Liability after disclaimer
Date: 24 April 2009
Authors: Malcolm Dowden
Issue: Vol 159, Issue 7366
Categories: Features, Procedure & practice
Where does loss lie when a liquidator disclaims a lease? Does it fall on the landlord or on the tenant's guarantor? After the property slump of the early 1990s, the House of Lords overturned previous authority to find that loss lay with the guarantor (Hindcastle v Barbara Attenborough Associates [1996] 1 All ER 737). Faced with a new recession in the property market, the Court of Appeal has confirmed that the same conclusion applies to the liabilities of a former tenant under an authorised guarantee agreement (AGA) (Shaw v Doleman [2009] EWCA Civ 283; [2009] All ER (D) 34 (Apr)).
Disclaimers & phantom leases
Guarantees protect landlords against the risk of a tenant defaulting on rent payments or other lease obligations. Until Hindcastle, guarantees could become worthless, at the moment of greatest need, when the liquidator of an insolvent tenant disclaimed the lease. For nearly a century authority followed Stacey v Hill [1901] 1 QB 660, where disclaimer under the Bankruptcy Act 1883 not only released the tenant from liability, but also triggered a consequential release of its guarantor.
Hindcastle ruled on the effect of s 178(4) Insolvency Act 1986. The disclaimer under that section:
● ends the rights, interests and liabilities of the tenant, but
● does not, except so far as is necessary for the purpose of releasing the tenant from any liability, affect the rights and liabilities of any other person.
Lord Nicholls explained that s 178(4) is a deeming provision. Where a lease is disclaimed its term is ended, and the tenant's interest reverts to the landlord. However, the rights and liabilities of guarantors remain as though the lease had continued.
AGAs & original tenant liability
AGAs were a compromise created by the Landlord and Tenant (Covenants) Act 1995 (LT(c)A 1995) to protect landlords against the full impact of tenant release under that Act.
The recession of the early 1990s highlighted the potentially unfair impact of the rules on privity of contract. The original tenant and any assignee who covenanted with the landlord to pay rents and perform covenants throughout the term of the lease could face demands for rent arrears, service charges or damages for disrepair many years after assigning the lease. To meet that problem, LT(c)A 1995 provides that where a lease granted on or after 1 January 1996 and being a “new” tenancy for the purposes of LT(c)A 1995 is assigned, the outgoing tenant is automatically released from liability for “tenant covenants”.
LT(c)A 1995, s 16 allows landlords to make consent to an assignment conditional on the outgoing tenant guaranteeing performance by its immediate assignee. The outgoing tenant will have found that assignee and had an opportunity to assess its financial strength and ability to meet its lease obligations. Liability under an AGA falls away when the lease ends, or where there is a further assignment.
AGAs & disclaimers
In Shaw the former tenant claimed that her AGA liabilities came to an end when her assignee's liquidator disclaimed the lease. The AGA defined the “Liability Period” as ending when the assignee “ceased to be bound by the covenants in the lease”. The tenant's key argument was that her release was a matter of contractual interpretation, falling outside the House of Lords' ruling on the effect of s 178(4).
That argument failed. The Court of Appeal held that the wording of the AGA, including the definition of Liability Period must be read in its statutory context. Lord Justice Stanley Burnton said: “The appellants case, on analysis, is that the determination by disclaimer of the liabilities of the company (or, to use the words of the guarantee, the determination of the period during which the Assignee is bound by the tenant covenants in the Lease) has determined her liability. But that is precisely what is precluded by section 178(4).”
The court also rejected the argument that release should be allowed because the landlord had failed to exercise its option (created by another clause in the AGA) to require the tenant to take up a new lease in the event of disclaimer. The landlord is free to decide. The option is neither inconsistent with continuation of the guarantor's liability, nor does it indicate that the parties intended that liability to come to an end on disclaimer.
A way out?
Although it found against the tenant in Shaw the Court of Appeal confirmed that it is possible to draft an AGA so that the former tenant is expressly released on disclaimer. However, in practice, it is difficult to see why a landlord would agree to a provision that would end the guarantee on one of the main events it was taken to protect against.
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