Landlord and tenant update (January 2002)

Citation

Dowden, M. (2002), "Landlord and tenant update (January 2002)", Journal of Property Investment & Finance, Vol. 20 No. 3. https://doi.org/10.1108/jpif.2002.11220cab.001

Landlord and tenant update (January 2002)

Landlord and tenant update (January 2002)

Malcolm Dowden

Nabarro Nathanson

Landlord covenants and the 1995 Act

2001 saw the first ruling on the landlord release provisions of the Landlord and Tenant (Covenants) Act 1995 (the "Act"). In BHP Petroleum Great Britain Ltd v. Chesterfield Properties Ltd [2001] 22 EG 155 Lightman J held that a release under section 6 does not apply to personal obligations undertaken by the former landlord. Consequently, a landlord who had given a personal warranty on building defects could not escape it on assignment of its reversion to an associated company. Although uncontroversial on its facts, the judgment has much wider implications. Covenants that are personal to one party only are common in landlord and tenant relationships and the rather startling effect of this judgment is to take such covenants outside the scheme of the 1995 Act and into the realms of common law.

The case arose from a 1997 agreement for lease in which Chesterfield undertook to make good defects and to repair physical damage to the property to be comprised in the lease. The burden of those obligations was expressed to be personal to Chesterfield Properties plc, although the benefit was to enure for the tenant's successors in title and could be assigned to each successive assignee of the lease.

The lease was granted to BHP on 1 July 1997. In the months following the grant of the lease the question of liability for defects in and for repairs to the toughened glass cladding became critical. Several of the units fractured and one fell, causing injury to a passer-by. In May 2000, a dangerous structure notice was issued in respect of the building.

On 9 July 1999 Chesterfield Properties plc transferred the reversion to an associated company, Chesterfield (Neathouse) Limited and, on 30 July 1999, served notice on BHP, pursuant to section 8 of the Act, seeking a release from "the landlord's obligations under the tenancy". Since BHP served no counternotice, Chesterfield considered that they had been released from all of their obligations under the agreement for lease. Chesterfield's argument depended on the view that its personal covenants were nonetheless "landlord covenants" for the purposes of the Act.

Lightman J rejected Chesterfield's argument. His judgment turned on the definitions contained in section 28(1) of the Act:

… "landlord" and "tenant", in relation to a tenancy, mean the person for the time being entitled to the reversion expectant on the term of the tenancy and the person so entitled to that term respectively.

… "landlord covenant", in relation to a tenancy, means a covenant falling to be complied with by the landlord of premises demised by the tenancy.

In the key passage of his judgment Lightman J stated that in order to fall within the definition of "landlord covenant" or "tenant covenant" an obligation:

… must be a covenant "falling to be complied with by the landlord of premises demised by the tenancy", and the landlord for this purpose means "the person for the time being entitled to the reversion expectant on the term of the tenancy". Focus, as it seems to me, must be placed on the words "for the time being". These words to my mind connote, not merely that the covenant falls to be complied with by the landlord at any particular point in time (as submitted by Mr Berry for [Chesterfield]), but that it falls to be complied with by the person who may from time to time be entitled to the reversion. It may be noted that a tenant covenant is likewise defined as a covenant falling to be complied by the person "so" (i.e. like the landlord in the case of the landlord covenant) for the time being entitled to the tenancy. In short the only covenant that can constitute a landlord or tenant covenant is a covenant which is capable of subsisting (in the language of section 3 of the Act) as a transmissible covenant and accordingly a personal covenant cannot qualify.

The Court of Appeal (Parker and Judge LJJ and Bodey J) agreed (30 November 2001, Neutral Citation No.[2001] EWCA Civ 1797). If an obligation is personal to a particular landlord then it does not fall to be complied with by the person "for the time being" entitled to the reversion and so it cannot be a "landlord covenant" as defined by section 28(1). Accordingly, Chesterfield remained bound.

