Authorised guarantee agreements (AGAs) are in the news again, at least to the extent of featuring in The Code for Leasing Business Premises in England and Wales 2007.

AGAs are a creature of statute, namely the Landlord and Tenant (Covenants) Act 1995. Their form and content are strictly regulated by s16 of the 1995 Act. In addition, the common law must at times be taken into account.

Despite the passage of eleven years, poorly drafted examples of AGAs are still seen, and certain aspects of their operation are not always understood. Let us go back to basics. (References in this article to ‘the tenant’ are references to the outgoing or assigning tenant, unless the contrary is made apparent.)

What is an AGA?

Section 16(2) of the 1995 Act provides that an agreement is an AGA if:

• under it the tenant guarantees the performance of tenant covenants to any extent by the assignee;

• it is entered into in the circumstances referred to in s16(3) of the 1995 Act; and

• its provisions conform with the requirements set out in s16(4) and (5) of the 1995 Act.

Section 16(4) states that an agreement is not an AGA to the extent that it purports:

• to impose on the tenant any requirement to guarantee in any way the performance of tenant covenants by any person other than the assignee; or

• to impose on the tenant any liability, restriction or other requirement (of whatever nature) in relation to any time after the assignee is released from such tenant covenants by virtue of the 1995 Act.

This means, for instance, that an AGA cannot oblige the tenant to guarantee performance of the tenant covenants ‘by the assignee and its successors in title’. The 1995 Act would render it ineffective, save as to the guarantee of performance by the tenant’s immediate assignee and subject to the operation of s16(6).

For the avoidance of any doubt, the draftsman should express the liability of the tenant under the AGA to subsist, notwithstanding that the contractual term of the lease has expired, and a continuation tenancy under s24 of the Landlord and Tenant Act 1954 has arisen. See in this respect Junction Estates Ltd v Cope [1974]. Here it was held that, in the absence of clear words, a guarantor’s liability under its contract of guarantee will extend only for the contractual term of the lease. By analogy, this should apply equally in the case of a tenant under an AGA.

Again, clear wording is desirable to ensure that the tenant is liable under the AGA for any interim rent ordered under ss24A to 24D of the 1954 Act that is in excess of the contractual rent. See Herbert Duncan Ltd v Cluttons [1993]. Here the Court of Appeal decided, as a matter of construction of the lease, that the liability of the original tenant under the lease did extend to the continuation tenancy. However, the appeal judges held that the original tenant was liable only for rent at the contractual rate, in this case £70,000 per annum, and not at the level of the interim rent that had been ordered, namely £200,000 per annum. Once more, by analogy, this should apply also in the case of an AGA.

Section 16(5) of the 1995 Act states that an AGA may nevertheless:

• impose on the tenant any liability as sole or principal debtor in respect of any obligations of the assignee under the tenant covenants;

• impose on the tenant liabilities as guarantor, in respect of the assignee’s performance of the tenant covenants, which are not more onerous than those to which they would be subject in the event of their being liable as sole or principal debtor;

• require the tenant, in the event of the assigned tenancy being disclaimed, to enter into a new tenancy of the premises, but such new tenancy must not be for more than the unexpired residue of the assigned tenancy nor contain more onerous terms; and

• make incidental or supplementary provision to the foregoing.

Within the statutory limitations, the parties are therefore at liberty to specify the terms of the AGA. It is unclear how strictly the courts would be likely to construe the expression ‘incidental or supplementary provision’. The better view is that this would be restricted to provisions dealing with non-substantive matters such as service of notices etc.

In practice, many of the terms of an AGA will reflect the provisions of a contractual guarantor’s covenant in a modern lease. However, it would not be appropriate to impose a requirement on the tenant to enter into a new (meaning ‘substitute’) lease in the event of premature determination of the lease otherwise than as a result of disclaimer. (This is outside the scope of the statutory provision, and on the basis of the decision in Active Estates Ltd v Parness [2002] would probably be ineffective.) Nor would it be appropriate to provide for payment of additional rent, following premature determination, in order to offset letting costs or voids. (This would also appear to be outside the scope of the statutory provisions.)

It is doubtful whether a provision in an AGA requiring the appointment of a replacement guarantor, in the event of the tenant under the AGA meeting with death, bankruptcy or liquidation, would be effective. The 1995 Act makes it clear that only a tenant may enter into an AGA.

Equally, a tenant under an AGA cannot be required to bind itself to join as guarantor in any renewal of the lease, as this would involve it in committing itself in respect of an entirely different tenancy.

There must be doubt as to whether s16 of the 1995 Act allows the landlord to require an indemnity from the tenant under the AGA. (It would appear not to be expressly sanctioned.) Against that, the tenant can be required to accept liability as sole or principal debtor, and advantage should be taken of this to cover the possibility in any given case of the guarantee failing.

Finally, any offending provisions should be automatically excised. (This is the likely effect of s16(4) and s25(1) of the 1995 Act.) The remainder of the AGA should stand, but a prudent draftsman may not want to run any risk in this respect and will certainly seek to include wording that would result in severance.

