Limiting Landlords' Liability - International Law Office

On December 1 2005 the House of Lords gave its judgment in London Diocesan Fund v Avonridge Property Company Ltd; the decision has significant implications for the scope of the Landlord and Tenant (Covenants) Act 1995.

Facts

In February 2002 Avonridge bought a long lease of seven small shop units. Avonridge made a profit of around £200,000 by granting subleases of six of the shops for around £75,000 each. The subleases were for nominal rents and for substantially the same term as the headlease.

The headlease contained a landlord's covenant to pay the rent reserved by the headlease, but not after Avonridge had disposed of its interest in the property. Having granted the subleases, Avonridge assigned the headlease to a third party, which granted a seventh underlease at a premium and then absconded; the rents due under the headlease were left unpaid.

The head lessor commenced forfeiture proceedings and the subtenants were granted relief. However, as a term of relief, the subtenants were required to pay the rent arrears under the headlease and take new leases of their individual units. The new leases required that the subtenants pay annual rent based on a proportion of the rent that would have fallen due under the headlease. This put them in a markedly worse position than under their previous subleases, which had reserved only the nominal rent, the value having been given in the form of the premium paid for the grant of the sublease.

The subtenants pursued Avonridge for breach of the landlord's covenant to pay the rent under the headlease. Avonridge was held liable for this failure by the court of first instance and the Court of Appeal on the grounds that, as the original landlord, it was bound by privity of contract. Avonridge remained liable for payment of rent after it had disposed of its interest; the exclusion with which it had sought to limit its liability to the period for which it held the headlease was void under the anti-avoidance provisions in Section 25 of the act.

House of Lords Decision

Despite its acknowledgement at the outset that Avonridge's case was "not overburdened with merit", the House of Lords held that, as a result of the limitation in the covenant to pay the headlease rent, Avonridge was not liable for non-payment after it had disposed of its interest in the property.

Landlords' Liability

The act was introduced in order to address practical issues arising from the doctrine of privity of contract, whereby a tenant which has at any time given a landlord a contractual covenant under a lease remains liable for a later breach on the basis of that contractual promise, even if such a breach occurs after the tenant has assigned its interest in the lease to a third party. Before the introduction of the act, this resulted in many tenants being held liable for large claims for dilapidations or substantial rent arrears long after they believed that they had ended their connection to a property. The act provides that a tenant is not liable under the tenant covenants in a lease beyond the duration of the tenancy. Liability ends upon lawful assignment, except in certain limited circumstances.

However, the act does not limit the landlord's liability in the same way. Landlords remain potentially liable under the doctrine of privity of contract unless they apply under the act to the tenant to be released from the landlord covenants. If the tenant refuses to release the landlord, the landlord is entitled to apply to the court, which will release the landlord only if it considers it reasonable to do so. The different treatment of landlord and tenant is held to be justified by the fact that, whereas landlords are usually able to object to a proposed assignment, tenants are rarely given the right to object to a landlord disposing of its interest. It is impossible to 'contract out' of the act: Section 25 states that an agreement relating to a tenancy that has the "effect to exclude, modify or otherwise frustrate the operation of any provision of this act" will be void.

It might appear that a provision which allows a landlord to limit its liability under the terms of the lease to the period for which it remains landlord excludes or modifies the operation of provisions in the act. It renders completely unnecessary the statutory provisions in relation to the landlord's ability to apply for a release of its liability. However, the House of Lords took a different view and examined the purpose of the legislation. It considered that the act had been introduced solely in order to mitigate the harshness of the privity doctrine. Before its introduction, there had been nothing to prevent parties agreeing by contract that a liability, whether of the landlord or tenant, would persist only for the time that the party in question had an interest in the lease. The act was not intended to remove this pre-existing right, but rather to limit the rights of landlords - and, in certain cases, tenants - to call on parties with no interest in a lease to answer for breaches of covenant committed by their successors in title. Looked at in this way, the limitation in this case was in line with the purpose of the act.

Comment

The implications of this case may depend on the strength of the market at any given time. Landlords may well wish to enter negotiations to limit their liability to the period for which they remain landlord. In a tenant's market, tenants will probably seek to reject this, or require a corresponding provision that the landlord shall not assign its interest without the tenant's consent. However, where tenants do not have the bargaining power to do this, the clause will remain.

For further information on this topic please contact Laura Cram at Ashurst by telephone (+44 20 7638 1111) or by fax (+44 20 7638 1112) or by email (laura.cram@ashurst.com).