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Taming Frankenstein’s monster

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The decision of the High Court in EMI Group Ltd v O & H Q1 Ltd [2016] EWHC 529 (Ch); [2016] PLSCS 87 highlights the far-reaching and almost certainly unanticipated consequences of the anti...

This article was originally published by Estates Gazette

The decision of the High Court in EMI Group Ltd v O & H Q1 Ltd[2016] EWHC 529 (Ch); [2016] PLSCS 87 highlights the far-reaching and almost certainly unanticipated consequences of the anti-avoidance provisions in the Landlord and Tenant (Covenants) Act 1995 (“the Act”) and its application to “new” leases (ie leases granted on or after 1 January 1996). The consequences of this decision were described during the case as creating a “Frankenstein’s monster”.

The reasons for the anti-avoidance provisions are well-rehearsed, and a useful reminder is contained in Allyson Colby’s legal note on page 115. However, the impractical and over-restrictive nature of these provisions in practice has been widened (or, at least, been made more evident) as a consequence of a series of recent cases.

The case law

On the main points in issue, EMI follows the obiter comments of Lord Neuberger in K/S Victoria Street vHouse of Fraser (Stores Management) Ltd [2012] Ch 497; [2011] 2 EGLR 11.  In EMI, the High Court addressed two specific questions:

• Is a tenant precluded under the Act from assigning the tenancy to its guarantor as this would fall foul of the Act’s anti-avoidance provisions (section 25(1))?

• If so, is any agreement which seeks to give effect to such an arrangement void, because it frustrates the overall purpose of the Act?

The court’s answers in each case were a resounding “yes”. A tenant may not assign to its guarantor and, if it purports to do so, such a transaction is void. As such, the court applied strictly the anti-avoidance provisions in the Act which, in turn, has created a number of awkward practical issues for tenants, guarantors and even landlords. Perhaps the Law Commission will come to our rescue in recommending reform of the Act, albeit we are unlikely to benefit from that for some time.

The implications

The deputy judge in EMI, Amanda Tipples QC, accepted that the effect of her decision raises numerous practical difficulties and commercial concerns. However, she felt compelled to stick to what she saw was the strict wording and effect of the Act. What makes these issues unusual is that a mutually beneficial “solution” to an issue is outlawed by the Act.

For example, take an insolvent tenant, a reasonably good business, a willing guarantor (which might be a group company of the tenant) and a pragmatic landlord. The perfect solution might seem an assignment of the residue of the lease to the current tenant’s guarantor. The business can then continue without interruption, the guarantor (which is “on the hook” in any event) gains more control of the situation and the landlord gets a solvent tenant. Everyone might be happy, save for the fact that such a transaction is void. So the parties now have to find another way forward and, in the case of a transaction that has already happened, a way of dealing with the situation.

Where a void transaction has already occurred, the purported tenant (for ease, this will be referred to as the “tenant”, and the same approach will be taken with other related terms) may have become the registered proprietor and the parties are probably, on the face of it, enjoying a happy and mutually beneficial landlord and tenant relationship. Until, of course, they read the widespread comment on EMI (including this article, perhaps). Such parties then need to consider the consequences of their ill-fated relationship.

Given that the Act was enacted some 20 years ago, such a transaction may have occurred quite far back and, since then, further “assignments” may have taken place. Unless new implied tenancies have been created since the first void “assignment”, none of the parties (from the guarantor “assignee” onwards) will have tenant status. Therefore, none of these subsequent “assignments” will be valid.

As to whether an implied tenancy has been created following a void “assignment”, this will very much depend on all the circumstances and the conduct of the respective parties. However, even if such a tenancy has been created, it will probably not be in identical terms as the lease and cannot coexist with the lease. Instead, it will be a tenancy based on the parties’ conduct, which could be significantly different from the lease (which will have been surrendered). The alternative (and perhaps more likely) scenario is quite simply that the tenant that purported to assign to its guarantor is still the tenant and remains “on the hook” for the rents and other obligations in the lease, while the current “tenant” has no rights to occupy.

Therefore, the implications of EMI impact not only on tenants and their guarantors, but also on landlords. What are the key factors that landlords and tenants should consider following EMI?

For landlords – after a void transaction

• Where consent is required of the landlord to an assignment, it now has the right to refuse its consent to an application from a tenant to assign to its guarantor (and it should so). When refusing consent, a landlord should make clear, in writing, the reasons for its refusal.

• Landlords should carry out a review of previous assignments to establish whether any assignments have fallen foul of the anti-avoidance provisions of the Act. If they have done, then it should consider how best to rectify the situation. That might mean the tenant that purported to assign to its guarantor assigning to another party (such as another group company).

• Landlords will need to consider whether some sort of implied tenancy might have arisen with the current “tenant” and, if so, on what terms.

• It will generally be in a landlord’s interests to resolve any Land Registry registration of title issues where a party is registered as a tenant, but does not have that status.

• If there are arrears of rents, a landlord will need to consider which party is its “former” tenant under the Act and, having done so, to serve a section 17 notice on that party (rather than on the purported assignee).

For “tenants” and tenants – after a void transaction

• A current “tenant” will need to consider whether it really is a tenant under the lease or whether it is either a trespasser or a tenant under some sort of implied tenancy. It will then need to decide what to do. Its options are, essentially, to carry on occupying and paying the “rent” or to approach the landlord to see if a mutually acceptable way forward can be agreed (bearing in mind that the situation is also not ideal for the landlord, as demonstrated above).

• A “tenant” with a charge over its interest in a property will need to consider the implications of this scenario and how best to deal with it.

• A “tenant” which has paid consideration to its “assignor” will need to consider whether it can recoup the premium paid and how best to do so.

• A former tenant which thinks it is “off the hook” (as there has been a subsequent “assignment”) might now find that it can still be served with a section 17 notice and have a claim for arrears of rents made against it by the landlord.

For landlords, tenants and guarantors – before transactions

All parties to a potential transaction need to be vigilant and aware of EMI and its implications. Having ascertained the issue, they need to find other means of achieving the same objective. Typically, parties will consider an EMI-type transaction either where there is an inter-company reorganisation or where the tenant has become insolvent. In the former case, in the light of EMI, it will mean either not transferring the residual interest in the lease or transferring it to another group company (ie a company that is not the current guarantor). In the latter case, while assigning to the guarantor might seem a neat solution for an insolvent tenant, it will mean, instead, assigning to another company (perhaps within the same group). Thanks to theK/S Victoria decision, the existing guarantor cannot guarantee the obligations of the assignee, even if assignor and assignee are group companies. This causes huge practical difficulties for intra-group assignments.

What is patently not an option now (and, in fact, never has been since the Act was enacted) is an assignment to the current guarantor.

Have your say

With the Law Commission responding to the widespread concern and dissatisfaction with the Act, now is the time to have your say. In its recent consultation paper, Updating the Land Registration Act 2002, the Law Commission says that it welcomes the views of its consultees. So there is an opportunity to opine on the current law and, perhaps more importantly, give views as to how the law might be changed so as to retain sufficient anti-avoidance capabilities, but operate in a more commercial and practical manner. Then, in time, it may be possible for transactions to take place that are logical and commercially expedient for all parties.

In the meantime, be vigilant and, if relevant, check your portfolio for possible past breaches.

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