This post was also written by Alex Heaton.
A recent High Court decision on the liability of a guarantor is already causing investors concern. See our earlier posting . Here we consider the immediate implications for tenants and their guarantors, and, perhaps surprisingly, it is not all good news.
The case involved a lease granted to Tenant A whose obligations were guaranteed. When Tenant A assigned its lease to Tenant B, the landlord granted consent and relied on the lease clause requiring that both Tenant A and its guarantor enter into an authorised guarantee agreement. The Court decided that, when Tenant B defaulted and the landlord tried to enforce against the guarantor, the landlord was unable to do so as the guarantee was void because of the anti-avoidance provisions of the Landlord and Tenant (Covenants) Act 1995.
What are the implications for tenants? Here are some initial thoughts pending the appeal of the case:
Taking a new lease – as landlords’ unease increases over the enforceability of guarantees following assignment, you can expect landlords to examine covenant strengths of tenants and their guarantors separately. It is likely that parent companies, which, in the past, would have stood as guarantors, may find themselves having to enter into leases as sole or joint tenant either instead of or alongside their subsidiaries. This may upset the structure many groups adopt for holding property in one entity or the desire to keep businesses in separate divisions.
Ease of assignments – a landlord is likely to be particularly wary of consenting to an assignment where the existing tenant is of a relatively weak covenant strength and the landlord is relying heavily on the covenant strength of the existing tenant’s guarantor. Existing lease assignment clauses are often heavily weighted in the landlord’s favour. We expect that landlords will refuse consent to assign rather than lose a valuable guarantee. If it is proving difficult to obtain consent to an assignment, it may be worthwhile for tenants to consider subletting as an alternative.
Assigning to a group company – we think it will get harder to do authorised group assignments where a parent company guarantees the performance of one of its subsidiaries as tenant. In order to obtain the landlord’s consent to an intra-group assignment, tenants may have to offer a different company to act as a guarantor for the assignee or be prepared to provide alternative security.
Alternatives to guarantors – you may find more and more landlords seeking rent deposits, letters of credit and other alternative security arrangements in lieu of guarantors. Rent deposits do, of course, bring their own complications, not least the question of how to protect each party from the consequences of the other becoming insolvent. They also tie up a large amount of cash for a long period, but the principle behind them is relatively simple and their certainty has a definite appeal for landlords. Where the tenants can offer them, rent deposits may be the key to unlocking deals.
Existing guarantors – bad news for landlords is potentially good news for guarantors who believe themselves to be guaranteeing obligations under authorised guarantee agreements. If the tenant whose performance a guarantor originally guaranteed has assigned the lease, any authorised guarantee agreement that the guarantor entered into as part of the assignment process may now be unenforceable and the guarantor may be released from its liability.
Conclusion and Warning
This case is being appealed and the outcome will affect many leases and guarantees. For the time being, however, the High Court decision stands, causing concern for landlords granting new leases to tenants with guarantors, for existing investors for whom covenant strength and value depend on such a guarantee, and for potential buyers of investments. Tenants should be prepared for landlords taking an increasingly cautious approach to covenant strength, making their plans for their leases harder to implement.
Please contact your usual Reed Smith attorney for specific advice.
