The liability of guarantors in the light of Topland Portfolio No. 1 Limited v Smiths News Trading Limited 0 Comments

The liability of guarantors in the light of Topland Portfolio No. 1 Limited v Smiths News Trading Limited

Although it is established law that the guarantor for a tenant under a lease will be excepted from further liability if the tenant agrees with the landlord (without the guarantor’s consent) to an arrangement which increases the tenant’s liability under the lease, to what extent is that principle likely to apply in relation to the majority of modern leases?

The principle referred to above is usually known as the rule in Holme V Brunskill (1878) LR 3 QBD 495 and has very recently been applied by the Court of Appeal in the case of Topland Portfolio No. 1 Limited v Smiths News Trading Limited ([2014] EWCA Civ 18) in upholding the decision of Alison Foster QC sitting as a Deputy High Court Judge ([2013] EWHC 1445 (Ch).

The facts in Holme V Brunskill may seem somewhat irrelevant to modern commercial leases.  In that case the plaintiff let a farm in Cumberland to a tenant farmer, together with a flock of sheep.  At the time when the farm was let, it extended to 234 acres and there were 700 sheep.  The surety guaranteed the tenant’s obligation to redeliver the flock of sheep in good condition at the end of the lease.  When the flock was redelivered, however, the sheep were reduced in number and were not in good condition.

Earlier, in the cFlock of sheepourse of the term, the tenant had made an agreement with the plaintiff that he would surrender a field of about 7 acres in exchange for a decrease in his rent of £10 a year.  The surety neither consented to, nor knew of, this variation to the original lease.  A majority of the Court of Appeal held that the surety was discharged from his obligations by reason of the variation, even though a jury had held that the variation had not substantially or materially altered the tenant’s obligations under the lease.  Although it is difficult to relate these facts to, say, a lease of a modern office building, the principle is sound and was expressed by Cotton LJ (in Holme v Brunskill) in the following terms:-

The true rule, in my opinion, is that, if there is any agreement between the principals with reference to the contract guaranteed, the surety ought to be consulted, and that if he has not consented to the alteration, although in cases where it is, without inquiry, evident that the alteration is unsubstantial or that it cannot be otherwise than beneficial to the surety, the surety may not be discharged, yet that if it is not self-evident that the alteration is unsubstantial or one which cannot be prejudicial to the surety, the court will not, in an action against the surety, go into an inquiry as to the effect of the alteration or allow the question whether the surety is discharged or not to be determined by the finding of a jury as to the materiality of the alteration, or on the question whether it is to the prejudice of the surety, but will hold that in such a case the surety himself must be the sole judge whether or not he will consent to remain liable notwithstanding the alteration, and that if he has not so consented, he will be discharged.

The above words were quoted with approval by the Court of Appeal in Topland. The facts in Topland are easier to relate to a lease of a modern building.

The following statement of facts is from the judgement.

Topland was the freehold owner of land known as the Do It All Site, on the south side of Glentworth Road, Westgate, Morcombe (“the Property”).  The freehold was subject to a 35 year lease dated 18th May 1981 between PAT (Pensions) Limited (“PAT”) as Lessor, WH Smith Do It All Limited (later known as Payless DIY Limited, “Payless”) as Lessee and Smiths (the Respondent) (then known as WH Smith & Son Limited) as Surety (“the Lease”).

On 28th September 1987 PAT granted Payless a licence which authorised certain alterations to the Property (“the Licence”).  Smiths was not a party to the Licence and did not consent to it.

Topland bought the reversion in 2001.  By 2011 the annual rent was £310,000 plus VAT payable quarterly.  Payless went into administration on 5th May 2011.  Rent was paid up to 21st June 2011, but on that date the Administrators disclaimed the Lease.  By 8th February 2012, when Topland brought their claim, there were rent arrears under the Lease amounting to £281,038.36 plus interest.  On 15th August 2012 Payless was dissolved.  On 8th October 2012 Topland gave notice to Smiths requiring it to take a new lease for the remainder of the term of the Lease (under the terms of its covenant as Surety in the Lease).

