he was a party to the AGA.
 

A further concern for landlords is the possibility that guarantors who entered into an AGA when the tenant assigned the lease, and who have subsequently paid out in accordance with the covenants given by them to the landlord in the AGA, might now consider the possibility of seeking to recover those payments from the landlord on the basis that the payments were made under a mistake as to their legal liability.  
 

Certainly the majority of the House of Lords in Kleinwort Benson Limited v Lincoln CC (1998) 3 WLR.1095 took the view that if the law is effectively changed by a judicial decision a payment made in accordance with the previous law can in fact be recovered.  Whilst a minority of the House of Lords in that case did not agree with this view, it at least gives rise to the real possibility that tenant guarantors who have entered into an AGA on an assignment of the lease and who have subsequently made a substantial payment as a result of the assignee's default may, subject to any restrictions imposed by limitation, seek to recover those payments from the landlord. A potential further headache for landlords?

For more information, please contact:

Alan Walker

Tel: 0845 165 5413

The content of this article is for information only and should not be relied upon as a substitute for legal advice. Copyright 2010 Cobbetts LLP - All Rights Reserved - March 2010.