In upholding Lightman J's reasoning, the Court of Appeal greatly clarified the operation and effect of the Act's provisions for the transmission and release of covenants. It was formerly considered that a covenant expressed to be personal to one party rather than to both might be transmissible in part (see, for example, Megarry and Wade, 2000, para 15-080). For example, where the burden of a covenant was expressed to be personal to the landlord, it was thought that the benefit of that covenant might nonetheless pass to assignees of the tenant by virtue of section 3 of the Act. However, BHP v. Chesterfield confirms that an obligation contained in a post-1995 lease, the burden of which is personal to one party, will fall outside the definitions of "landlord covenant" or "tenant covenant" so that the benefit of that covenant will not pass by virtue of the Act to a successor in title to the other party.

Since the transmission provisions of the Act will not apply, how can practitioners ensure that the benefit of a covenant, the burden of which is personal, will pass to successors in title?

Statute law provides no assistance. Section 30(4) of the Act disapplies from "new" tenancies (and not just from "landlord covenants" and "tenant covenants") sections 141 and 142 of the Law of Property Act 1925. The predecessors to those sections (dating back to the Grantees of Reversions Act 1540 (32 Hen 8 c.34)) were repealed as part of the 1925 overhaul of property legislation. Consequently, even though personal covenants do not fall within the transmission provisions of the Act, there is no other applicable statutory regime. It is, therefore, necessary to fall back on common law and, in particular, on the doctrine of privity of estate. While there is privity of estate between the holders of the reversion and of the term covenants that "touch and concern" the land bind those parties and are enforceable as between them.

Usefully, in System Floors v. Ruralpride [1995] 1 EGLR 48, the Court of Appeal confirmed that where the burden of a covenant is personal to one party it is nonetheless capable of being a covenant that "touches and concerns" the land so as to make the benefit run in favour of successors in title to the other party. In order to determine whether a covenant "touches and concerns" the land reference may be had to dicta of Bayley J in Mayor of Congleton v. Pattison (1808) 10 East 130 at 138 and to the more recent, "non-exhaustive" test laid down by Lord Oliver in P&A Swift Investments v. Combined English Stores Group Plc [1989] AC 632. If the covenant benefits an assignee in its capacity as tenant, then it ought to fall within the category of covenants enforceable while there is privity of estate.

However, practitioners may be reluctant to rely on the application of a doctrine that was always notoriously difficult to apply. Instead, express provision may be made to ensure that assignees take the benefit and are able to enforce covenants the burden of which is personal to the other party. Two principal methods are available:

1. 1.

   a clause confirming that the benefit of the covenant may be assigned to the next assignee of the lease; or

2. 2.

   a clause bringing into play the Contracts (Rights of Third Parties) Act 1999 under which the relevant covenant is made for the benefit of the original tenant and its assignees.

These methods ought to be available notwithstanding comments in Hansard and in textbooks (Hansard (HC), July 14 1995 Vol. 263 Col. 1241, cited in Megarry and Wade, 2000, para 15-079) to the effect that the Act provides a comprehensive code for transmitting the benefit (and burden) of covenants, in which the concept of privity of estate has no place. Those statements must be read as applying only to "landlord covenants" or "tenant covenants" as defined by section 28(1), since those are the only covenants to which the Act applies (Landlord and Tenant (Covenants) Act 1995 section 2(1)). Since covenants that are personal to one party fall outside those definitions it is highly unlikely that an express assignment would fall foul of the anti-avoidance provisions in section 25 of the Act.

Of the two, the Third Parties Act route may be the easier to manage. Where an express assignment is required the parties to an assignment of the lease must remember to complete the necessary document, and must comply with the requirements of section 136 of the Law of Property Act 1925. Where the Third Parties Act is employed no assignment is necessary. The benefit of the covenant is not passing – rather, the assignee enters into the class of those entitled to enforce it.

Apart from obligations contained in agreements for lease and relating to building works or to the remedying of defects, personal obligations are most likely to be found in collateral agreements or side letters to leases. Common examples include the personal obligation of a tenant to provide a rent deposit and to top up that deposit in the event that sums are withdrawn following a breach of covenant. Pre-1995 Act authority (Hua Chiao Commercial Bank Limited v. Chiaphua Industries Limited [1987] AC 99) suggest that these obligations do not "touch and concern" the land and so rent deposit deeds should make express provision in respect of the benefit of those obligations, or for the assignee and the tenant to enter into a fresh rent deposit deed, on any assignment of the reversion. Similarly, where side letters contain obligations or concessions that are personal to the original landlord, those letters ought to provide for the passing of benefit to assignees of the lease.

