Going GAGA about AGAs?

Author: Roy Perrott

In December last year, we reported on a court case (Good Harvest v Centaur Services Limited) that threw into doubt the value of an AGA given by the outgoing tenant’s guarantor. However, a recent decision (Victoria Street v House of Fraser) has turned the tide back in favour of landlords.

First, let’s take a step back and remind ourselves how the Landlord and Tenant (Covenants) Act 1995 (1995 Act) works. Historically, a tenant remained liable throughout the term of the lease for breaches of the tenant’s covenants. It did not matter that the tenant had long since assigned the lease to someone else. Even if there had been several subsequent assignments, the tenant remained on the hook. This was clearly unfair. If the current tenant defaulted, the landlord could look to recover from whichever of its previous tenants had the deepest pockets, even if that tenant was in no way connected to the current tenant and was in no way to blame for the current tenant’s default.

The 1995 Act abolished privity of contract in leases but allows landlords to require, as a condition of the assignment, that the outgoing tenant guarantees the assignee’s obligations in the form of an authorised guarantee agreement (AGA). An AGA lasts for one assignment only. On the second assignment, the tenant is released. The 1995 Act contains a wide anti-avoidance provision, which says that any attempt to circumvent the legislation will be void. In the absence of privity of contract, AGAs are critically important to landlords. If the current tenant defaults, the landlord can invoke the AGA and require the outgoing tenant to make good the landlord’s loss. But what if the outgoing tenant is itself of dubious financial standing, such that the landlord insisted upon (and obtained) a guarantor for that tenant at the time the lease was granted? Can the landlord insist that the guarantor guarantee the AGA?

It is surprising, considering its importance to landlords, that it took more than 14 years to get an answer to that question. Sadly, for landlords, the decision in Good Harvest was that the guarantor could not be required to guarantee the AGA. As the court saw it, the 1995 Act makes it clear that, subject to the ability to call upon the outgoing tenant to give an AGA, the outgoing tenant and any "other person bound by a covenant of the tenancy" are released on an assignment.

The 1995 Act allows the landlord to require the outgoing "tenant" to enter into an AGA. However, there is no mention of guarantors. The judge concluded that, if Parliament had intended guarantors to be bound, the legislation would have said so. Moreover, the court said that there was no difference between a guarantor voluntarily agreeing to guarantee the AGA and a guarantor that is required to guarantee the AGA by the express terms of the lease. For intergroup assignments, this was a particularly worrying development as, on an intergroup assignment, any attempt to extend a parent company guarantee to the assignee would be void.

But the story does not end there. In Good Harvest, the guarantor had agreed in the AGA to guarantee the performance of the tenant covenants by the assignee. In many AGAs, however, the guarantee is drafted so that the guarantor guarantees the outgoing tenant’s obligations rather than those of the assignee (i.e. a form of sub-guarantee, or "GAGA"). You might be thinking that the outcome is ultimately the same: the assignee defaults and the landlord recovers from the outgoing tenant’s guarantor. Whether the guarantee is of the assignee’s obligations under the lease, or of the outgoing tenant’s obligations under the AGA, is immaterial. Luckily for landlords, however, the Court of Appeal decided in the recent House of Fraser case that a GAGA does not fall foul of the 1995 Act.

So, where does this leave landlords? As long as the AGA is drafted properly, a landlord will be able to join the guarantor into the AGA. Of course, if the outgoing tenant refuses to enter into an AGA, something which is common in sales by a liquidator or administrator, the landlord is in difficulty because, as we have seen, the landlord cannot require the guarantor to directly guarantee the assignee’s obligations, only those of the outgoing tenant. In other respects, though, order has been restored and landlords are now in a much better position than was the case this time last year.

Roy Perrott, Professional Support Lawyer, Fladgate LLP (rperrott@fladgate.com)

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