Privity of Contract – Authorised Guarantee Agreement

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Commercial Lease:

It is an established rule of English law that a person can only enforce a contract if he is a party to it or a lawful assignee of the benefit of the contract.

In the context of a business tenancy, the “privity of contract” doctrine means the first (original) tenant can assign his interest in the tenancy (presupposing the lease permits assignment), but not his relationship with the landlord.

Before the Landlord and Tenant (Covenants) Act 1995, the first tenant remained liable for the rent, etc throughout the term of the tenancy, regardless of assignment. An assignee default at any time meant the original tenant could suddenly be presented with a demand for rent at any time.

Also, privity of contract did not then include any right for the original tenant to take over the remainder of the tenancy. How far down along the line the landlord could pursue an original tenant was brought home to a friend, a beneficiary of a will where the deceased had been the original tenant.

After 1 January 1996 when the 1995 Act came into operation, the change in the law introduced what is known as an Authorised Guarantee Agreement, or “AGA� for short. Now, and assuming completion of an AGA, the first tenant on assignment only remains liable for the duration of the first assignee’s interest in the tenancy. When that first assignee assigns, the first tenant bows out and the first assignee becomes liable for performance of the second assignee’s interest, and so on.

Along with the right for the outgoing tenant to take over the remainder of the tenancy should its incumbent assignee default, the Act also introduced a formality into what had been largely dependent upon case law whereby a landlord can specify in the lease the criteria that a proposed assignee has to satisfy to avoid any claim the landlord is being unreasonable in refusing consent to the assignment.

Any joy that landlords may have jumped for dissipated when it was realised that draconian criteria could have a deprecating effect at rent review. Consequently, the criteria have been softened and case-law has added to the tort measures of Landlord and Tenant Act 1988 by providing an indicative time limit on how long may be allowed before it could be said the landlord is unreasonably withholding or delaying consent.

Unlike a new letting in the market where the landlord can refuse offers without having to give reasons, a tenant wishing to assign is presenting the landlord with a substitute tenant whose financial or investment covenant status the landlord may have little or no choice but to accept. Even so, landlords are not obliged to ‘rubber stamp’ a tenant’s application to assign.

There is no reason why detailed enquiries may not be made and actually it is prudent to do so. Not only for the landlord’s benefit, but also for the outgoing tenant for whom the added protection of the landlord’s carefulness might prevent the outgoing tenant’s performance as guarantor from ever being called upon.

To the landlord, what matters is not whether the assignee could afford the rent out of the business, whether or not the business at the premises is also being disposed of, but whether the tenant could afford to pay even if the business failed.

Although few tenants are of independent means, business tenancy law assumes all tenants to be so; generally, rent and compliance with other terms and conditions of the tenancy is nothing to do with how the tenant chooses to use the premises.

Amongst larger companies, there is a preference for either underletting or surrender if possible. Assignment is to be avoided because of the risk of privity bounce-back through assignee default. Underletting enables the tenant to keep tabs but has its own problems from procuring a reliable tenant to one that does not mind, should the tenant or lease require, the underlease being contracted out of the Landlord and Tenant Act 1954.

The value of an AGA to the landlord depends upon whether the outgoing previous tenant can be traced if need be. But what an AGA does not have any control over is whether the outgoing tenant would have any money or assets for the landlord to call upon for the AGA to be honoured.

Where the outgoing tenant is a weak covenant or shrewd, the success in whether better for the landlord to ask for a deposit in exchange for scrapping the AGA depends upon how canny the outgoing tenant.

Where a premium for the lease is being paid, or the leasehold business as a going concern at the premises is to be sold, in my experience, few tenants seem too concerned as to the long-term risk of assignee default.

The trend for tenancy term 10 years even with a tenant break clause at the 5th year is nevertheless a long period of time in which anything could happen. On the face of it, outgoing tenants that are individuals or partnerships may not be able to do much about minimising the liability but outgoing tenants that are limited companies with no guarantor may be in a stronger position to dump the liability.

As for pro-active management to capitalise on any opportunity to enhance the value of the reversion, landlords should not unwittingly limit the potential in the AGA cushion by varying the terms of the tenancy for an assignee, because that could limit the outgoing tenant’s guarantor of the assignee’s performance to the date of the variation.

To be on the safe side, it may be better to vary terms of the tenancy before the AGA is entered into, provided any variation would not fall foul of any unreasonable criteria in the lease, or invoke the wrath of the Landlord and Tenant 1988. Treading carefully at every stage is the name of the game. There are no easy answers, it all depends on the circumstances.

Michael Lever
The Rent Review Specialist
Established 1975

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