The Court of Appeal judgement in Topland sets out a number of provisions from the Lease but only the following need to be referred to for the purposes of this blog post:

  • Clause 1(b)v of the Lease defined “the demised premises” as meaning: “the land and premises described in Part 1 of the First Schedule hereto and each and every part thereof together with the appurtenances thereto belonging and together also with any buildings and each and every part thereof now or hereafter erected or in the course of erection thereon or on any part together with all additions, alterations and improvements thereto which may be carried out by or on behalf of the Lessee prior to or during the term and shall also include any plate glass windows and doors and all Landlord’s fixtures and fittings now or hereafter in or about the same”.
  • The principal covenants by the Lessee were set out in Part 1 of the Second Schedule and included:-
    +          full repairing and decorating obligations;
    +          a covenant that no building or structure of any kind should at any time be erected upon the demised premises, with the proviso that the restriction should not prevent the erection of greenhouses and sheds in connection with the use to the Premises as a garden centre;

garden centreThe key obligation by the Surety for the purposes of the case was in clause 5.1, in the following terms:-

The Lessee shall at all times pay the rent hereinbefore reserved at the times and in manner hereinbefore contained and shall duly observe and perform all the covenants and conditions on the Lessee’s part hereinbefore contained to be observed and performed and that if the Lessee shall make default in the payment of the rent herein reserved or any part thereof or in observing and performing the said covenants and conditions or any of them the Surety will pay and make good to the Lessor on demand all loss damage costs and expenses thereby arising or incurred by the Lessor PROVIDED ALWAYS and it is agreed that notwithstanding any neglect or forbearance on the part of the Lessor to obtain payment of the rent herein reserved or any part thereof when the same shall become payable or to enforce observance or performance of any of the covenants or conditions on the Lessees part to be observed and performed or any time which may be given by the Lessor to the Lessee or that the Lessee may have ceased to exist shall not release or exonerate or in any way affect the liability of the Surety under this covenant.”

The terms of the Licence can be briefly summarised.  The Lessor authorised certain works namely:-

The construction of an opening of the west wall of the warehouse forming part of the demised premises the construction of a new garden centre on the west side of the said warehouse and alterations to the layout of the existing car parking area

The erection of a high security boundary fence.”

The key point is that the Respondent surety was not a party to the Licence and knew nothing of it or of the carrying out of the authorised works.

Smiths contended that the case fell squarely within the rule in Holme V Brunskill, since it is far from self-evident that the alterations to the Lease as a result of the Licence was insubstantial or that Smiths could not suffer prejudice.  On the contrary, Smiths argued that the effect of the Works was to enlarge the burden of performing the Lessee’s obligations under the Lease, in particular the repairing obligations.

Topland disputed that the rule in Holme V Brunskill applied to the case for two main reasons.  First, Topland contended that it is clear that the Licence did not increase the Lessee’s obligations under the Lease so as to prejudice the Surety. Secondly, Topland relied upon the proviso to paragraph 1 of the Fifth Schedule (quoted above), contending that the Licence amounted to either “forbearance” or “time … given” by the Lessor.

The Court (I respectfully submit correctly) gave relatively short shrift to Topland’s arguments.  Counsel for Topland’s justification for his argument that there was increase in the Lessee’s obligations as a result of the Licence was that the definition of “the demised premises” in the Lease incorporated any additions, alterations and improvements to the Property.  Accordingly, Counsel submitted, the Surety must be taken to have appreciated that all of the Lessee’s covenants relating to the Property would also apply to the Property as added to, altered or improved.

Counsel for Smiths accepted that the scheme of the Lease envisaged that the burden on the Lessee could be increased in certain respects (in particular, by virtue of the rent review clause), but that the Surety would not have known at the time when it became party to the Lease that those burdens could be increased as a result of additions, alterations or improvements to the demised premises, because no such additions, alterations or improvements could be made unless the Lessor consented outside the framework of the Lease.  The Court accepted the submissions of Smiths’ Counsel and added that the deputy judge was right to conclude that the Licence had the clear potential, to put it at its lowest, to increase the obligations on the Lessee, and hence on the Surety in the event of the Lessee’s default (i.e. that the rule in Holme v Brunskill applied).

PatienceTopland’s second argument was that the Licence was a forbearance within the proviso in clause 5.1.  Topland’s Counsel put forward three arguments:-

i)             “the covenant against alterations in the Second Schedule to the Lease is an absolute covenant in relation to alterations which “ …. interfere with the construction … [or] …. arrangement … [or] …. external appearance of the demised premises or … cut, maim, injure or remove any of the walls …”.

ii)            That is just what the Licence sanctioned. The construction of the opening was a “cutting or maiming of a wall”, whilst the construction of a new garden centre, alterations to the car park layout and erection of a high security boundary fence “interfere[d] with the external appearance of the demised premises”.

iii)           The Licence was an express waiver of the Lessor’s right to prevent such alterations. It was therefore a forbearance by the Lessor from enforcing the absolute covenant.

