In times of economic difficulty former tenants of buildings can often find themselves served with a notice relating to their old premises and being told that they remain liable for the rents and other tenant liabilities under the lease. They can even be threatened with legal action if they do not pay. This can come as quite a shock to former tenants that, in some cases, vacated a property over 20 years ago.
Over the past few months there has, not surprisingly, been an increase in landlords looking to former occupiers to settle rental liabilities where the current tenant has defaulted. However, there are several statutory provisions that afford some protection to former tenants so they may not be liable. This article summarises the rights and liabilities of former tenants and sets out some points for them to consider when faced with a demand for payment.
Legislation
The starting point is to look at whether there is any potential liability.
Generally speaking, former tenant liability can be separated into two categories depending on when the lease was granted:
- either before 1 January 1996 (an old lease); or
- after 1 January 1996 (a new lease).
If the former tenant was the original tenant of an old lease, it will remain liable for all sums and other liabilities due under the lease until the end of the term, even though the lease may have been assigned many years ago. This is due to the doctrine of privity of contract.
A former tenant of a new lease will not be bound by privity of contract. The tenant’s liability will have ceased upon assignment unless an authorised guarantee agreement (AGA) was entered into upon the disposal of its interest, in which case it will be liable for the default of its immediate successor.
In this article, unless otherwise stated, the position of former tenants is the same regardless of whether they have a new or old lease.
If there is liability what sums can be claimed?
Essentially, a landlord can claim any sum falling due under the lease from a former tenant that is liable. It is necessary to distinguish between fixed charges and unliquidated sums. Fixed charges are sums capable of definition or ascertainment in the lease: for example, the annual rent, service charge and insurance rents. Only fixed charges require the service by the landlord of a statutory notice as a prerequisite to a former tenant being liable to pay. However, what about sums that are unquantified, such as damages for the tenant’s failure to keep the property in repair, particularly at the end of the term? Generally, these sums will fall within the category of unliquidated charges, although there may be exceptions. As such, they are also capable of being demanded from the former tenant, although the time limits imposed by the Landlord and Tenant (Covenants) Act 1995 (the 1995 Act) (see below) do not apply.
Factors limiting liability
Timing
Former tenant liability for fixed charges only crystallises on the service of a notice under s17 of the 1995 Act. If no notice is served, there is no liability.
It is important to remember that a landlord looking to a former tenant to settle any fixed charges must serve the requisite notice. Simply demanding rents under the lease or the AGA is not sufficient. Any payment of a fixed charge without service of a valid section 17 notice would be voluntary and could cause problems if a former tenant in turn needs to claim under an indemnity that it obtained from its assignee.
A section 17 notice can only cover fixed charges that have fallen due in the six months preceding service of the notice. Any fixed charges that have fallen due over six months prior to the service of the notice are out of time and a former tenant’s liability will have ceased in this respect. It was during the last recession in the early 1990s, such was the outcry from former tenants who suddenly found themselves liable for interests they had forgotten about, that the government introduced this limitation.
Over the past few years there has been confusion over the status of rent review ‘top-ups’, ie the backdated additional reviewed rent due once a rent review is agreed. The courts originally decided that a notice had to be served every quarter to ensure that money was capable of demand under s17. The case went to the House of Lords, where it was decided that the backdated rental uplift payable on the finalisation of a rent review only falls due when the reviewed rent is determined and so a section 17 notice only needs to be served then and not before.
It is therefore important to check the amounts demanded under a notice. A notice may cover a variety of sums due under the terms of the lease, not just the yearly rent but also insurance rents, service charges and possibly interest. Each item mentioned in the notice needs to be checked to make sure it has been demanded within the six-month time limit. While the yearly rent and service charge is payable on quarter days, insurance rents are often payable on demand annually once the landlord has paid the premium.
Variations
An original tenant of an old lease has agreed to be bound by the covenants for the duration of the term granted. Where a covenant is varied by subsequent agreement between successors in title, the former tenant will not be liable for any increase in liability as a result of the variation to which they did not agree. Depending on the wording of the AGA the same may apply to former tenants of new leases.
