Lease variations and vanishing guarantors: Topland Portfolio No 1 Limited v Smiths News Trading Limited (CA)

Posted: 14/02/2014

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The Court of Appeal recently affirmed last year’s High Court decision that a licence for alterations granted to a tenant without the consent of its guarantor released the guarantor.  

Background

The case concerned a 35 year lease of a DIY superstore.  W H Smith Do-it-all Ltd was the tenant and Smiths News Trading Limited stood as guarantor. Topland was the Landlord. The tenant went into administration in 2011 and the administrators disclaimed the lease. Arrears of rent accrued and the landlord called upon the guarantor to pay the arrears and take up a new lease for the remainder of the term. The guarantor argued that it was released from its obligations as a result of a licence to alter entered into without its consent.

Terms of the lease and the licence  

The relevant terms of the lease were as follows:

• the alterations clause prohibited structural alterations, the erection of new buildings and alterations to the external appearance of the premises (although the erection of greenhouses and sheds in connection with the use of the property as a garden centre was permitted);
• the premises were described as including buildings erected at any time on the premises and all alterations, additions and improvements made by the tenant during (or prior to) the term;
• the repair, decoration and yielding up covenants extended to the premises and all additions and improvements. 

In 1987 the tenant sought permission to build a new garden centre on the west side of an existing warehouse. The landlord consented by way of a licence for alterations, allowing the tenant to open up one side of the warehouse, construct the new garden centre and alter the layout of the existing car park. It was accepted that the licence amounted to a variation of the lease (as it allowed the tenant to carry out works which were outside the scope of the lease). 

The licence:

• required the premises to be reinstated at the end of the term (if the landlord reasonably required such reinstatement); and
• applied all the lease covenants to the premises as altered by the permitted works. 

The guarantor argued that:

• the licence was a material variation of the lease which would have a substantial effect on the guarantor; and
• as the guarantor was not a party to the licence (and did not otherwise consent to this variation of the lease) they had been released from their guarantee obligations. 

High Court

The court referred to the longstanding case of Holme v  Brunskill [1878] which established the rule that a guarantor is discharged from its obligations under a guarantee where the underlying contract is varied after the guarantee is given unless:

• the guarantor has consented to the variation; or
• the variation is insubstantial and incapable of prejudicing the guarantor.

The court agreed with the guarantor; the licence had increased the guarantor’s obligations under the lease and it had therefore been released.  

Court of Appeal

The landlord appealed and was unsuccessful on a number of grounds. First, Topland argued that there had been no increase in the tenant's obligations as a result of the licence, because the definition of the "demised premises" in the lease incorporated additions, alterations and improvements to the property. The Court of Appeal disagreed. The guarantor had guaranteed a lease under which no alterations, additions or improvements could be made without going outside the framework of the lease. The court said if such consent was sought by the tenant “the Surety was entitled to expect that its consent would be sought as well”. They went on to say that “the licence had clear potential…to increase the obligations on the Lessee, and hence on the Surety in the event of the lessee’s default”. As a result, the rule in Holme v Brunskill [1878] had been triggered.

The landlord also argued that the licence fell within the guarantor saving provisions in the lease. The guarantor saving provisions in the Lease were not comprehensive and only applied:

• in the event of any forbearance or extra time given by the landlord in respect of a breach of covenant; or
• where the tenant ceased to exist. 

Topland argued that, because the lease prohibited alterations and additions to the property (except for the erection of sheds and greenhouses), the grant of the licence amounted to forbearance (as it effectively sanctioned what would otherwise have been a breach). Again, the court disagreed. The forbearance proviso in the lease required a failure to enforce a breach; the grant of the licence did not amount to “forbearance” as the tenant was never in breach. 

Lastly, Topland argued that granting the licence amounted to the giving of time by the landlord (and so fell within the guarantee saving provisions). They argued that the licence postponed the date on which the covenant against alterations was enforced. This argument also failed. As the tenant had not been not in breach of covenant when the licence was granted, it could not be said that the licence postponed the time when the landlord was entitled to ask the tenant to remove the works; rather the licence granted the tenant permission to construct the works.

Practical points

The availability of a guarantor often underpins the decision to grant a lease and obviously impacts the value of a landlord’s investment. The inadvertent release of a guarantor can have disastrous consequences. It has long been the case that lease variations have the potential to release a guarantor and it is essential that steps are taken to reduce the risk of inadvertent release:

• It is not always clear whether a particular variation will prejudice a guarantor so it is safest to assume that all variations may potentially increase a guarantor’s obligations. As a result, guarantors should join in all licences and other supplemental documents to consent to such variations where at all possible;
• In practice, it may not always be possible to get guarantors to sign ancillary documents. This will be especially true of previous tenants acting as guarantors under an AGA. In such circumstances, there are other steps that can be taken to protect the landlord’s position:
• include an obligation in your lease and AGA requiring guarantors to enter into supplemental documents;
• ensure your guarantee provisions include comprehensive guarantor-saving provisions. In particular, expressly provide that variations (however material) agreed between the landlord and the tenant will not discharge the guarantee. A word of caution, however; such provisos are not 100% failsafe (although some comfort can be drawn from the judge’s comments in the Topland case that it is possible to contract out of the rule in Holme v Brunskill).
• Careful due diligence is required when buying investment property to check that guarantors have not been inadvertently released;
• Also remember that former tenants guaranteeing the obligations of incoming tenants under AGAs are guarantors who could also be released. Always consider the value of such AGAs and the effect of any licence/supplemental document upon it, before granting consent to matters outside what is envisaged by the lease.

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