Smiths contended that forbearance occurs where A is in breach of an existing obligation to B (e.g. A is overdue in paying the rent) which B abstains from enforcing.  In granting the Licence, however, the Lessor was not forbearing to enforcing the covenant against alterations since there had been no breach of it and there was nothing to enforce.  It was positively authorising the Works despite the covenant.

fractured timeThe Court referred to a number of earlier cases including Howard de Walden Estates Ltd v Pasta Place Ltd [1995] 1 EGLR 79.  In that case the premises were originally used by the tenant as a delicatessen. The landlord granted the tenant successive licences permitting the installation of eight tables for the consumption of food and non-alcoholic beverages, permitting the service of Italian wine for consumption with food and permitting the off-licence sale of beers, ciders and wine as well as the use of adjoining premises as a fire escape.

Morland J rejected the argument that the grant of the licences amounted to forbearance by the lessor for reasons which he expressed as follows:-

  • The next question is can the plaintiff rely upon the proviso to override the general law? In my judgment, on a proper construction of the proviso, they clearly cannot. The proviso … does envisage a landlord having a wide discretion in dealing with a tenant, but, in my judgment, it is a wide discretion in dealing with a tenant who has broken his obligations under the lease. …The proviso, in my judgment, has to be construed in a way to give purpose to the object of the proviso which is … to give a wide discretion to the lessor or landlord. On the other hand, the words of the proviso are clear, that they are designed for the situation where there is either a breach or an apprehended breach of covenant failure to pay the rent.

In Topland, the Court of Appeal agreed with Morland J and rejected Topland’s argument giving two main reasons:

First, as I have explained, the context, purpose and wording of the proviso make it clear that it is concerned with failure to enforce in the event of breach, not with prior authorisation. Secondly, the distinction is a perfectly rational one to draw. If asked for authorisation, the Lessor can decide whether or not to consent and can negotiate over terms. After a breach, the Lessor is presented with a fait accompli and must decide whether or not to enforce.”

The above is a somewhat lengthy introduction to the real point I want to make here (although even then I would stress that it is not a complete statement of what was discussed by the Court of Appeal in Topland) but it is a necessary background to what follows.

The lease in Topland did not really give the landlord any support; the only two points the landlord could rely on were the definition of the demised premises and the reference to “forbearance” in the guarantor’s covenant.  Modern leases, however, often contain provisions which might well overcome the rule in Holme v Brunskill and make sureties liable for the tenant’s obligations under the lease to whatever extent it may be changed or varied (it is a moot point whether that is the intention of some of the provisions but it could be the effect).

The provisions I have in mind come in two major forms:-

1.   an extended definition of the meaning of “Lease” to include all supplementary or ancillary documents (the wording varies); and

2.  specific attempts to expand the surety’s liability by requiring it to be a party to any supplementary or ancillary document.

Obviously, in practice leases take a huge variety of forms according to the preferences of the solicitors drafting them.  I can only really illustrate my point by reference to the most widely used published precedents.

So far as provisions on the lines of (1) above are concerned I have looked at the following:-

A.  The Encyclopaedia of Forms and Precedents (Butterworths) Volume 23 S3, Precedent 11 (last amended 12/2011).  This is a precedent for a lease of an entire office building with a guarantor for the tenant.  In this precedent the definition of “this Lease” in clause 1.20 reads as follows:-

Unless expressly stated to the contrary, the expression “this Lease” includes any documents supplemental to or collateral with this document or entered into in accordance with this document.”

The covenants on the part of the Guarantor are in clause 6.1.2 and I quote again:-

6.1.2.1    Payment of Rent and Performance of the Lease

                The Tenant must pay the Lease Rents and VAT charged on them punctually and observe and perform the covenants and other conditions of this Lease ……  notwithstanding:-

(a)  any time or indulgence granted by the Landlord to the Tenant, any neglect or forbearance of the Landlord in enforcing the payment of the Lease Rents or the observance and performance of the covenants or other terms of this Lease

(b)   that the terms of this Lease may have been varied by agreement between the Landlord and the Tenant [, provided that no variation is to bind the Guarantor to the extent that it is materially prejudicial to him]

