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Copyright © 2011, Emerald Group Publishing Limited
Landlord and tenant update December 2010
Article Type: Law Briefing From: Journal of Property Investment & Finance, Volume 29, Issue 2
Guarantors and authorised guarantee agreements
Landlord and Tenant (Covenants) Act 1995 aimed to address the perceived injustice of former tenants remaining liable for payment of rents and performance of covenants, often long after assigning the lease. It provides an automatic release from “tenant covenants” on assignment of a tenancy created on or after 1 January 1996 where there was no previous agreement for lease or court order for its grant. The Act also provides a consequential release for guarantors. Under the Act, ongoing liability can only be achieved by imposing a requirement that the outgoing tenant must enter into an authorised guarantee agreement (AGA).
From the outset, commercial landlords have sought ways to deal with the adverse impact on their investments where the covenant strength that induced the grant of the tenancy was that of the guarantor. On assignment, landlords can look only to the outgoing tenant for an AGA. There is no provision allowing the landlord to require the guarantor to enter into, or stand behind, an AGA. If the outgoing tenant is a weak covenant, the covenant strength available to the landlord after assignment might be significantly diminished.
In Good Harvest v. Centaur Services  All ER (D) 238, the High Court confirmed that guarantors cannot be compelled to give or join in authorised guarantee agreements. That ruling was not a surprise. A direct requirement for the guarantor of a former tenant to enter into an AGA has no basis in s 16 of the Act, which sets out the criteria for a valid AGA. Consequently, any such requirement must fall foul of the anti-avoidance provisions in s 25. However, the decision was controversial in light of the judge’s ruling that any guarantee actually given pursuant to such an agreement is void and not just the agreement itself. It overturned a significant strand of commentary on the anti-avoidance provisions, which distinguished between executory agreements (ie agreements that remained to be performed) and executed agreements.
Counsel for the landlord in Good Harvest argued that once actually given by the outgoing tenant’s guarantor, a new guarantee of the assignee’s obligations did not ”exclude, modify or otherwise frustrate” the operation of the Act. The guarantor would be undertaking new obligations, not reviving obligations released on assignment. The judge rejected the argument, saying: “Had Parliament intended a tenant’s guarantor to be able to guarantee obligations of an assignee, it could have been expected to say so explicitly”.
The implications of Good Harvest were explored in K/S Victoria Street v. House of Fraser (Stores Management)  EWHC 3006 (Ch). Ruling on preliminary issues, the judge gave some support for the decision, albeit lukewarm. Counsel for the landlord argued that Good Harvest should be distinguished and that it had, in any event, been wrongly decided. Whilst agreeing that there were difficulties with parts of the judge’s reasoning, the deputy judge in the High Court said he could not conscientiously say that he would have come to a different decision. He ruled that the matters relied on were “not materially distinguishing factors”.
The claim by the landlord, K/S Victoria Street (K/S) was for specific performance of executory clauses in a lease by which the tenant, House of Fraser (Stores management) (Stores Management), agreed to assign the lease to a group company of the surety, House of Fraser Limited (HFL) of equal or greater covenant strength to a named company. If a company was not chosen by a certain date the assignee was to be House of Fraser (Stores) Ltd (Stores). HFL was to stand as surety of the assignee’s liabilities.
In Good Harvest Newey J confirmed that “Were it the case that a tenant’s guarantor could be required to give a guarantee for an assignee of the tenant, there would seem to be nothing to limit the guarantor’s exposure to the period before that first assignee himself assigned”. The deputy judge in K/S Victoria Street did not find this argument compelling. It did not take into account the fact that s 24 of the Act would operate again on assignment by the assignee so that the guarantor would be released from the tenant covenants along with the assignee. The release was from a “covenant of the tenancy” which extended, by virtue of s 28(1) of the Act to a new guarantee given by a guarantor on first assignment as well as guarantees given in an original lease. It was also unsatisfactory to resolve the position with regard to new guarantees by way of direct covenant on the basis that permitting them would frustrate the intention of the legislation, whilst leaving open the question whether under the legislation a guarantor can sub-guarantee a tenant’s obligations under an AGA, which has the same substantial effect.
