Virtual alienation

Alienation clauses are standard features of both commercial and residential leases. They are used ultimately to protect a landlord's interest in the property by giving him a fair degree of control over the tenant on the transfer of the tenant's interest to another party whether by the usual method of formal assignment or by sub-leasing or some other means.

In practice, the tenant covenants not to assign or sublet the property which is subject to the lease without the consent of the landlord, with this consent not to be withheld unreasonably. This situation allows the landlord to examine any prospective tenant for their suitability and financial viability and also to enter into an authorised guarantee agreement (AGA) under section 16 of the Landlord and Tenant (Covenants) Act 1995 which makes the present tenant liable for any breaches in covenant by his immediate successor in title.

It is clear, then, like in many aspects of landlord and tenant law '“ especially with regard to business tenancies '“ that the landlord maintains the upper hand in any negotiations. The recent Court of Appeal decision in Clarence House Ltd v National Westminster Bank plc [2009] EWCA Civ 1311; [2010] 08 EG 106 is likely to be of interest to tenants and their professional advisers.

Clarence House was the landlord, and NatWest the tenant, of a property under a 25-year lease. The lease included standard alienation covenants: '(i) not to execute any declaration of trust with regard to the premises; (ii) not to part with or share possession or occupation; (iii) not to sublet the whole without the landlord's prior written consent; and (iv) not to assign the lease without the landlord's prior written consent.'

Passing the benefits and burdens

NatWest had, however, already granted a sub-lease of the property to William M Mercer Limited on 30 January 2001 which had been approved by the landlords, and NatWest was not therefore in actual occupation of the premises. However, on 10 June 2005, because of a corporate restructure, NatWest entered into an agreement entitled a 'virtual assignment' with a company called New Liberty Property Holdings Limited. Under this agreement all the 'economic benefits and burdens' of the lease were passed to New Liberty, but the lease was not actually assigned or sublet to them.

The central clause of the virtual assignment stated that: 'The intention of the virtual assignment is to pass to the buyer all of the economic benefits and burdens of the leases and underleases in respect of the properties, together with the obligation to manage all dealings with the landlords and undertenants as if the properties had been assigned to the buyer. Therefore any monies from the undertenants pursuant to any underleases, together with the proceeds for the surrender of any underleases, shall belong to the buyer.'

No breach

Clarence House, concerned for the security of their investment, sought a declaration that the virtual assignment amounted to a breach of the lease. It argued that it either amounted to a declaration of trust, to sharing or parting with possession, to an assignment of the property without consent and/or to a sub-lease of the property without consent. At first instance, His Honour Judge Hodge QC accepted that NatWest was not in breach of the covenants against assigning, subletting or creating a trust, but he found them guilty of breaching the covenant against sharing or parting with possession. Natwest appealed.

Allowing the appeal, Ward LJ disagreed that the tenant had actually parted with possession as New Liberty had no right to actually occupy the property '“ exclusive possession being a touchstone of all genuine tenancies. Further, and perhaps more interestingly, Ward LJ also did not think that New Liberty's receiving of rents and profits from the property constituted possession either as they received rents in their capacity as agent even though they were contractually entitled to retain them. Finally, the court agreed that there had been no breach of real assignment or of trust and, therefore, the landlord, Clarence House, had failed.

A welcome ruling

The decision should be welcomed ultimately by both parties though as the current situation allows tenants '“ especially corporate ones '“ to remove relatively quickly, and without the consent of the landlord, lease liabilities from the company balance sheet which can be useful in a number of commercial contexts. It also allows sale and leaseback arrangements or situations where the tenant wishes to remove property management responsibilities from themselves to a third party.

Landlords, however, may not be in too difficult a position. Draftsmen representing the landlord can now add a specific clause prohibiting the 'virtual assignment' of a lease as a standard part of their alienation covenants should the landlord so desire for nothing in the judgment prevents this being specifically excluded.

Fundamentally, though, the obligations of the tenant to the landlord remain. The tenant's rights of indemnity under the virtual assignment are only as strong as the virtual assignee is, and the tenant still needs to remember that under any substantial default the landlord will invariably come looking for them.