Harvest festival

The Court of Appeal's decision in K/S Victoria Street v House of Fraser (Stores Management) Ltd and Others [2011] EWCA Civ 904 has provided much-needed guidance on the application of the Landlord and Tenant (Covenants) Act 1995 to guarantee agreements under a lease.

The central purpose of the Act is to ensure that a tenant's obligations terminate upon assignment (section 24(2)). One exception to this is an agreement that a tenant enters into an authorised guarantee agreement (AGA) upon assignment. In Good Harvest Partnership LLP v Centaur Services Ltd [2010] EWHC 330, the court decided that a guarantor could not guarantee a tenant's assignee under an AGA, or give a new guarantee of the assignee's obligations.

In House of Fraser the High Court (somewhat reluctantly) followed the decision in Good Harvest. The Court of Appeal upheld its decision, affirming Good Harvest but providing welcome clarification of how it should be applied.

The Court of Appeal interpreted the anti-avoidance provisions contained in section 25(1) of the Act such that they invalidate any guarantee given by a tenant's guarantor of the obligations of the assignee. Critics argue that this limits the commercial freedom of parties, especially in circumstances involving intra-group assignments and a willing guarantor.

However, the Court of Appeal preferred this interpretation to the alternative, namely that section 25(1) invalidates guarantees given by a tenant's guarantor of the obligations of an assignee only if such a guarantee is provided at the landlord's insistence. While this appears more commercially acceptable, the court emphasised that section 25(1) is concerned with the effect of an agreement and not its purpose. This interpretation would require the courts to review the parties' subjective reasoning behind such agreements, which would not be desirable.

Guiding light

The judgment contains clear guidance which effectively ensures that the Court of Appeal's decision does not restrict parties' freedom to enter into agreements which essentially amount to repeat guarantees. The guidance provides a set of rules within which parties can operate relatively freely. These can be summarised as follows:

1. An existing guarantor (G) of a tenant (T1) cannot validly be obliged or required (or agree) to guarantee the liability of an assignee (T2). Similarly, a direct guarantor of T2's liabilities cannot be obliged to guarantee T3's liabilities. Therefore any provision which has the effect of committing G in advance to guarantee the future liability of an assignee will be void.

2. Assuming there is no prior agreement that G will in future guarantee T2 or T2's obligation, section 25 will nonetheless invalidate any agreement on assignment under which G assumes direct responsibilities to T2.

3. Section 25 does not invalidate any agreement which requires G to act as guarantor of T1's obligations under an AGA, in circumstances where G is sub-guaranteeing T1's AGA.

4. There is nothing in the Act to prevent G from giving a direct guarantee of T3's liabilities, even if it has already guaranteed T1. Thus a landlord may, if reasonable to do so, require G to provide a fresh guarantee for T3 upon assignment from T2. The reasoning here is that the assignment from T1 to T2 releases G and such a release is not then frustrated by the resumption of liability upon the assignment to T3.

The question of whether a guarantor can act as a co-guarantor with T1 under an AGA (in respect of T2's obligations) was not decided by the Court of Appeal on this occasion. However, given that this has the same effect in practice as G guaranteeing T1's obligations under the AGA, good arguments exist for allowing such an arrangement.

Practical implications

Landlords of existing Good Harvest-style 'new leases' will remain unable to enforce obligations upon guarantors to give a repeat guarantee upon assignment. Given that no application has been made by House of Fraser to appeal to the Supreme Court, this decision is likely to stand.

Landlords of these leases will need to assess the capital value of their properties, especially where value lies in the strength of an assumed guarantor in circumstances where the covenant strength of the tenant is questionable. These landlords may find that potential buyers will offer less and that lenders may lend less based on the security which the property represents.

However, the position for parties entering into leases is now clear. In preparing their precedents and drafting new leases practitioners should heed the Court of Appeal's sound advice: 'We would hope that those responsible for drafting leases are aware of these conclusions, and that, as a result, the 1995 Act should not lead to many practical difficulties of the sort discussed above.'