Partner Article

Virtual Assignments Risk Forfeiture of Lease

With Watson Burton LLP Law Firm

In the current climate more and more tenants may be considering assigning their leases to release themselves from the burden of rent payments. However, landlords may be reluctant to grant consent to assignment if there is a risk that the assignee is not of good financial standing. As a result, tenants are increasingly considering entering into ‘virtual assignments’ if they believe that consent is unlikely to be obtained.

A ‘virtual assignment’ is an arrangement whereby all the economic benefits and burdens of a lease are transferred to a third party without an assignment of the leasehold or a change in the occupancy of the premises.

Companies have used virtual assignments when re-structuring or when they are dealing with a portfolio of transactions and there is no time to get consent from the landlord or consent is unlikely to be given. They are generally used where a lease contains covenants restricting or prohibiting assignments or underletting without the landlord’s consent. However, the general conclusion is that they are now ineffective following the 2009 case of Clarence House Limited v National Westminster Bank plc.

The case concerned National Westminster Bank plc (the tenant) and Clarence House Limited (the landlord). A lease of office premises was granted for 25 years and it contained various, standard restrictions against underletting and assigning the lease.

In 2005, RBS Group plc (NatWest’s parent company) entered into a master agreement with New Liberty Property Holdings Ltd and, following this, NatWest entered into a virtual assignment with New Liberty. NatWest also gave power of attorney to New Liberty to allow it to act on behalf of NatWest in relation to the property in accordance with the terms of the virtual assignment.

Clarence House Limited was not informed of this arrangement and it was not asked to grant consent to the assignment. As a result, it commenced proceedings, arguing that NatWest was in breach of the alienation provisions in its lease by entering into the virtual assignment.

NatWest strongly disputed the fact that it was in breach, arguing that the purpose of the virtual assignment was to transfer the economic benefits and burdens only and that the arrangement did not alter the relationship between the landlord and tenant.

The High Court held that there had been a breach of the covenant ‘not to share or part with possession or occupation’ and this would allow the landlord to forfeit or claim damages if it chose to do so.

The key concern for Clarence House Limited was that, following the virtual assignment, the rental income from the undertenant belonged beneficially to New Liberty and this could impact upon NatWest’s ability to pay the rent as tenant under the lease. Even if New Liberty were not in occupation of the premises, they were at least sharing possession and this was enough for Natwest to be in breach of the lease, regardless of whether Natwest actually retained some control over the property.

This decision is likely to be welcomed by landlords who will be concerned that a virtual assignment will evade certain aspects of the landlord and tenant relationship. Landlords have no control over the financial strength of a virtual assignee and any rent paid by an undertenant would also go to the virtual assignee. However, such concern should be tempered against the fact that the tenant will remain liable under the lease and if the tenant does not pay rent the landlord could then require the undertenant to pay rent directly to the landlord.

Commercial tenants should be wary if they are considering virtual assignments. This is a breach of common alienation provisions and the tenant will potentially be exposing itself to action by the landlord.

Some comfort could be drawn from the fact that, in the current climate, a landlord may not want to issue forfeiture proceedings and if a landlord is to claim damages it will have to demonstrate that it has suffered a loss, which may be difficult. However, following Clarence House Limited v National Westminster Bank plc case the general conclusion is that virtual assignments are ineffective and it may be necessary to go back to the formal process of assigning with consent from the Landlord. In light of this, if a tenant is still considering a virtual assignment, it would be advisable to seek legal advice on its options and the risks involved before going ahead.

If you have any queries relating to this article please contact Claire Pringle on 0191 244 4222 or e-mail claire.pringle@watsonburton.com.

This was posted in Bdaily's Members' News section by Ruth Mitchell .