Nonetheless, the deputy judge could not conscientiously say that the Good Harvest decision was wrong and he therefore had to follow and apply it. The fact that in Good Harvest: the tenant had needed the landlord’s consent to assign and when it was sought it was only given conditionally on the defendant entering into an AGA, and the agreement was not limited to a guarantee of the liabilities of any particular tenant or class of tenant did not make this case materially distinguishable from it.
The judgment does not touch on any of the approaches that were not considered to be conclusively barred by Good Harvest, including assignment to a guarantor who then gives an AGA on assignment to the third party assignee. This technique was adopted by many lease draftsmen shortly after the Act came into force. It relies on the fact that the landlord is entitled to specify conditions that must be satisfied before the landlord’s obligation to give consent to an assignment takes effect. If the tenant is required to assign to its guarantor then the guarantor becomes, for however short a period, the tenant. A further assignment is then permitted to the arms-length assignee. Having been tenant by virtue of the first assignment, the former guarantor can then be called upon to give an AGA. Unless and until conclusively ruled ineffective, this is likely to remain the favoured approach to the drafting of provisions designed to preserve the covenant strength available to landlords.
CRC – the UK’s new “carbon tax”?
On 20 October 2010 the UK’s Chancellor of the Exchequer announced that money raised from the sale of allowances under the CRC Energy Efficiency Scheme will be diverted to the Treasury and “used to support the public finances (including spending on the environment), rather than recycled to participants”. The announcement marks a radical departure from the scheme which, during extensive consultation, was presented as “revenue neutral” rather than “revenue raising”. The Confederation of British Industry immediately denounced the change of plan as a “stealth tax”. In fact, there is no stealth. Once implemented, CRC will have all the hallmarks of a tax, reopening the acrimonious debate between landlords and tenants over who should pay the costs of compliance.
The announcement is bad news for tenants who have accepted specific obligations to meet the costs of allowances and administration. In many cases, tenant resistance to such clauses has been overcome by amendments promising reimbursement of the whole or a fair proportion of “revenue recycling” payments “received by” or “due to” the landlord. In practice, those amendments were always vulnerable. CRC operates at corporate group level. The CRC participant might be a parent company several rungs up the landlord’s corporate ladder. The landlord company might have received and, in the absence of specific contractual arrangements within the group, have been entitled to nothing. With that risk in mind, some tenants took the logical step of requiring the landlord either to pay or to “procure” payments. However, with funds going to the Treasury, even that approach is now worthless. Tenants are left with specific obligations to pay, and no mitigation through revenue recycling.
A Pyrrhic victory?
Arguably, the news is even worse for tenants whose lease obligations pre-date CRC, and for those who successfully resisted CRC obligations in leases negotiated during the past year. Landlords’ perceived need for CRC clauses stemmed in large part from a concern that costs could not be passed on using existing lease provisions. In particular, it was considered unlikely that costs could be passed on using the tenant’s general covenant to pay all taxes and outgoings relating to its use and occupation of the premises.
The diversion of CRC funds to the Treasury mean that the scheme now looks very much like a tax, and successfully resisting specific CRC clauses may prove to have been a Pyrrhic victory.
The House of Lords considered the hallmarks of taxation in Aston Cantlow v. Wallbank  3 All ER 1213. Lord Scott approved the description of: “a charge by the government... a pecuniary burden laid upon individuals or property to support the government, exacted by legislative authority”. It is an enforced contribution enacted pursuant to legislative authority. This is entirely consistent with other commonwealth jurisdictions (e.g. Inland Revenue Commissioner and Attorney General v. Lilleyman (1964) 7 WIR 496; Smith v. Ministry of Housing and National Insurance  BHS J. No. 90). Converted from “revenue neutral” to “revenue raising” status, CRC seems to tick all of the relevant boxes.
