Legal Updates

Property Law – Underlease – Enforceability of Terms

The case of Prudential Assurance Co Ltd v. Ayers and Another [2007], concerned a tenant who took an assignment of an underlease and entered into a deed with the immediate landlord. The deed contained a clause limiting the tenant's liability under the underlease to claims against previous tenants, as well as against the current tenant.

The Contracts (Rights of Third Parties) Act 1999 (“the Act”) provides, so far as relevant:

“1(1) Subject to the provisions of this Act, a person who is not a party to a contract (a “third party”) may in his own right enforce a term of the contract if:

(a) The contract expressly provides that he may, or

(b) Subject to subsection (2), the term purports to confer a benefit on him…

(2) Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party…

(3) The third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into… “

The claimant company (“the Company”) was the lessee of a large office space located in the City of London. The defendants were the original underlessees of the premises, until 2001, when they were replaced by a US law firm, A & G. The Company agreed to the assignment by the defendants to A & G, and A & G made a covenant with the Company to pay the rent:

“In the manner and at the respective times appointed for payment thereof and will perform and observe all the covenants on the part of the lessee and the covenants and provisions contained in the Underlease”.

In accordance with clause 6, the defendants covenanted with and guaranteed to the Company that if A & G made default in payment of the rents payable under the underlease, before any further lawful assignment of the underlease, then the defendants would pay the rents notwithstanding any time or indulgence granted by the Company to A & G, or any neglect of the Prudential or any variation in the terms of the underlease.

On the 21st of June 2001, a supplemental deed was entered into only between the Company and A & G, expressed to be supplemental to the underlease (“the Deed”). Clause 2.1 of the Deed provided for the following:

“The liability of the Tenant under the Lease and all documents ancillary to or supplemental to the Lease and the liability of the Tenant under any authorised guarantee agreement given in connection with any assignment of the Lease shall be limited to the Partnership (including, but not limited to all its assets, income and accounts) and such liability shall not extend to the personal assets of individual partners (present, past or future) therein. Consequently any recovery by the Landlord against the Tenant or any previous tenant under the Lease for any such default shall be limited to assets of the Partnership and shall not extend to the personal assets of any individual partners therein other than the capital and current accounts of such partners in the Partnership. Further, no partner (present, past or future) of the Tenant shall be required by the Landlord at any time to loan or contribute personal money or property to the Tenant to enable it to discharge any obligation owed to the Landlord”.

A & G subsequently found themselves in financial difficulty and became bankrupt in both the US and the UK. At that point they left a debt of around £1.5 million owed due to unpaid obligations under the underlease. The Company therefore looked to recover the money from the defendants, as they were A & G’s guarantors.

The defendants argued that the effect of clause 2 (in terms of what had occurred) was wholly for them to escape liability as guarantor. The issue to be determined by the court was whether the defendants, who were not party to the Deed, could take advantage of the limitation of recovery against them, which in turn depended upon whether the provision in clause 2.1 of the Deed, which sought to restrict recoverability against 'any previous tenant', was a term which purported 'to confer a benefit on' the previous tenants within the meaning of s.1(1)(b) of the Act (as outlined above).

The court held that:

§   Section 1(1)(b) of the Act was satisfied if it had the effect of conferring a benefit on the third party in question. There was no requirement within s.1(1)(b) that the benefit on the third party should be the predominant purpose behind the term or that it denied the applicability of s.1(1)(b) if a benefit was conferred on someone other than the third party. It was found that the Act had no such additional requirement.

§   The term or provision in question was clause 2.1, namely that recovery by the Company against 'any previous tenant … shall be limited to assets of the Partnership'. It would not ordinarily be expected that recovery against A would be against assets other than those belonging to A, but the sense was sufficiently clear, namely, that whilst the Company was fully entitled to recover in respect of the full reserved rent from partnership assets, it had been entitled to nothing more than that which had been derived from those assets, either from the defendants or from 'any previous tenant'. To that extent, where the previous tenant was a guarantor, the sense of clause 2.1 manifestly conferred a benefit of a cap as to recoverability on the previous tenant.

As a result, the defendants, as previous tenants, were entitled to enforce the provisions of clause 2.1 against the Company.

Please contact us for more information on assessing damages due under termination of a contract at  enquiries@rtcoopers.com

© RT COOPERS, 2007. This Briefing Note does not provide a comprehensive or complete statement of the law relating to the issues discussed nor does it constitute legal advice. It is intended only to highlight general issues. Specialist legal advice should always be sought in relation to particular circumstances.

 

 

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