The wording of clause 6.1.2.1 (in my view) may or may not exclude the rule in Holme v Brunskill depending on whether the words in square brackets in clause 6.1.2.1(b) are included or not, but even if they are not included the question is; does the extended definition of “this Lease” have the same effect?  I cannot find any decision of the Courts on this particular point and I think it is probably open for determination; my instinct is that the courts would favour the surety on this, but it may be a matter of degree i.e. it may (notwithstanding the formulation of the rule in Holme v Brunskill itself) depend on the extent of the prejudice to the surety arising from the execution of the ancillary document.
Risk
B.  Hill & Redman’s Law of Landlord and Tenant (Butterworths) Division G Precedent L1 “Lease of Whole”.  Clause 2.3 states:-

2.3          References to this Lease are references to this Lease and any deed or document supplemental to this Lease

That is not quite as wide as the Encyclopaedia of Forms and Precedents example quoted above; again whether it is wide enough to overcome the rule in Holme v Brunskill is unclear (my own view is the same).  The guarantor’s obligations are tied to another definition “the Tenant’s Obligations” which means “the covenants conditions and other obligations on the part of the Tenant under this Lease” (my italics).  The actual obligations of the Guarantor are set out in Schedule 5, paragraph 5 of which states:-

The Guarantor shall not be released from liability and the Landlord shall be fully entitled to all of its rights notwithstanding:-

(a)  the giving of any time or indulgence by the Landlord to the Tenant; …
(e)  any variation of this Lease (so far as is permitted under the 1995 Act).”

This is on the face of it somewhat extreme but I am a little puzzled by the reference to “the 1995 Act” which is defined in Schedule 1 as meaning the Landlord and Tenant (Covenants) Act 1995.  I confess that I cannot see that the 1995 Act prohibits any particular kind of variation of lease; the editor’s will see this post and be free to comment.

C.  Ross Commercial Property Precedents (Butterworths) Division R, Precedent 1.  This is a slightly different kind of lease but the principles are the same.  Clause 1.25 defines “this Lease” in the following terms:-

unless expressly stated to the contrary, the expression “this Lease” includes any document supplemental to or collateral with this document or entered into in accordance with this document”.

I do not think that creates any different a result than what will be likely under examples A and B above.  The guarantor’s covenants are set out clause 6; the wording of the main covenant is fairly similar to those quoted above so I will not repeat it but (similar to the Hill & Redman precedent) in clause 6.1.2.1(b) the guarantor’s covenant applies notwithstanding:-

that the terms of this Lease may have been varied by agreement between the Landlord and the Tenant, [provided that no variation is to bind the Guarantor to the extent that it is materially prejudicial to him]”.

This is virtually identical to the wording in the example from the Encyclopaedia of Forms and Precedents at A above.

DespairSo far as (2) above is concerned (clearly deliberate attempts to extend the liability of the surety) the best example is a precedent published by the Practical Law Company; I am looking at precedent 84 “Lease of Whole with prescribed clauses” in PLC Property.  There is no extended definition of the “Lease” but the editors approach the matter in an entirely different way by including in the Schedule “Guarantee and Indemnity” an obligation in paragraph 3.1 on the part of the Guarantor to:-

join in and give its consent to the terms of any consent, approval, variation or other document that may be entered into by the Tenant in connection with this lease …”

and (in clause 3.2):-

The Guarantor shall not be released by any variation of the rents reserved by, or the Tenant covenants in, this Lease (or the Tenants in this Lease …whether or not

(a)             the variation is  material or prejudicial to the Guarantor, or
(b)             the variation is made in a document or
(c)             The Guarantor has consented, in writing or otherwise to the variation.”

This will (I submit) undoubtedly override the rule in Holme v Brunskill and to my mind (and with respect to the PLC editors) goes much too far.  I cannot believe that any competent legal practitioner would advise a potential guarantor to enter into a lease with these provisions without some variation on the lines of those in the Encyclopaedia of Forms and Precedents and Ross ensuring that the guarantor cannot be required to do anything which is to its material disadvantage.
Not negoatiable
In summary, Topland clearly shows that the rule in Holme v Brunskill is alive and kicking but it is, to my mind, potentially (and seriously) weakened by the manner in which modern leases tend to be drafted.  The lesson for any solicitor advising a guarantor (and a supplemental lesson is that no legal practitioner should be advising both the guarantor and the tenant) is that the lease provisions in relation to the guarantor’s liability should exclude liability occurring after a variation or change, to which the guarantor is not a party, in the terms of the lease (and this could include a licence) which materially increases the extent of the guarantor’s potential liability.

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