No guarantees

Tenant insolvency is always a major concern for lawyers and other professionals active in commercial property, and these matters take on an even greater significance during times of economic downturn.

One of the options open to a liquidator or a trustee in bankruptcy is to disclaim the lease. The simple effect of this is that the disclaimer operates to bring to an end both the tenant's rights and his obligations with regard to the property disclaimed. It does not, however, bring to an end the rights and obligations of any third parties such as guarantors or former tenants and the landlord may well be entitled to pursue them for matters such as rent arrears.

The traditional common law position was that a tenant who covenanted with the landlord to do something in a lease remained so bound even if their actual tenancy had been assigned. This position produced numerous results which could seem very harsh to former tenants who may have assigned their interest decades before and who, of course, had no control over subsequent reassignments. This position was amended for all leases enacted on or after 1 January 1996 by the Landlord & Tenant (Covenants) Act 1995. This Act basically means that a former tenant is no longer liable for any of the obligations of the lease once the tenancy has been assigned. However, landlords are permitted in certain circumstances to obtain a limited guarantee from the tenant. This is an authorised guarantee agreement (AGA) sanctioned by section 16 of the 1995 Act which can be used to guarantee the obligations of the next, and only the next, tenant. AGAs are now almost standard obligations on lease assignment. This makes the recent decision in Doleman v Shaw particularly important.

The liability period

In Doleman v Shaw [2009] EWCA Civ 283; [2009] 27 EG 92, the appellant was originally the tenant of a retail unit let for a term of ten years from 2004. In August 2005, the lease was assigned with an AGA being entered into by the appellant guaranteeing the assignee's performance of the tenant's covenants in the lease throughout a 'liability period' which was further defined as being 'the period during which the assignee is bound by the tenant covenants'. The assignee by 2007 was in difficulty and fell into arrears. A judgment was entered and they vacated the premises, entering in to liquidation in August 2007. The liquidator disclaimed the lease in October 2007. The respondent brought proceedings for rental arrears along with insurance rent and associated costs and interest. At first instance, the judge found in favour of the landlord, and the tenant appealed arguing that the clause stipulating the duration of the liability period came to end when the tenancy itself ended.

The appeal was, however, unsuccessful. In short, section 178(4) of the Insolvency Act 1986 makes it clear that the only relationship that is terminated by a disclaimed lease is the one between landlord and tenant. All others remain in place. The earlier case of Hindcastle v Barbara Attenborough Associates Limited [1997] AC 70 was followed; Mummery LJ quoted approvingly from it:

'The statute provides that a disclaimer operates to determine the interest of the tenant in the disclaimed property but not so as to effect the rights or liabilities of any other person. Thus, when the lease is disclaimed it is determined and the reversion accelerated but the rights and liabilities of others, such as guarantors and original tenants, are to remain as though the lease has continued and had not been determined. In this way the determination of the lease is not permitted to affect the rights or liabilities of other persons.'

Different wording

The judgment does make it clear, however, that parties are free to contract the agreement in such a way that the guarantor's liability does come to an end if the lease is ever disclaimed. Had the wording been different, then the outcome could well have been too. Draftsmen representing the tenant need then to make explicit the fact that guarantor's liability will come to an end if the lease is disclaimed if that is what has been agreed and intended by all parties. It may also be something that ought to be a point of negotiation between the parties. As the clause used in this agreement appears to be similar to that found in Form 217 in Volume 22 (1) of the Encyclopaedia of Forms and Precedents (5th Edition), then solicitors need to take special care: the mere presence of a precedent in an established work does not mean that it will give the client the intended effect.

A final word of warning, however, must be sounded for landlords considering such an option. If the landlord effectively takes possession of the property or acts in any other way which would render the tenancy over, then the law will almost certainly infer the acceptance of a surrender. In such cases, the tenancy will be deemed to be actually over and any guarantor's liability will end with it.

Whether one should mitigate one's losses and re-let the property or seek compensation from a tenant or guarantor is a commercial matter with proper advice being sought from property professionals.