Collateral damage

The recent case of Crestfort Ltd & ors v Tesco Stores Ltd & anor (2005) will serve as a warning to tenants and undertenants that seek to enter into an underlease that is in breach of the alienation provisions of the headlease. In this case, as a result of the unlawful underletting by the tenant Tesco, the High Court granted an injunction ordering the surrender of the underlease and an inquiry into compensatory damages. This judgment appears to give landlords more strength in this area. But all may not be lost for tenants, as the case may have also reopened the door for the use of collateral agreements as a means of getting round restrictive provisions.

The facts

Crestfort owned the freehold of a warehouse and office building in Milton Keynes, which was let to Tesco. The alienation provisions of Tesco’s lease provided that Tesco was not to underlet “without the previous consent in writing of the landlord (which consent shall not be unreasonably withheld provided always that… any permitted underlease shall be granted subject to like covenants as are herein contained except as to the rent thereby reserved and the length of the term thereby granted)”. This is a common provision in most commercial leases and Section 1 of the Landlord and Tenant Act 1988 (LTA) regulates the means by which a Landlord may give or withhold consent.

Tesco’s application to underlet was refused on the basis that it was in breach of both its repairing and insuring obligations and, furthermore, the underlease was on different terms to the headlease. In particular the repairing obligations were more limited. In spite of this, Tesco entered into the underlease with Magspeed without consent. Tesco believed that Crestfort did not have an effective remedy against the underletting if it did not wish to forfeit the lease. However, Crestfort issued legal proceedings seeking an injunction requiring the surrender of the underlease and damages.

The decision

The High Court held that as Tesco granted an underlease that did not satisfy the preconditions imposed by the headlease in relation to the undertenant’s repairing obligations, this meant that Crestfort was not obliged to consider the application to underlet. Accordingly, the court dismissed Tesco’s counterclaim that Crestfort had unreasonably withheld consent.

The court granted an injunction requiring the underlease to be surrendered as Tesco was in breach of the covenant in the headlease and because the undertenant was liable in the tort of wrongful interference with contractual relations, as it had induced a breach of contract between Crestfort and Tesco. The undertenant knew that Tesco was committing a breach of its obligations by granting the underlease without the landlord’s consent and hence by entering into the underlease it intended to procure that breach.

While discussing the issue of damages, the judge commented on the effectiveness of collateral agreements as a means of getting round restrictive provisions in the headlease.

The changing view of collateral agreements

The earlier case of Allied Dunbar Assurance Plc v Homebase Ltd & anor (2002) held that collateral agreements between the tenant and subtenant were not effective. In the case, the landlord, Allied Dunbar, and the tenant, Homebase, agreed an underlease that complied with the terms of headlease. However, in reality, undertenant Lairdale was only prepared to pay a sum of rent that was less than what was required under the headlease. To overcome this, Homebase and Lairdale created a collateral deed, personal between them, stating that Homebase would refund the difference between the rent paid and the lower rent that Lairdale was willing to pay and would indemnify Lairdale against some repairing obligations.

Homebase argued that the collateral deed was personal to the tenant and undertenant and that the landlord had unreasonably withheld consent to the underletting under Section 1(3)(a) of the LTA 1988. This argument was dismissed by Lord Justice Chadwick, who held that the collateral deed was ineffective as it should be read in conjunction with the underlease, thereby varying its terms. As the head landlord may eventually become the direct landlord of the undertenant, the terms of the underlease in relation to rent and repairs were of the utmost importance.

A similar situation arose in Cresfort. Here, Tesco and proposed undertenant Magspeed contended that it was open to them to remedy the breach by varying the underlease to impose a full repairing obligation on Magspeed in accordance with the requirement in the headlease, but for a third party – another company within the Tesco group – to indemnify Magspeed for any repairing liability exceeding the more limited repairing obligations contained in the original underlease. Cresfort argued that such an indemnity should be read together with the underlease and, therefore, be held to be ineffective, as was decided in Allied Dunbar. However, it was held here that as the collateral agreement was between a subtenant and a third party, as opposed to the tenant, it was ‘totally different’ as it did not vary the terms of the underlease and would not weaken the repairing obligation if the head landlord became the direct landlord of the undertenant.

A practical solution?

This case should serve as a warning to tenants that seek to breach the alienation covenants of their leases in a similar fashion on the assumption that the only remedy open to the landlord is one of forfeiture. The ability to seek an injunction forcing the undertenant to surrender its lease to the tenant provides a landlord with a viable alternative to forfeiture and one that protects against any unwanted underlettings while maintaining the valuable rental income. On the other hand, the comments made in relation to collateral agreements have perhaps opened the door once again for their use, albeit in a modified form, as a means of sidestepping the restrictive covenants in the headlease where such agreements involve third parties rather than the tenant itself. This is particularly useful when tenants wish to sublet their over-rented properties at less than the passing rent, despite a prohibition against this in its lease.

Jay Bhandal and Laura-Jane Atkins are trainee solicitors at Maples Teesdale