It is highly likely that some hard-pressed landlords will now argue that existing lease obligations can be used to pass costs on to their tenants. Their likely magnitude certainly makes the argument worthwhile. KPMG estimates that scrapping revenue recycling could represent a five to ten fold increase in the costs of compliance. Penalties remain, but without the incentivising effect of weighted repayments, based on relative performance.
A tax on use or occupation?
Faced with a demand for payment, tenants might argue that the reconfigured CRC does not fall within the general obligation to pay taxes and outgoings contained in most leases. CRC is a tax levied on the highest UK parent company in a group. The requirement to register as a CRC participant, and the extent of liability, are determined by the energy in respect of which group members are direct contracting parties. The tenant of multi-let premises might observe that the CRC participant status of the landlord’s group could be determined by energy consumed at its owner-occupied corporate headquarters or in other, more energy-intensive, parts of its portfolio. However, landlords would no doubt counter by arguing that the extent of CRC liability is determined by energy use, and that in turn depends on occupiers’ behaviour. From a landlord’s perspective, the causal connection between occupiers’ energy consumption and liability is likely to provide a sufficient basis for demanding tenant payments.
The incentive to press for payment is amplified where landlords have invested in Carbon Trust Standard certification and other early action measures. Without revenue recycling, the benefits will be severely diluted and return on investment can be salvaged only by minimising compliance costs and applying financial pressure on tenants to prompt energy-saving behaviour.
Open to challenge?
The Coalition government’s withdrawal of revenue recycling payments departs from the scheme that was the subject of extensive consultation, based on regulatory impact assessments stressing its “revenue neutral” status. The result is a new tax, with arbitrary thresholds and with no clear current basis in primary legislation. Climate Change Act 2008 mandated the creation of an emissions trading scheme, not a new carbon tax.
It is possible that, since the announcement was made in October 2010, the Coalition government has identified possible problems with the diversion of revenue recycling payments. In a consultation paper on minor amendments issued in November 2010, the UK Department of Energy and Climate Change noted:
The CRC scheme is a joint scheme between the UK Government and the Devolved Administrations and revenue recycling is a matter for all the Devolved Administrations to review following the UK Government’s announcement.
This laconic observation casts doubt on the legitimacy of the original announcement. If the effect of diversion is to convert CRC into a form of carbon tax, then there is a strong argument that it would be ultra vires the Devolved Administrations to implement it. The Welsh Assembly Government, for example, has no tax raising power. Moreover, there has been intense lobbying in Wales seeking to persuade the Welsh Assembly Government to retain recycling payments in their original form. Consequently, there is a possibility that at least one of the Devolved Administrations might reach a different conclusion from the UK Government. It is possible that a high street multiple retail tenant might be faced with an irrecoverable tax bill in respect of its English premises, but with only a cashflow impact in Wales.
Equality Act 2010 – reasonable adjustments – physical features
Equality Act 2010 s 20(4) imposes a general duty on a duty holder (referred to in the legislation as “A”) to take reasonable steps to make reasonable adjustments to a physical feature where they put a disabled person at a substantial disadvantage in relation to a relevant matter compared to a person who is not disabled so as to avoid the disadvantage.
The physical feature may:
arise from the design or construction of a building;
be a feature of an approach to, exit from, or access to a building;
be a fixture or fitting, or furniture, furnishings, materials, equipment or other chattels, in or on premises; or
be any other physical element or quality.
Compliance with the duty may involve:
removing the physical feature in question;
altering it; or
providing a reasonable means of avoiding it.
Premises and duty holder
The duty holder in relation to common parts is the “controller” of the premises, the commonhold association or the responsible person in relation to common parts. In practice this will usually mean the landlord or manager of the premises (“landlord”).
Sch 4 relates to reasonable adjustments to:
premises to be let;
commonhold premises; and
Under Equality Act 2010, Sch 4, paras 2-4, the landlord is not under a duty to remove or alter a physical feature within premises that are let or to be let. However, he may be approached to give consent to the alteration or removal of a physical feature if a disabled tenant requires consent under his lease to carry out such works within his premises.