The statutory code introduced in 1995 sought to introduce a welcome simplicity into the transmission of landlord and tenant covenants. It is perhaps ironic that this code should have been interpreted by the courts in a manner that necessitates, in the case of personal covenants, an investigation into common-law concepts that the Act sought to replace. We can confidently expect to see this issue before the courts again.

Landlord's consent to assignment

In Ashworth Frazer v. Gloucester City Council [2001] UKHL 59 the House of Lords emphasised that whether a landlord's conduct in withholding consent to an assignment is unreasonable will be a question of fact in each case. Commenting on the large body of reported cases on the question of landlord's consent, Lord Bingham stressed that they are of illustrative value only. Each decision rests on its facts and care must be taken not to elevate a decision made on the facts of a particular case into a principle of law.

Leave was given to appeal to the House of Lords because the Court of Appeal had considered itself bound by Killick v. Second Covent Garden Property Co Limited [1973] 1 WLR 658 to rule that a proposed assignee's intention to use the premises in breach of the user covenant could not, of itself, justify withholding consent. Chadwick LJ had explained that so long as a landlord, in granting consent, reserved its right to enforce the user covenant in the lease, its legal position would be unaffected in that it could take steps to restrain any breach on the part of an assignee.

The House of Lords unanimously overruled Killick and reaffirmed that the duty of a landlord when withholding consent is to show that his conduct was reasonable. As Danckwerts LJ observed in Pimms Limited v. Tallow Chandlers Company, it is not necessary for landlords to prove that the conclusions which led them to refuse consent were justified, if they were conclusions which might be reached by a reasonable man in the circumstances. Applying this to the facts before him, Lord Rodger of Earlsferry concluded:

The central plank in the reasoning of the court in Killick seems to be that it would be unreasonable for the landlord to withhold consent because the assignment does not change the legal relationship between the landlord and the tenant. So the landlord would have exactly the same powers to prevent a breach of covenant by the assignee as by the existing tenant. The landlord would therefore be in the same position, neither better nor worse, to enforce the user covenant. As an analysis of the landlord's legal position that is undoubtedly correct. But the reality is that a reasonable landlord could well look at the matter more broadly and see that his position would be significantly altered by the assignment. It is one thing to have a tenant who complies with the user covenant in the lease and against whom there is no need to take steps to enforce the covenant. It is quite another to have a new tenant who does not comply with, or who challenges the interpretation of, the user covenant and against whom the landlord might need to take steps to enforce it or to contest the tenant's interpretation, with all the inconvenience and potential cost involved. It is also a different thing to have a new tenant who intends to apply to the Lands Tribunal under section 84 of the Law of Property Act 1925 to discharge or modify the user covenant. Again the landlord would face the prospect of becoming embroiled in legal proceedings. If they occurred, all or any of these matters would make a huge practical difference to the landlord. So the prospect that one or other of them will probably happen is one which a reasonable landlord must be entitled at least to take into account when asked to consent to the assignment of a lease. It is therefore in my view wholly unrealistic to suggest, as Killick does, that no reasonable landlord, faced with the probability of real changes of these kinds, would withhold consent to an assignment simply because, technically, his legal position and his legal remedies would remain the same.

However, Lord Rodger was at pains to point out the limited effect of overruling Killick. In particular, it does not establish any contrary rule of law that it will always be reasonable for a landlord to withhold consent to an assignment simply on the ground that the proposed assignee intends to use the premises in breach of a user covenant. While that will usually be a reasonable ground for withholding consent, there may be circumstances where refusal of consent on this ground alone would be unreasonable. It will depend on the circumstances of the particular case.

Practitioners should also bear in mind that the House of Lords ruling does not diminish the force of Chadwick LJ's comments where consent to an assignment is given. If the landlord has grounds to believe that the proposed assignee intends to use the premises for a purpose that will be in breach of the user covenant then, when giving consent, the landlord should reserve its rights to enforce that covenant in order to avoid disabling himself (by waiver, estoppel or otherwise) from so doing.

