The Law Commission’s 14th programme of reform in the UK

Reform of the Landlord and Tenant (Covenants) Act 1995: An end to the AGA saga?

Before 1996, leases were governed by privity of contract, meaning the original tenant or guarantor remained liable throughout the term of the lease, even after it was assigned. With typical lease terms of 25 years, outgoing tenants could be required to pay the arrears of the incoming tenant many years after assigning the lease.

Following a Law Commission recommendation, the Landlord and Tenant (Covenants) Act 1995 came into force on 1 January 1996. For leases entered into after that date, tenants were released from their obligations on an assignment of the lease unless they expressly agreed to guarantee the performance of the incoming tenant's lease obligations under an authorised guarantee agreement, or AGA – often required by landlords as a condition of consent to the assignment. The 1995 Act therefore went a long way towards removing some of the risks and potential injustices associated with lease assignment.

However, the introduction of AGAs has not been without its problems – particularly in terms of the limits on what former guarantors can do. In Good Harvest Partnership LLP v Centaur Services Limited [2010] EWHC 330 (Ch); [2010] 1 EGLR 29 the court confirmed that the original tenant's guarantor could not enter into an AGA to guarantee the obligations of the assignee, as to do so would go against the protections of the 1995 Act.

The Court of Appeal later clarified in KS Victoria Street v House of Fraser (Stores Management) Ltd [2010] EWHC 3006 (Ch); [2011] 2 EGLR 11 that guarantors can guarantee the tenant's performance of its obligations under an AGA, known as a sub-guarantee (or GAGA). Similarly, while the tenant's guarantor cannot guarantee the immediate assignee, it may guarantee the performance of subsequent assignees.

The limitations on guarantors have proved particularly difficult in the context of intra-group assignments; in EMI Group Limited v O&H Q1 Ltd [2016] EWHC 529 (Ch); [2016] EGLR 26 the High Court determined that a tenant cannot assign its lease to its guarantor under the 1995 Act.

The Law Commission will hopefully consider amendments to the 1995 Act which would allow the assignor's guarantor to repeat the guarantee with a group company assignee, to guarantee both the assignor and assignee's obligations, or to provide a sub-guarantee in an intra-group assignment. This could simplify many complex leasing transactions.

Rights of first refusal under the Landlord and Tenant Act 1987: Exclusion of commercial units

Part 1 of the Landlord and Tenant Act 1987 requires landlords of a building containing two or more flats (at least half of which are held by qualifying residential tenants) to serve a “right of first refusal” notice on those tenants when making a disposal of the whole, or part of a building. This gives them the right to buy that interest – and two months to make a decision – before the landlord can go ahead.

The 1987 Act doesn't apply to buildings where non-residential parts of the building amount to more than 50% of the internal floor space. Nonetheless, it still applies to many mixed-use buildings.

The 1987 Act creates confusion about which “disposals” are subject to rights of first refusal; while the grant of the lease of a single flat is expressly excluded from the definition of a disposal, disposals are widely defined, with no specific exclusion for the grant of commercial leases.

This has led to uncertainty over whether qualifying residential tenants in mixed-use buildings should be given a right of first refusal prior to the grant of leases of commercial units. This seems to go well beyond the purpose of the legislation, which was to give tenants the right to step in and acquire the building where their landlords intend to sell its interest, rather than to take over commercial parts of the building.

Set against the significant cost and time burden the notice process in the 1987 Act imposes on landlords, there is a clear case for amending the legislation to specify that it does not apply to the grant of a commercial lease, particularly in light of the criminal sanctions which can be imposed on landlords for non-compliance.

The 1987 Act also causes problems on subsequent sales of the property, with purchasers reluctant to proceed where there is a lack of evidence of proper service on previous sales. Purchasers run the risk of residential tenants arguing that they should have been entitled to acquire the property on a previous sale. While there is a six-month time limit for the residential tenants, this only begins to run from the date they are notified that a disposal has taken place, so can hang over subsequent purchases if no notification was given.

Whether the Law Commission considers an all-out review of the 1987 Act, or a redefinition of “disposals” caught by the Act to exclude commercial units, reform to the 1987 Act is long overdue, and any review will be welcome news to commercial landlords.

What comes next?

The PLA has long highlighted both the 1995 Act and the 1987 Act as areas where relatively small changes could make big differences to the real estate industry. The inclusion of commercial leasehold reform targeted at this legislation in the Law Commission's 14th Reform Programme will be widely welcomed by our members, and across the industry.

The timetable for each area of reform – including these commercial leasehold reforms – will be announced by the Law Commission in due course. I would encourage the industry to engage in the Law Commission's consultation process to ensure that these reforms have the best possible chance of making it onto the statute books.

An earlier version of this article appeared in Estates Gazette.

Authored by Paul Tonkin.

Paul is Chair of the Property Litigation Association’s Law Reform Committee.