When may an AGA be made?

Section 5 of the 1995 Act operates to release a tenant from the tenant covenants on an assignment of a new tenancy. Section 11 prevents such a release, however, on an ‘excluded assignment’, which is defined to mean an assignment in breach of covenant or an assignment by operation of law. The tenant then only achieves its release on the next assignment (if any) that is not an excluded one.

First example

In 2004 L grants a lease to T for a term of ten years. In 2005 T assigns the lease to A1 in breach of covenant. From that point on both T and A1 are liable to L upon the tenant covenants. In 2006 A1 assigns the lease to A2 with L’s consent. At that point, T achieves a release under the 1995 Act, as does A1.

(Section 24(2) of the 1995 Act operates to release the tenant’s contractual guarantor in those circumstances to the same extent that the tenant itself is released.)

The effect of s16(1) of the 1995 Act is that where a release of the tenant occurs by statute, nothing in the 1995 Act is to preclude the tenant from entering into an AGA in respect of the performance by its assignee of those tenant covenants from which they have been released. The provision is therefore drafted as an exception to the general antiavoidance provisions of s25(1) of the 1995 Act, which render void any agreement seeking to exclude, modify or otherwise frustrate the operation of any provision of the 1995 Act. Without this statutory exception, which is separately reflected in s25(3) of the 1995 Act, the requirement for an AGA could not be imposed.

Section 16(6) of the Act covers the situation of an excluded assignment. There is no immediate release of the tenant, and so an AGA would not be appropriate or, indeed, permissible. On the assumption that the following assignment is not an excluded one, both the former tenant and the assigning tenant will be released on that later assignment. Provided that the landlord enters into an AGA with the assigning tenant on that later assignment, they may also require the former tenant likewise to enter into an AGA in respect of performance by the later assignee of the tenant’s covenants in question.

Second example

In the situation referred to earlier, subject to the terms of the lease L could require both T and A1 to enter into AGAs on the assignment of the lease in 2006 to A2, each of which would guarantee the performance by A2 of the tenant’s covenants in the lease.

A tenant may also face liability under a second AGA. As a result of the terms of the first AGA, it may be required to enter into a substitute lease on the original lease being disclaimed while vested in its assignee. When assigning that substitute lease, it may once more be required to enter into an AGA by the landlord. There is nothing in the 1995 Act to prevent this.

Third example

In 2004 L grants a lease to T for a term of ten years. With L’s consent, T assigns the lease to A1 in 2005, entering into an AGA with L. In 2006 A1 goes into insolvent liquidation and the liquidator disclaims the lease. L then requires T, under the provisions of the AGA, to take up a substitute lease for the unexpired residue of the term of the disclaimed lease. T, with L’s consent, immediately assigns that substitute lease. Once more, L may be entitled to require an AGA from T.

Calling for an AGA

Section 16(3) of the 1995 Act limits the circumstances in which a landlord of a new tenancy may call for an AGA to be entered into. The circumstances are that:

• there is an absolute or qualified covenant against assignment preventing assignment without the consent of the landlord or some other person;

• consent is given subject to a condition lawfully imposed that the tenant should enter into an AGA; and

• the AGAis entered into in pursuance of that condition.

(It follows that the requirement for consent might be that of a head landlord or a mortgagee.)

Where the covenant against assignment is absolute, it will always be lawful for the landlord to insist upon an AGA being entered into. Otherwise, a condition may be regarded as being lawfully imposed if the landlord has specified it as a condition for assignment under s19(1A) of the Landlord and Tenant Act 1927.

In the absence of such an express condition, a landlord may seek to impose such a requirement as a condition for granting consent, if it is reasonable to do so under s19(1)(a) of the 1927 Act.

The criteria against which reasonableness – and therefore lawfulness – will be judged are those set out by the Court of Appeal in International Fluid Drilling Ltd v Louisville Investments [1986] as supplemented by the Court of Appeal in Straudley Investments Ltd v Mount Eden Land Ltd [1996].

Should the requirement for an AGA be an automatic one?

The freedom given to landlords by s19(1A) of the 1927 Act enables a landlord to insist upon an AGA from each successive tenant, by making it a condition of each assignment. In practice, it would seem that many landlords still adopt this approach.

But what is the position on lease renewal? Section 35 of the 1954 Act (‘other terms of the new tenancy’) is amended by paragraph 4 of Schedule 1 to the 1995 Act. In essence, the amendment provides that the reference to ‘all relevant circumstances’ in s35 of the 1954 Act includes a reference to the operation of the provisions of the 1995 Act.

In Wallis Fashion Group Ltd v CGU Life Assurance Ltd [2000] the expired lease had been an old tenancy for the purposes of the 1995 Act. In the usual way, there was a qualified covenant against assignment coupled with the requirement for a direct covenant from the incoming assignee. The policy of the landlord on renewal was to take advantage of the changes brought about by the 1995 Act, and to stipulate for an AGA to be provided automatically on each assignment. Other tenants on the development had accepted this. The tenant in the present case objected, and argued that the requirement for the AGA should be tempered by a test of reasonableness. The point had to be decided by Neuberger J (as he then was). Here is a summary of his conclusions:

• (By implication) it was open to a landlord to seek to insert provision for an AGA on lease renewal.

