Partnerships and leases: A bad combination?

Unlike limited liability partnerships, a traditional partnership cannot enter into a lease in its own name. If one wants to take a lease, a maximum of four partners (trustee partners) will be named as tenants.

The trustee partners will have joint and several personal liability but, where there are more than four partners, those not on the lease will indemnify the trustee partners against their liabilities as a matter of general law, if not under any partnership deed.The partners will want to include lease provisions to ensure that if any of the trustee partners cease to be partners they can be taken off the lease with minimum delay and without the retiring partner having any continuing liability. Non-trustee partners are not at risk on retirement and should under the terms of their retirement cease to indemnify the trustee partners.

While there is no difficulty in a partnership taking a lease, having done so it may be difficult or impossible to change the trustee partners to reflect changes in the partnership.

Problems arose as a result of the Landlord and Tenant (Covenants) Act 1995. Different considerations apply to leases granted before the 1995 Act came into force. Its purpose was to ensure that a person assigning a lease granted after 1 January 1996, and any guarantor of the assignor, is released under section 5 from all future liability under the lease on completion of the assignment. The 1995 Act contains a strong anti-avoidance provision in section 25 to prevent landlords from circumventing this statutory release.

For example, ABC Solicitors is a partnership of six: A, B, C, D, E, and F. It carries on its business from recently acquired leasehold premises. The lease is vested in A, B, C, and D, who hold it on trust for themselves, E, and F. Subject to certain conditions, including that the lease must be in the names of four partners, the lease permits assignment between partners without the landlord’s consent.

A wishes to retire from ABC Solicitors and to be released with no continuing contingent liability in respect of the lease so far as any breaches after the date of his retirement are concerned.

The obvious solution is for A, B, C, and D to assign to B, C, D, and E, thereby releasing A. However, this may not be possible.

The courts have interpreted section 25 of the 1995 Act broadly in K/S Victoria Street v House of Fraser (Stores Management) Ltd and others [2011] EWHC 3179 and EMI Group Ltd v O&H QI Ltd [2016] EWHC 529 (Ch). These decisions confirmed that a guarantor cannot guarantee an immediate assignee or take an assignment as, in either case, section 25 prevents a person who has liability under a lease and whose liability would be released under section 5 of the Act from taking on liability either as assignee or guarantor following the assignment. The effect of these decisions is to make invalid an assignment to a person who was guarantor of the assignor.

The cases concerned guarantees and not assignments between partners, so it remains possible that the courts might distinguish the situation in which the assignment was to some of the assigning tenants plus others. However, the reasoning applied in the recent cases would seem as applicable to the release of assigning tenants as it is to guarantors.

It is likely that an assignment by A, B, C, and D to B, C, D, and E would either be of no effect or would be an assignment to E alone, in breach of the lease. B, C, and D would be released on the assignment by the operation of section 5 and precluded by section 25 from accepting liability under the lease by taking the assignment.

The following approaches to this problem should be considered.

Ignore the problem

Could the partners proceed with the assignment, taking the view that the landlord is unlikely to raise the issue and, even if it were to do so, the courts might distinguish the earlier cases and declare the arrangement valid? Prior to Good Harvest Partnership LLP v Centaur Services Ltd [2010] EWHC 330 (Ch), which surprised many before being confirmed by K/S Victoria Street, partnership assignments generally proceeded on this basis.

However, landlords are unlikely to be satisfied by this approach, which is not supported by the recent cases, and parliament shows no signs of intervening to change the law to save such transfers.

Assignment to the other partners

If ABC Solicitors had sufficient partners it would be possible to assign to all new partners. A, B, C, and D could assign to E, F, G, and H subject to complying with the lease’s requirements. Alternatively, it may have been possible for A, B, C, and D to assign to partners E and F had the alienation provision in the lease not required that the tenancy be held by four trustee partners.

Subletting

This is a potential solution if the lease permits the premises to be sublet as a whole. However, it is likely that the landlord’s consent would be required, although, provided the rent is paid and the lease covenants complied with, it is unlikely that consent could be reasonably withheld.

Unfortunately, A, B, C, and D would remain the tenants under what would become an intermediate lease and therefore the object of ensuring that A was released from all continuing liability would not be achieved.

Substitution of trustees

It may be possible to treat the trustee partners as trustees for the partnership. If so, depending on the precise wording of the lease, potentially partner E could be substituted for partner A as trustee under the Trustee Act 1925. This is not a route that has been used in the past, and therefore there is uncertainty as to whether this interpretation of the situation would be supported by the court.

Such an arrangement might be treated as an assignment by operation of law and therefore would be an excluded assignment under section 11 of the 1995 Act. This would mean that there would be no release for A from his contingent liability.

Nominee company

The partnership can establish a nominee company to hold partnership leases. The partners themselves can give a guarantee to the landlord containing a provision for retiring partners to be released.

The partners could establish ABC Ltd, the issued share capital of which would be owned by the partners of ABC Solicitors. ABC Ltd would take an assignment of the lease with its obligations being guaranteed by all the partners. The guarantee would have provision for retiring partners to be released without needing the landlord’s consent, provided all partners guaranteed the lease and there were at all times a minimum number of guaranteeing partners. Newly appointed partners would be required to sign up to the guarantee.

An assignment to ABC Ltd would require the consent of the landlord, who would probably be entitled to require that the trustee partners provided an authorised guarantee agreement (AGA) (a guarantee of the immediate assignee allowed under an exception to section 5 of the 1995 Act), although it may be possible to persuade the landlord to drop that requirement.

Nominee companies provide an attractive solution from both parties’ perspectives. Where the lease is vested in four trustee partners, the landlord can only sue the trustee partners in the absence of a guarantee from the other partners. If a nominee company is the tenant and all partners guarantee its obligations, the landlord has the benefit of direct covenants from all the partners. The partners have sufficient flexibility to enable them to release retiring partners from future liability without needing consent.

If the lease has security of tenure, because the nominee company is holding the lease on trust for the partners, it will be treated as carrying on business at the premises for the purposes of the tenant’s right to renew the lease under part II of the Landlord and Tenant Act 1954.

Therefore, a potential resolution would be for A, B, C, and D, with the landlord’s consent, to assign the lease to ABC Ltd with a guarantee in the landlord’s favour from B, C, D, E, and F, A having retired. The landlord consented to the assignment without requiring an AGA, as, in return for giving up A’s guarantee, it was given a direct covenant from E and F.

The courts’ interpretation of the 1995 Act does mean that it is inadvisable for traditional partnerships to hold leases. Where a partnership wishes to acquire leasehold premises, it would be advisable to put forward as tenant a nominee company owned by the partnership with a guarantee in favour of the landlord given by all partners.

Simon Hartley is a property dispute resolution partner at RadcliffesLeBrasseur

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