Commercial landlords will typically, as a condition of permitting a tenant to assign a lease, require a guarantee is given by the outgoing tenant of the continuing performance by the incoming tenant of all of the tenant’s covenants contained in the lease. This kind of guarantee is referred to as an Authorised Guarantee Agreement (AGA). Aside perhaps from repairing obligations, the covenants that the landlord will be most concerned to enforce under an AGA are those which require the tenant to make payments of the rent and business rates.

In the event of the insolvency of the assignee the Trustee or Liquidator has a statutory power to disclaim a lease. The 1997 case of Hindcastle Limited v Barbara Attenborough Ltd firmly established the principle that a disclaimer operates to end the lease between the insolvent tenant and its landlord but not in respect of any other party with an interest in the tenancy including that of a guarantor. So service of a notice of disclaimer by a liquidator of an assignee will terminate any ongoing liability on the insolvent company under the lease including both for rent and rates. This leaves the landlord to seek to enforce payment by the guarantor under any AGA.

In the recent case of Schroder Exempt Property Unit Trust and Others v Birmingham City Council, it was argued by a landlord that the original tenant under an AGA was liable to pay both the rent and rates as if the lease continued in existence. The court accepted that the Hindcastle principle fixed the guarantor with liability for the rent. The landlord had not taken back the property and, as the statutory power of disclaimer only terminated the lease vis-à-vis the landlord and the insolvent assignee, the original tenant’s guarantee to pay the ongoing rent was still enforceable as if the tenancy continued.

However, the court decided that the concept of an ongoing lease for the purposes of maintaining the liability of the guarantor was a legal fiction. The insolvent assignee no longer benefited from the lease and had no right to possession of the property and nor did the guarantor. The landlord had the right to go into the property at any time and to take back possession of it. The court held that in these circumstances it was the landlord that had, for the purposes of the Local Government Finance Act 1988, an entitlement to possession and it was that right to possession that was sufficient to fix the landlord with a direct liability for the rates. The guarantor was not liable to indemnify the landlord because the applicable covenant in the lease was one to pay the tenant’s rates liability under the lease, but following the disclaimer the assignee had no lease. The rates liability post disclaimer issued out of the landlord’s right to possession and not that of the tenant/assignee and the AGA was a guarantee only of any default by the tenant of its liability to pay rates.

The upshot was that the guarantor had to pay the ongoing rent as if the lease was in place but the landlord had to pay the rates as if it was not. Landlord’s can seek to avoid this split scenario by imposing obligations on guarantors to take a new lease following disclaimer if required to do so by the landlord. Many AGAs already have such an option for the landlord but since Hindcastle there appeared to be no consistent reason to exercise that option but the Schroder case will make it more desirable for a landlord to do so and thus require the guarantor to take a new lease and as a result become directly liable for the rates on the premises. The case of RVB Investments v Bibby suggests that even if the guarantor itself becomes insolvent the mere exercise of the option will be sufficient to shift the right to possession from the landlord to the guarantor and with it the liability to pay rates.

For advice on these issues whether your interest is that of a landlord, an insolvent tenant or as a guarantor our Property Litigation and Insolvency Teams led by David Eminton and Mike Pavitt respectively will be happy to assist.