• Guidance given by the House of Lords in O’May v City of London Real Property Co Ltd [1983] makes it clear that there has to be a good reason for imposing a new term against the will of one of the parties.

• The fact that the tenant would be in a much more favourable position (in relation to future liability) under the renewal lease did not afford such a reason. That was because this had been brought about by the sea change made by the 1995 Act.

• It would not be a correct exercise of judicial discretion to introduce a term that would deprive the tenant of the benefit of supervening legislation.

• The tenant’s proposal struck a fair balance between the interests of the parties, being not ungenerous to the landlord.

• The fact that other tenants on the development had accepted the landlord’s wording was significant, but did not outweigh the considerations that favoured this tenant’s case.

Accordingly, landlords should be conscious that while on a new letting in the market it may be possible to secure an automatic AGA provision, this will not be the case on renewal where the tenant objects.

Should the lease specify the form?

As with the form of a contractual guarantor’s covenants, the need for certainty dictates that the required form of AGA should be annexed or set out as a schedule to the lease. The lease will then contain provisions (within the alienation clause) obliging the tenant to enter into the AGA as a condition of the particular assignment. Typical wording is as follows:

On or before any assignment and prior to allowing the proposed assignee into possession or occupation of the Premises the Tenant and any former tenant who by virtue of s11 of the 1995 Act was not released from liability on any previous assignment of this Lease shall enter into an authorised guarantee agreement for the purposes of s16 of the 1995 Act in favour of the Landlord by way of deed in the form of the draft agreement set out in the… schedule to this Lease.

On occasion, to allow the landlord some flexibility, the draftsman will supplement the wording above with the addition of the following:

… but with such amendments or additions as the Landlord reasonably requires in the light of the circumstances obtaining at such time.

The landlord’s successors

The benefit of the covenants by the tenant in the AGAwill pass automatically to the landlord’s successor in title on an assignment of the reversion. (Section 3 of the 1995 Act applies only to landlord and tenant covenants, and so is not relevant in this context.) The benefit passes under common law. See in this respect P&A Swift Investments v Combined English Stores Group Plc [1989]. Here, the House of Lords held that a claim to enforce a guarantor’s covenant can, where there is no express assignment, be based upon the common law rule that the assignee has the legal estate and the covenant touches and concerns the land.

What protections will be available to the tenant?

First of all, s16(8) of the 1995 Act provides that the rules of law relating to guarantees (and in particular those relating to the release of sureties) are, subject to its terms, as applicable to AGAs as they are to any other guarantee agreement. This means that, to the extent that the AGA does not provide expressly to the contrary, the tenant under an AGAis capable of being released, for example, by:

• any variations of the lease which prejudice the tenant;

• indulgences or concessions granted by the landlord;

• a surrender of part; or

• the release of a co-surety.

Furthermore, in the event that the landlord and the assignee negotiate variations to the lease that affect the legal estate, ie involve an addition to the demise or an extension to the term, by implication a deemed surrender and re-grant will come about. This will terminate the future liability of the tenant under the AGA.

As we have seen, the tenant will be released from its liability under the AGA on an assignment of the lease by its assignee, provided that such assignment is not an excluded one. (In practice, the tenant should seek a covenant from the assignee to notify it of any further assignment and not to enter into an excluded assignment.)

Where the landlord seeks to recover from the tenant under the AGAwhat the 1995 Act refers to as a ‘fixed charge’ (ie rent, service charge, insurance premiums and any liquidated sums specified in the lease as payable in the event of default) by virtue of s17 of the 1995 Act it is a precondition of liability that a default notice in prescribed form is served upon it within six months of the sum in question falling due. (By contrast, a contractual guarantor of the current tenant is not within the scope of s17.)

The effect of s18 of the 1995 Act is that the tenant will not be liable under the AGA to pay any amount to the landlord in respect of a tenant covenant to the extent that the amount is referable to a relevant variation of the lease after the date of the assignment by it. (For this purpose, a variation may be effected by deed or otherwise.) A‘relevant variation’ is, in essence, one that the landlord had no obligation to allow.

By virtue of s19 of the 1995 Act, a tenant who remains liable under an AGA and who has met a section 17 notice in full is entitled to claim an overriding lease from the landlord. (This can be advantageous where the landlord has elected to waive the VAT exemption. The tenant in those circumstances cannot recover the VAT element on payments it makes to the landlord as a result of the default of the assignee. It is able to do so, however, if the payments are made under an overriding lease.) Generally, this will also give the tenant a degree of control over the assignee and the potential for recourse to the demised premises.

Conclusion

Despite the guidance given in the new Code, landlords will inevitably continue to place reliance upon AGAs and, accordingly, upon the ability to call for them. It is important to recognise the extent to which their form and content are regulated by statute, and the consequences of one being entered into.  © Property Law Journal