This does not usually include rent reviews. The rationale for this is that the former tenant agreed to a mechanism providing for an increase in the rent during the term. The former tenant has agreed in advance to an increase in rent. Therefore, providing that any subsequent rent reviews adhere to the rent review mechanism prescribed in the lease, the former tenant will be bound by such an increase in rent. If, however, a rent review is agreed outside the rent review mechanism prescribed, it is possible that any increase in liability cannot be demanded from the former tenant as the increased liability is derived from an agreement to which the former tenant has not agreed.
An example of this is where subsequent parties to the lease have agreed to change the open-market rent review to fixed or index-linked increases. If a former tenant has not given their agreement to such a change, they may not be liable for any increased amount arising from the variation.
Before making any payment under a demand from the landlord, copies of all the current lease documentation should be obtained so that any variations can be ascertained.
Overriding lease
Once the full payment has been made of fixed charges demanded under a section 17 notice, a former tenant has the right to call for an overriding lease. This is a lease that slots in between the landlord and defaulting tenant’s interest. This allows the former tenant to gain some control over the leasehold structure so it can attempt to mitigate its losses. It can take action against the defaulting tenant and can ultimately terminate the lease by forfeiture. This would then allow the former tenant to relet the premises or even occupy them if it so wished. Before exercising the right to an overriding lease, the full consequences should be considered. Whereas, as a former tenant, its liability is contingent – that is, it doesn’t crystallise until the landlord gives a section 17 notice – as overriding leasee, the former tenant will have a primary liability to pay the rent to the landlord each quarter regardless of whether it has been demanded by the landlord and also to comply with all the other lease covenants (eg pay rates).
If the option to call for an overriding lease is exercised, the 1995 Act requires the former tenant to reimburse the landlord for the reasonable legal fees they have incurred in drafting the lease, in addition to covering its own costs. Further, as an overriding lease is the grant of a new interest in land, it will attract a liability to pay stamp duty land tax (SDLT). The amount payable will depend upon the length of the lease term. If a former tenant’s main priority is gaining control, an alternative means of securing this is to take an assignment from the defaulting tenant. Although, if the tenant is insolvent, there may be difficulties in persuading the insolvency practitioner to assign (ie a premium might be demanded). No SDLT will be payable and while the former tenant may be liable for the landlord’s costs in granting a licence to assign, these should not be as great as those incurred in granting a new (overriding) lease.
An overriding lease is granted on the same terms as the lease in place at that time. This will include any variations made after the original grant of the lease. Variations may have been made after the former tenant disposed of its interest and these may increase liability for which the former tenant is not liable pursuant to s17. By accepting an overriding lease, the former tenant will be taking a lease with the increased liability. The term of the overriding lease will be for the remainder of the term granted, less a few days to prevent it from being deemed an assignment.
If the original lease was an old lease then the overriding lease will also be treated as an old lease, meaning that the original tenant liability will continue to apply. If the overriding lease were later assigned then the former tenant would still remain on the hook.
It is worth noting that, in the current economic climate, the availability of new undertenants may be limited. Therefore former tenants are also questioning whether an overriding lease constitutes mitigation of their losses at all, due to the potential increase in costs and liability it can represent.
Indemnity
On any assignment a former tenant should have obtained an indemnity from the assignee so if a former tenant is required to make a payment to a landlord it should look to see whether it has any potential recourse under any indemnity in its favour.
Summary
While there is a risk of potential liability for former tenants, it is important to question any demands received from former landlords. Just because a notice is served demanding money, this does not mean all sums are necessarily payable. It is important for former tenants to check each sum against the leasehold documentation and to ascertain the extent of their liability. In the future, former tenants may be forced to reassess which option represents more efficient mitigation of loss. While at first it may seem unpalatable for a former tenant to be on the hook for the remainder of a lease term, this may in fact be preferable to the increased burden of accepting an overriding lease, with its ancillary costs of marketing and letting the property. All these factors should be taken into account when a former tenant is confronted with the shock of a long-forgotten liability.
By Danielle Drummond-Brassington, senior solicitor, CMS Cameron McKenna LLP.
E-mail: danielle.drummond-brassington@cms-cmck.com.
- What is my liability: original tenant or AGA?
- If under an AGA am I still bound?
- What sums have been demanded?
- When did they fall due?
- Has the notice been served on time?
- Have there been any variations to the lease?