A tenant has no right under his lease to carry out works to the common parts. Para 5 imposes a positive duty on the landlord to take reasonable steps, where a physical feature puts a disabled tenant, who is using the premises as his only or main home, at a substantial disadvantage in relation to a relevant matter compared to a person who is not disabled, to avoid the disadvantage. The duty is triggered by a request served by the disabled tenant (which in this context includes a tenant or other lawful occupier of the premises).
Recovering the costs from the disabled tenant
If the landlord establishes that he is under a duty to carry out the works requested under para 5, he may seek to recover the costs either directly from the disabled tenant or from all tenants through the service charge.
S 20(7) provides that, subject to express provision to the contrary, the landlord cannot require the disabled tenant to pay to any extent the landlord’s costs of complying with the duty. However, if the landlord makes a statutory decision under Sch 4, para 7(1) that it is reasonable to carry out the works requested, the disabled tenant and the landlord must enter into a written agreement (i.e. a bilateral contract) as to the rights and responsibilities in relation to the works, particularly as to:
the costs of any work to be undertaken;
other costs arising from the works; and
the reinstatement of the common parts if the disabled tenant stops living in the premises.
Para 7(3) provides that, before the agreement is made, it is always reasonable for the landlord to insist that the disabled tenant should pay the cost of all three points above – providing the “express provision to the contrary” referred to in s 20(7). The landlord can therefore require the disabled tenant to pay the full cost of the works requested, and for their reinstatement. The agreement is binding on the landlord’s successor but not on the tenant’s.
Recovering the costs through the service charge
If the costs involved in complying with the duty are so considerable that the disabled tenant alone could not pay for them, the landlord could try to recover the costs through the service charge.
Regardless of whether the landlord wants to recover the costs through the service charge, under para 6, the landlord must consult all people who would be affected by any works requested under para 5 (i.e. the other tenants and occupiers) but can disregard any views expressed against the works if he reasonably believes that the view is expressed because of the disability. However, a para 6 consultation must be looked at in the context of a Landlord and Tenant Act 1985 consultation, as it is only by compliance with the 1985 Act that the landlord can attempt to recover the cost of the works through the service charge and spread the cost between all of the tenants in the building. Para 6 does not give the landlord any right to add the cost of the works to the service charge. The 1985 Act consultation procedures are rigorous and strict. If the landlord has complied with the 1985 Act, he will also have complied with para 6, but not vice versa. Therefore, if the landlord wants to recover the cost of the works through the service charge he must comply with both the para 6 and the 1985 Act consultation procedures.
Whether the landlord is successful or not under the 1985 Act depends on whether or not the other tenants object to the cost of the works being recovered through the service charge. If they do not object, then, even if the works only benefit the disabled tenant (e.g. hand rails to the front door), the landlord could recover. However, to stand any chance at all of recovering the cost of the works outside the terms of the para 7 agreement, the landlord must conduct a full 1985 Act consultation. The landlord stands a greater chance of a successful 1985 Act consultation, even if the other tenants object to the works, if the works benefit all of the tenants (e.g. the installation of a lift).
The landlord therefore needs to ensure that the para 7 agreement makes provision for him to carry out a 1985 Act consultation and recover the cost of the works through the service charge but also to recover the cost of the works directly from the disabled tenant if he is not able to recover them as a result of the 1985 Act consultation.
The drafting of Equality Act 2010 seems to assume that the para 5 works will be of relatively low value and paid for by the tenant. It does not seem to have properly considered the cost of high value items such as lifts and entry control systems, which may well be far too great for one person (i.e. the disabled tenant). The para 6 consultation only works in respect of small items for which the tenant will bear the cost and will not enable the landlord to claim for a large item through the service charge. Therefore, when taking into account the cost of any works, the 1985 Act consultation must always be considered.