VAT – inducements; European court judgments in Mirror Group and Cantor FitzgeraldOn 9 October 2001 the European Court of Justice (ECJ) issued its judgments in two cases concerning the application of Article 13B(b) of sixth Council Directive (Directive 77/388), which exempts from VAT "the leasing or letting of immovable property". The cases concerned:

• •

  payments by a landlord to a tenant as an inducement to take a new lease, or an option on a new lease (C&E Commissioners v. Mirror Group PLC (Mirror Group [1998] VATDR 206 (VTD 15443); ECJ Case C-409/98)); and

• •

  payments by a current tenant to a prospective new tenant as an inducement to take an assignment of an existing lease (C&E Commissioners v. Cantor Fitzgerald International (Cantor Fitzgerald International [1997] VATDR 233 (VTD 15070; ECJ case C-108/99)).

Customs argued that these payments involved taxable supplies by the incoming tenant, so that VAT was due. The taxpayers said that the supplies were exempt by virtue of Article 13B(b), and in the light of C&E Commissioners v. Lubbock Fine (Lubbock Fine [1994] STC 101; [1993] ECR 1-6665; ECJ case C-63/92), in which the ECJ ruled that a tenant who surrendered a lease to its landlord in return for a payment by the landlord had made an exempt supply.

The court concluded that "leasing or letting of immovable property" by definition involves the landlord of property assigning to the tenant, in return for rent and for an agreed period, the right to occupy his property and to exclude other persons from it. Consequently, this exemption does not cover a supply of services made by a person who does not initially have any interest in the property and who, for example, accepts the grant or assignment of a lease in return for payment.

In Cantor the relevant supply was not by a tenant to landlord, but rather by a new tenant to an existing tenant. That supply was taxable and the decision may be taken as establishing that a payment made by an existing tenant to induce an assignee to take on its lease will always be standard rated.

In Mirror the decision was less clear cut. The ECJ said that a tenant who undertakes, in return for payment from the landlord, to become a tenant and to pay the rent does not, so far as that action is concerned, make a supply of services to the landlord. However, if the payment is for the tenant undertaking to transfer his business to the building, and the landlord considers that this will attract other tenants, then (surprisingly) the tenant could be seen as making a taxable supply of advertising services. Applying this element of the ECJ's ruling will involve an essentially subjective assessment of whether the presence of the particular tenant will attract others (i.e. whether it will be an "anchor tenant"). There will inevitably be cases in which the landlord will argue that there is no supply at all. For example, where the tenant is expanding rather than transferring its business, or where other tenants will not be attracted because it is a lease of whole or where there is no room for other tenants. In such cases it may be advisable to seek advance clearance from Customs & Excise.

The terms of the ECJ judgments appear to cast some doubt on the existing exemption for "reverse surrenders" (where a tenant pays his landlord to accept a surrender of the lease). The rationale underpinning the Mirror decision seems, reasonably enough, to be that a person receiving for an interest in property cannot be said to be granting an interest in that property. Consequently, the supply made by the person who receives a payment as an inducement to take an interest in property cannot fall within the exemption. This analysis runs counter to Schedule 9 of the VAT Act 1994, which applied the Lubbock Fine decision to reverse premiums as well as to those paid by landlord to tenant as consideration for the surrender, with the result that a premium, reverse or otherwise, is exempt unless the recipient has elected.

Implications

Payments to accept an assignment of a lease are clearly consideration for a taxable supply. Any outstanding dispute with Customs & Excise, or commercial arrangement (e.g. to hold potential VAT in escrow) made pending the outcome of this case, can probably now be settled and VAT on such transactions accounted for. In some of these cases, however, payments are characterised as a contribution to works which may be taxable as a supply of those works. This should not normally apply to a tenant's normal fitting out works, but care will need to be taken when drafting such arrangements. The borderlines are unclear, and it remains to be seen how Customs will react. But it will certainly be worth revisiting transactions completed within the last three years in the light of the ECJ judgments, and making a claim against Customs or (as appropriate) the other party to the transaction.

ReferenceMegarry, R. and Wade, W. (2000), The Law of Real Property, 6th ed., Sweet & Maxwell, London.