Virtually no chance?
Date: 23 October 2009
Authors: Joseph Ollech
Issue: Vol 159, Issue 7390
Categories: Features, Property
Alienation covenants are a common feature of both commercial and residential leases. They are key to a landlord’s ability to control the onward passage of the leasehold interest, whether it be by assignment or by sub-lease, by licence to part with or share possession, or via the creation of a trust structure.
Covenants by the tenant against alienation can take a variety of forms. For example, they may be absolute or conditional, or they can relate to the whole of the premises or to part. Typically the tenant covenants not to assign or sublet the premises which are the subject of the lease, without the consent of the landlord which is not to be unreasonably withheld.
When presented with a request to permit an assignment the landlord will have an opportunity to consider the credentials of the proposed new tenants, and in all likelihood to require his current tenant to enter into an authorised guarantee agreement (AGA) in accordance with the Landlord and Tenant (Covenants) Act 1995.
A tenant who wishes to assign, sub-let or otherwise deal with his leasehold interest may wish to avoid having to go cap in hand to his landlord for several reasons. In some cases time may be a factor, and the landlord’s involvement likely to cause delay.
Perhaps the landlord is entitled to demand payment of a premium, or at least is likely to be entitled to its costs incurred in dealing with the request. Doubtless in all cases the tenant would be delighted not to have to grant an AGA if it could avoid doing so. There may, in many cases, be a concern that the landlord may reasonably withhold consent and frustrate the tenant’s plans.
Whatever the reason, a device sometimes employed by tenants to try and avoid their obligations is an arrangement referred to as a “virtual assignment”. The essence of the arrangement is an attempt by the tenant to pass on the rights and duties of the lease, or its “economic benefits and burdens“ without actually assigning or sub-letting the premises to a third party.
Such an approach was highlighted in litigation between Abbey National and HMRC in 2006. However, that dispute was of primary interest for tax lawyers.
The key question dealt with by the Court of Appeal in The Commissioners of Revenue and Customs v Abbey National Plc [2006] EWCA Civ 886, [2006] All ER (D) 336 (Jun) was whether a contractual arrangement relating to real property which, under domestic law, fell short (and was intended to fall short) of being a transaction of leasing or letting, was nevertheless to be treated as if it were such a transaction for VAT purposes, with the consequence that it was an exempt supply.
A legal first
Clarence House Limited v National Westminster Bank Plc [2009] EWHC 77 (Ch), [2009] 3 All ER 175 is the first time the court has examined the effect of a virtual assignment on a tenant’s alienation covenants. The novelty of the question is reflected by the lack of authority available to counsel or His Honour Judge Hodge QC. The judge distinguished himself by delivering a lucid and clearly reasoned judgment based entirely on first principles. Given its clarity and simplicity (in the elegant sense of the word) it is likely that his decision will be an important reference point in the future.
Background
The background facts were these: Clarence House was the landlord, and NatWest the tenant, of part of the ground and first floor of a building under a 25-year lease. The lease included 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.
In this particular case it so happened that NatWest had granted one properly authorised sub-lease of the whole to William M Mercer Limited on 30 January 2001, and NatWest was not in fact in actual occupation of the premises. The arrangement which came under scrutiny, however, was entered into on 10 June 2005; at that time the chain of title was Clarence House—NatWest—Mercer.
In the context of a corporate restructure of NatWest and the Royal Bank of Scotland NatWest entered into a document called a “Virtual Assignment” with a company entitled New Liberty Property Holdings Limited (New Liberty).
Under the agreement all the “economic benefits and burdens” of the lease were passed to New Liberty, but the lease was not assigned or sublet to New Liberty.
The key words of the Virtual Assignment provided 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.”
Clarence House 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.
In his analysis the judge had to accept that NatWest was not in breach of the covenants against assigning, subletting or creating a trust. But he had no hesitation in deciding that there was a breach of the covenant against sharing or parting with possession.
Assignment
The judge, relying on the well established authority of Gentle v Faulkner [1900] 2 QB 267, agreed with NatWest that unless there is any contextual reason for supposing otherwise a covenant in a lease against assigning demised premises covers only a legal assignment. A legal assignment can only be completed by registration (Land Registration Act 2002, s 27(1)), and so it was perforce the case that no assignment had, in fact, taken place.
Sub-lease
Judge Hodge also gave short shrift to the suggestion that New Liberty had the benefit of a sub-lease. Nothing in the wording had the result “in form or substance” of amounting to an underletting. Most importantly, no reversionary interest was reserved to NatWest and so it could not on any view be treated as sub-lease.
Declaration of trust
In this regard Judge Hodge felt that Clarence House’s argument had more force, in that the characteristics of the relationship between NatWest and New Liberty did suggest a bare trust arrangement; if that were so its status could not be masked by the parties choosing to call it a virtual assignment. Ultimately, however, the judge determined that the relationship was contractual and not equitable.
A telling point was his observation that under a bare trust the trustee’s sole duties to the beneficiary are not only to allow him to enjoy the trust property, but also to obey any direction the beneficiary may give as to how the trust property should be disposed of by putting an end to the trust. This power, à la Saunders v Vautier, was not available under the Virtual Assignment.
Sharing or parting with possession
Clarence House did not plead that there had been a breach of the covenant against sharing or parting with occupation. On the facts that was not sustainable since NatWest was not in actual occupation—Mercer was.
On other facts, for example where a corporate tenant in occupation attempts to pass the economic burden and benefit to a new company which then trades from the premises, one can see that sharing or parting with occupation would be an added difficulty.
However, Judge Hodge did decide that there was a breach of the covenant against sharing or parting with possession. He noted that the word “possession”, has a broader meaning than the mere physical control and presence on the premises. He referred to the definition of possession in s 205(1)(xix) of the Law of Property Act 1925 as including “receipt of rents and profits or the right to receive the same, if any”. Although acknowledging that this definition was peculiar to that particular statute he observed that it was the meaning ascribed to the word by those who draft lease documentation.
Furthermore, it had to bear a wider definition if it were not to be a meaningless repetition of the word “occupation” which appeared in the same clause.
Practice points
Although NatWest came close in that the Virtual Assignment did not trigger three out of four of the alienation covenants, it could not avoid being in breach of the covenant against parting with or sharing possession of the premises. It is not easy to imagine circumstances where a virtual assignment arrangement could avoid the same problem. Careful consideration of the precise wording of the alienation covenant must always be the first step.
If it so happens that the wording of a given lease does not expressly forbid parting or sharing with possession the tenant would appear to be in luck, but the wording of alienation covenants are so widely pro-forma that such opportunities are likely to be few and far between.
In any event a tenant considering such a gamble would do well to remember that the sympathy of the court is a real factor in litigation, and a party seeking to avoid its obligations under a lease would be unlikely to have its benefit.
Although Judge Hodge did not criticise NatWest’s attempt to dodge the covenants against alienation in so many words, he did say in his closing remarks that his decision, would, in the future, save draftsmen the trouble of simply including a covenant against virtual assignments in the alienation clause.
Joseph Ollech, barrister, Falcon Chambers.
Website: www.falcon-chambers.com.
E-mail: ollech@falcon-chambers.com
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